woodstove

What about the "something goes terribly wrong" scenario? Some (unlikely) script ideas... - Litigation like another "asbestos", eg shareholders become able to recover lost equity via directors & officers insurance, or any company that ever insured a soft drink manufacturer becomes liable for health impairment due to discoveries re hazards of BPA or whatever. - Targets of FFH lawsuit win, obtain punitive counter-judgement. Possibly with collusion of legislature, etc - assume the worst imaginable. - Insurance industry ranks are so thinned by collapse of insurers who placed capital at risk in foolish ways (a la AIG), that the rest of firms are forced to assume those liabilities - something like present process of good banks (and taxpayers) being strip mined to support bad banks. I have no case that any of the above is probable - maybe each is only 1 pct annual possibility, ie 1-in-100 years event? But it seems to me that there is some merit in diversification outside of a single industry and single firm in that industry. So maybe if there are five 100-year-event scenarios that might be developed, the returns table should include a 5 pct worst case of complete wipeout. Then can factor that into weighted expected return, and also into decision re what proportion of capital to allocate.

Thanks

Logorrhea

Crip, I think I read something a while back mid-2008 or maybe even earlier, about AIG getting an exemption from partitioning of reserves, essentially allowing them to use huge amount of reserves ($60b comes to mind) of insurance operations to support increased capital requirements of non-insurance ops. I'm not a follower of AIG and may be all wrong, but that was impression I got from general news. I've just got a problem with bad operations, which has to include AIG at top level where insurance and non-insurance operational units are both overseen, tainting good ones - both within AIG, and keeping good operations with other management groups from replacing bad ones. Would have made a lot more sense, eg with banks, to have put huge capital into the best banks so they could expand lending to fill in for the worst banks having reduced lending capacity.

Yeah, supporting AIG contracts supports the rest of system - cannot just shut down AIG for old stuff. But why are they being allowed to write new business? What rational manager in customer organization, can satisfy "prudent man" rule if relies on AIG as counterparty going forward? Should be in runoff already. Let Berkshire and other insurers who didn't kill their company with derivatives liabilities, grow their business. AIG 'investment' for world financial system is case of watering the weeds instead of the crops/flowers.

I like the three categories - Berk, Fairfax, General Disc - very much. It makes for very clean navigation eg when looking for discussion of recent annual results of Berk or Fairfax. One thing I would like as an enhancement, if possible, is some flag within a topic, saying which of the replies are new. I know ... if memory is good then don't need reminder that have read a reply already, and if memory is bad then should re-read the replies not previously seen.

"operationally Berkshire did not have a bad year in 2008" ... right on! And I think the "confessed unforced errors" aspect is overstated. It may be helpful for Buffett to think in those terms, and may be helpful protective colouration, but seen by a passive spectator, it looks more like Conoco was a trend-following hedge run out to end of trend, and Irish banks was a soundly conceived contrarian bet. Some of Buffett's macro trend following, eg currencies or oil & gas pricing, seem to involve being right initially - because of the discrepancy of price from value, plus pressures on price, are so strong - and then putting about half of profits back into following position re same trend. So Conoco can be seen as trend following begun with PetroChina, for instance. Or, if you prefer, think of it as a hedge against possibility that oil and gas prices would keep going up extraordinarily, and cause distress to other Berkshire enterprises. In either case, not a bad move seen in context. The Irish banks - completely outside my scope - but Buffett likely had sound analytical reasons for making the investments, and it probably depended on a binary decision of Irish bank regulators / government. Part of Berkshire's basket of financials, not bad investing strategy if some go down - like insurance writing. Maybe more problematic, but not yet clarified re loss ratio, is municipal bond insurance. Buffett's letter describes increasing premium and also projects a potential risk due to cultural shift in propensity to default, sticking far-away insurer with municipal debt default costs. It is still to be seen to what extent that risk might materialize. I'm sure Berkshire's people are very aware of the considerations though and do not really personally anticipate there will be material loss even if default rates in general population of municipal issuers gets severe.

Ok thanks that clarifies it. I'm still confused by lots of things though. Let me just set them out, and any further clarification is most welcome! Apr 18/08 mgmt info circular says Fairfax+subs held 17,443,300 units being 19+ pct of o/s units. Fairfax's early warning report says they held 12,745,200 units plus $6.0m conv debs (=1,250,000 units if conv at 4.80). Apr 18/08 mgmt info circ says Cundhill (via Mackenzie) held 17,228,400 units. Mackenzie's most recent early warning report says they now hold only 10,404,400 units being 11.5 pct of o/s units. So I'm not sure how those two sets of info reconcile. Are the two significant shareholders you refer to, Fairfax and Cundhill/Mackenzie? Or is there some other significant investor, ie with a large enough position or interest to be a participant in recapitalizing the company? About positions greater than 20 pct, was there not an offer by Third Avenue for some less-than-full more-than-20 position in Catalyst Paper? I'm not convinced that an offer for control position has to be for all shares. Brookfield backstopped a rights offering by Norbord, and as a result of NBD selling off before conclusion of the offer, Brookfield's fractional interest in Norbord went to 75 pct as there were few other exercisers on the rights offering. At present, Taiga Building Products has a rights offering at 14c, initiated when stock was trading 22c+, and it is being backstopped by the two parties who already hold 40pct and 20pct of the common, each party willing to exercise rights not taken up by others, so long as they do not either one end up with 50 pct of the company. I guess the point you are making is that such arrangements (rights offerings) require cooperation of company's board of directors etc. Considering SFK as a business, EDITDA down from $60m to $32m might put some stress on financial convenants, I suppose - though I've not attempted the calculations. I'm imagining there will be enough cash freed up via sale of excess inventory to be able to retire the $25m revolving credit in 2010, but certainly agree that it would be desirable to reduce fixed costs for long term debt and conv debs. The $15m-17m capex of 2007 and 2008 seems reasonable going forward, for maintenance (including some unplanned surprise breakdowns) and modest improvements of production assets. For 2009 planned capex of $10m seems affordable within the scope of the $32m projected EBITDA, allowing rest of cash flow to just about exactly cover 2009 financial costs. It would certainly be a good thing (Martha Stewart?) to get SFK's financial structure more "usual", eg 70 pct covered by common, 10 pct covered by preferred, 20 pct covered by debt. There is a high value attributed to the fixed assets (production facilities), which is being depreciated about $40m/yr whereas it requires maybe $16m/year for upkeep. Is the value of the fixed assets real? Perhaps it is ... very expensive to rebuild, I imagine. But that must be another consideration raising some uncertainty in mind of credit analysts. One further question, about natgas pricing effects on SFK. Have you looked into that? With natgas futures so low, I imagine it might be possible to lock in 2010 and later costs beneficially. Or, as an alternative, I wonder if there is merit is using biomass (excess inventory of wood chips, waste paper, or even pulp?) as fuel - Norbord did a nice conversion from natgas to biomass at one of their Texas plants. Looking forward to your reply/perspective!

An interesting bit is the dilution calculation in note 10 of the Dec/08 financial stmts. Instead of just saying the conv debs are anti-dilutive the calc of dilution assumes conversion price of 1.18 = weighted average trading price of units during 2008. So yeah I think the conv debs are being considered for conversion or repricing/replacement by another security. What's your mention of problem re current securities laws about? Are you referring to limitations on income trusts raising capital?

what about a rights issue to raise additional capital?

Re Jesse Livermore's "How to Trade in Stocks" (1940), that has been reprinted by Traders Press Inc, PO Box 6206, Greenville, SC 29606. The isbn is 0-934380-75-9. They have a website, I think, but I've not got the url handy. You could also search for Richard Smitten, who added some extra material to the book, copyright 2001.

My favourite part is the acknowledgement of Joe Brandon. Other interesting aspects... - Traded COP. Not usual buy & hold. - Sold some quality high-price/value holdings to finance purchase of others lower-price/value. - Problem of govt backed financing competing unfairly with Berkshire financing of Clayton eg. On the other hand, may be short term problem. During Japan's great recession, companies like Hitachi and Sony were able to issue long term bonds at say 1.5 pct. Making money, well run, what's not to like?

Great discussion! I know zip about underwriting. Paying something for float (2.5 pct) seems decent given probable investment returns. And there is utility in adjusting for fluctuations, to see whether normal operations (under unit managers control) are prudent, well run etc. What would be the impact of say a 1 pct increase in premiums, for same amount of risk? Would cause some loss of business, ie float. Is it more investment income loss than premium gain? That seems to me the sort of tradeoff which might be considered at high level. Maybe given an excess of cash at holding company, it would be a reasonable tradeoff - ie, look not at overall rate of investment return, but the marginal rate of return. What would happen if Fairfax priced for a really hard market, say 20 pct increase in premiums for same amount of risk coverage? Capital is scarce, AIG and KFS are impaired, cat bonds and alternatives to normal insurers are probably not considered prudent insurance purchases and might cost someone his job. Why should Fairfax be generous with making its capital available to insurees given 15 pct returns in other sorts of investments? It would be an interesting marketing test. Probably is considered routinely by unit managers via normal operations. Not second guessing. I trust the guys doing the work. Just interested in understanding how the various parts fit together and move.

The market value of my house (owned a long time) is less than what it would cost to rebuild. So my land value is negative, I guess. For some strange reason, my neighbour does not agree with my arithmetic, and refuses to accept my offer of $1.00 for his land. Even though the calculation shows he would be the net gainer on the transaction. Perhaps we can set up a derivative to value everything properly. He can then take the profit into his annual bonus.

ok, right, I see ... so the investment enhances capital ratios. Thanks for the explanation.

I apologize to the board for throwing fuel onto a "personalities" topic. Will refrain in future.

The preferred shares are non-cumulative? Not a very comfortable feeling. Would the bank have been able to issue a cumulative preferred and pay a lower interest spread? Or is there some tradition in bank preferreds that a non-cumulative conforms with? Just curious. Not knowledgable about either banks or preferred share investing.

Nice article, Sanjeev - thanks! She sounds like a fine person, and I'm sure she will have a happy life ... so sure, there is more story, she's young. One cannot but be struck by the similarily between her artistic methodology, leaving a painting exposed to the outdoors to see how it develops, and her life circumstances. On a slightly related note, about-chemistry (chemistry.about.com) has an interesting article about doing chromatography in chalk sticks. Tried it last night and got some interesting looking chalk colourations. Might be an enjoyable activity for others who like to tinker around.

About Ben Graham - he was always open to new ideas, re-formulating his methods. In later years, eg Intelligent Investor, he advocated keeping 25-75 pct of stocks+bonds investments in bonds, shifting towards 75 pct bonds when stock market seemed pricey. So I think, had Ben Graham been going into mid-2007 and following his own advice, he would have been 75 pct bonds, only 25 pct stocks. He probably would have come thru mid-2007 to the present pretty well. My point ... if we want to know what works, what might work in present circumstances, consider re-read of Ben Graham looking for clues to what he learned from his experiences in the 1930's. One thing that stands out is the companies he uses as examples often have no debt. Taking on major debt is pretty much a phenomenon of the 1990's. It really shows up in the S&P 500, mid-cap 400, small-cap 600 guides I have from 2001, which have 1990-1999 financial tallies. That debt has to be worked down, before there is a level of comfort restored. Even converts. SFK Pulp was brought up as an example. That the debentures convert well above 50c level is surely not a guarantee against dilution, re-negotiation. Consider what Brookfield did with Norbord. Ran the company with minimal working capital, no reserves, dividending out all "spare" cash so there was no cushion. Then, in depths (thus far) of outlook, offered financing and backstopped new equity issue at price (86c? that area) which was well above market (60-65c?), ending up with about 75 pct of the common.

A book by Alice Schroeder on Buffett's investment style would be very interesting. The attraction of Snowball, pre-publication, for me, was Schroeder as author, as the person who wrote that brokerage report on Berkshire about 9 years ago. Snowball turned out not to be the investment oriented book I was anticipating, but it's perfectly fine as a biography.