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Another good firm to look at is AWH. The only reason I could see (beyond Mr. Market), Aspen and Allied World are trading at a 30% disc to book is they both have about $1 b in Non-agency RMBS, CMBS and ABS (about 30% of their BV) but so does HCC. Go figure? Packer

I believe you thesis is dependent upon continued growth of these firms and reasonable starting valuations. As Sanjeev has pointed out the starting valuations were anything but conservative. For KO, the FCFx is still 20 despite years of sideways growth. Given the size of these firms, future growth will be harder to come by. Even looking @ BRK (probably the best run firm), its growth has declined to about 8% per year (over the past 5 to 10yrs) from 20% plus in the past. The only firm on the list that I think has a sustainable growth rate is JNJ but even then the challenges are large. Interestingly enough, I still see value in small and mid-cap names from a bottom's-up perspective (FCFx of 2.5 to 6) versus some of these large names where FCFxs are still above 10. Packer

I agree the competitors have an incentive to bad mouth AIG but given their backgrounds, I would have a tendency to beileve folks who have a long history in the industry of providing excellent return versus new guys who have an OK record in related businesses but not P&C. MetLife has had average performance and Gulob has done good at American Express but insurance was a small part of his business. I don't know how the rest of the 10 or so executives who have no insurance experience help AIG. In addition, I would adjust pre-2008 numbers for the increased losses in the reserve tri-angle to find out the real RoA. The stated numbers are estimates and historically the estimates have been overly aggresive. I am not invested in AIG so I don't have a horse in this race but thought I would mention so red flags that would filter them out of my circle of competance. They may do OK but I just can't see how they will overcome these issues other than hope and external events that I cannot predict. Packer

When a good underwriter like Berkley says that a competitor is underpricing premiums compared to what they would do to get an underwriting profit, I have a tendency to believe the disciplined underwriter versus the government-back entity. These markets are not rocket science to underwrite, the uncertainties are well known and if everyone who is good underwriter is letting cheap business go and AIG is not, then I think AIG is the patsy. In addition, if you look at the reserve triangle for the 2009 year alone, AIG underreserved by over $2 billion and rest of the history looks equally as bad. So unless AIG has turned on a dime, the problems may still be there. Also, using FCF for a measure of strength is dangerous as every thing is dependent upon the underwriting assumptions. If the going forward assumptions are the same as in the past the $2.2 billion can disappear pretty quick. In addition, revenue has declined with a 122% combined ratio and questionable reserving would lead me to believe there is more trouble than opportunity here. I was also surprised in looking at management in the proxy statement. Not one P&C person on the board and alot of ex-folks who got burned in the financial crisis and folks from totally unrelated businesses (airlines, auto parts, IT services, retail, aerospace, media (?)). How do these folks know how to lead a complex insurance company? What am I missing??? Packer

I agree but given how in hock AIG is, it appears that Berkowitz' IV may require some gov't generosity. You can read Eisman's thesis on the web but it appears sound. It looks there are multiple was to lose (bankruptcy & dilution) and one to win. If AIG was in such good shape, and we know there is a "soft" market, then why is it discounting premiums? Packer

It appears Steve Eisman is short AIG. He appears to be one of the few guys that understood the subprime crisis (according to the big short). He blew away Bill Miller with Bear Stearns and says AIG is either worth 0 or will be diluted down to about 7 when all the gov't dilution takes place. Their aggressive pricing plays into this narrative. With gov't backing they will write policies to keep the lights on. Packer

Another nice aspect of HCC is they have a 5% cost advantage (expense ratio in the 25% range) versus the competitors. This is one indication of a sustainable advantage. Packer

The contracts are negotiated every 3 years so there is some re-pricing risk if the costs go up. However, given the commodity nature of the tasks, I think the inflation risk is small. This is consistent with my overall assessment of low inflation given the high value added components (i.e. labor) are in surplus. Packer

SSW has fixed charter rates but also fixed costs provided by the manager. The manager has an incentive fee based upon the dividend paid. So for the $3.00 FCF if 90% is paid out the dividend would be $2.70 pre-incentive and $2.57 post incentive fee. See their 20-F for details. In essence this is a shipping triple-net lease operation. Packer

Another possible scenario is modest inflation with high real interest rates once the gov't stops supporting the market. The assets that will continue to decline in value are of two types: 1) sectors financed by gov't subsidies (education, housing) and 2) highly competitive/commodity fields (energy, technology). With high real rates, I think debt may still crush some firms and in the sectors mentioned above it could be deadly. I still see many firms with alot of debt that I think will restructure when even with the recovery they will not be able to start reducing principle with free cash flow. I agree stocks are priced better than bonds on the whole but I think you need to be do bottoms up analysis to make the real interpretation. Right now there are some income-type investments who have delay/deferred dividend payments that are great deals like SSW. An about in $3.00 in FCF once all the ships are delivered and cash flowing with LT fixed contracts. Right not its sells for just over $10. Packer

The cost of debt is below the WACC. I am just reducing the debt to a conservative level under the assumption the FCF is not really the equity holders until they reduce the principle to the point where they can distribute the FCF without the say of the debt holders. The conservative level is the level they could easily re-finance even under difficult economic circumstances. Packer

I have been trying to develop an adjustment to FCF for higher levels of debt. I would like to hear how others deal with leveraged firms and comments on this adjustment methodology. The method is to estimate the time it will take the firm to reduce its leverage to 3.0x EBITDA (a typical benchmark for Templeton) using FCF. Develop a discount factor for FCF as 1/(1.1)^(# of years calculated) and apply to all firms with debt > EBITDA*3.0. This allows for an apples to apples comparison of FCF for both levered and not so levered firms in the same industry. TIA Packer

One way would be to buy out of the money calls on TBT. You can buy Jan 12 75 calls for about 2. If IRs double (about 10%), then TBT will go to 120 from 40 today and calls will be worth 45 and if IRs go up to 20% then TBT will go to 160 so calls will be worth 85. These are only 1 yr 7 mo calls vs. Klarman's calls. The one risk is if the volatility increase above 25%, then TBTs performance degrades. I wasn't able to find any LEAPs on another LT bond ETF which would remove this risk. Do you own DD to confirm the numbers above. Packer

In reviewing some insurance companies, I came across these two firms who have grown BV significantly over the past 5 years (Arch by 19% an Allied World by 21%). It appears AW is more volatile with large hits in 2006 and in 1Q2010. They both sell around book, so the are relatively cheap. Has anyone else looked at these and what is your opinion. TIA. Packer

Has anyone looked at the underwriting triangles for WRB? It apperas they have some deficiencies versus redundacies for other good underwriter like Lancashire. I don't know if the magintude of the deficiences should cause alarm. How are these deficiences reflected in the loss ratios? Can any other of the insurance experts provide insight? TIA Packer

Sanjeev, I appreciate the time and effort you have put in to make this board a great forum of ideas. As other have stated, why don't you look into setting up a holding company/shell where you can purchase stakes in micro-cap companies and push for change and if appropriate find others who can turn them around. You have started to do this with ITEX but could expand it to include other firms. If the holding company is not practical now, I am sure there are others (me included) that would be interested in making co-investments in the small company space where you can provide the expertise in return for a fee. Your fund may do some of this, but my interest would be in smaller companies where if a deal happens it could be a game changer and the investment becomes a semi-active investment. This is a space where I think there are alot of opportunities and guys like Sadar have gotten too big in size and ego to play in and the co-investment idea provides a level of service between full service (a fund) and independently investing on our own. Thx. Packer

Since the annual meeting, I have been looking at insurance cos who grow BV or return on investment and are selling at or below book. The four I found are FFH, RNR, Lancashire and ACE. GLRE is in this group but is selling at a premium to book. Thanks to the board members we have had a good amount of discussion about FFH and Lancashire. What about ACE and RNR? RNR appears to have an about 20% return to shareholders as Lancashire and ace has about a 15% return. TIA. Packer

I think Sam's comments were that SD is a bet on whether gas prices will be greater than $6 (good return) or less than $6. He said the Forest acquisition was good one and the Arena acquisition was not as good. SD gave up some gas upside for Permian Basin wells SD knows well. He thinks SD is creating an advantage by using knowledge of region and analytics (seismic data). For ICO, he stated ICO has good reserves with 31% met and 70% underground. The underground resources are important because hill-top mining is being reviewed for stoppage. Met coal is important due to high steel demand. ICO is in the process of completing an large underground met coal mine which should come on stream in the next few years. ICO has recently also delevered the balance sheet. Packer

If you look at the reserve triangles on p 137 -142 of the AR you will get a sense that the underwriting is very conservative (i.e. there is a lot of reserves being released). The key question is the past a good indication of the future. If you look at the triangles the reserve releases appear to be occurring across hard and soft markets (back to the 2002/2003 time frame). An additional macro factor that I didn't fully understand until discussed at the meeting is that FFH (along with BRK-A and MKL) don't duration match assets and liabilities instead FFH holds alot of cash & puts and more aggressively invests the float with great results. Packer

While you may be right in the details and the letter of the law the big picture and intent of allowing an intermediary play both sides of a transaction and structure a deal they new was not prudent is poor management and supervision much like Solomon when WAB had to take over for awhile. This would be water under the bridge if these banks imposed some type of self-disciple on these transactions. Absent this, the gov't will gladly take on the regulatory responsibility. Packer

How do you determine the margin of safety for a security such as ELNK or USMO which have declining CFs? These firm sell for less than 3x FCF but in three years USMO's value would have declined by about (based upon a 6% decline in FCF per year) 20% and ELNK by 33% (based upon a 13% decline in FCF per year). If I use a 12% discount rate a starting point (from 1/8.5 Graham PE with no growth) and add 6% and 13% respectively I get FMV P/FCFs of 5.6x and 3x respectively. That would put USMO @ 41% of FMV and ELNK @ 83% of FMV. Any comments or other ways to look at these investments. TIA Packer

I would agree with you if the US and other tax payers did not have to bail the folks out who bought the securities that others shorted. In addition, one of the risks Goldman Sachs took when it facilitated this deal with "trash" bonds is that it may be held partially responsible. This is not simply facilitating a bad deal but doing the deal knowing the bonds were trash and someone else would buy them. Part of Goldsman fees must include a certain level of due diligence associated with deals that have their name on it. Packer

I agree there was risk but the Goldman e-mail reminded me of the dot com companies they and others brought to market. This liability is part of the reason they get the fees they do. Although at times their business appears to print money, there are risks. I wonder how this will play with other sub-prime deals. If you watched the Mike Lewis piece on 60 minutes, it appears GS sold AIG a good amount of short CDS contracts that the gov't had to make good on. In that case, M. Burry asked GS to put together a security he could make money on if sub mortgages went bad. If their are similar trash e-mails about this deal, then they may have a case. In addition, GS has deep pockets and they have not engraciated themselves to the public by reducing their salaries and taking more stock. Packer

I agree. You should find out if your friend will have hard time sleeping if her investment goes down 10%/20%/30%. If so, it may lead to a more peaceful life if she keeps it in something safe. I have known a few folks who do not like risk and the volatility would ruin their lives so it was just not worth it for them to invest in anything but short-term / low-risk investments like money market funds. Packer

I am just finishing this book and I think it has been the best book I have read since The Dhandho Investor. It really gets at the behavioral aspects of investing and what great investors due to combat these behavioral traps. Packer