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Viking, If you go back to the 1990 AR (http://www.fairfax.ca/Assets/Downloads/AR1990.pdf), FFH retired 23% of their outstanding shares. What did it take to make that decision? "At year-end 1990 our shares were selling at a 36% discount to book value per share as opposed to a 50% premium when we refinanced the company in September 1985." There were 2 sources of the shares cancellation -- a sale to Markel and a normal course issuer bid. "On December 18, 1990 the company received and cancelled 800,000 multiple voting and 850,505 subordinate voting shares as partial consideration for the sale of F-M to Markel Corporation (note 3). The value attributed to these shares was $14,855 based on a $9 share price on the date the transaction was completed of which $3,881 was charged to retained earnings. In addition, under the terms of a normal course issuer bid approved by The Toronto Stock Exchange the company purchased and cancelled 188,898 (1989 - 6,000) subordinate voting shares for an aggregate cost of $2,605 (1989 -$87), of which $1,198 (1989 - $45) was charged to retained earnings." 'A significant event in 1990 was the cancellation of 1,839,403 subordinate voting shares of Fairfax through the sale of F-M Acquisition and through an issuer bid on The Toronto Stock Exchange. The cancellation represented 25% of the outstanding shares of the company. The 1,650,505 shares cancelled in respect of the F-M transaction were valued at $9 per share based on the trading value on the date the transaction was completed." Since Watsa follows the Templeton school of value investing, I would expect that it will take more than a 10% discount to BV for FFH to make significant purchases on their normal course issuer bid. If similar insurance companies can be obtained in the marketplace (ORH, ZNT, etc), these expand the capacity of the insurance platform for the hard market. Another factor mentioned in the 1990 AR is debt reduction: "Since the total debt to equity ratio of 0.87:1, up from 0.2:1 in 1989, is higher than in past years, our main objective for 1991 is to reduce total debt outstanding so that we can take advantage of future opportunities. At the Fairfax entity level, cash flows are dependent on its insurance companies' ability to pay dividends. Other investments made by the entity will be sold during 1991 with the proceeds applied to outstanding debt. The company believes it is in a position to meet all expected cash requirements with its existing resources." In the 2009 AR just reported, the following is probably the deciding factor against share repurchases: "Our performance in 2009 continued to raise our ratings. A.M. Best affirmed our financial strength ratings at the A level and S&P raised Fairfax’s debt rating to investment grade and Crum & Forster’s financial strength rating to A–. We are focused on raising our debt ratings to the A level over time and maintaining them there. This was why we financed the privatization of OdysseyRe by issuing $1 billion in common equity, and we expect to continue to maintain a minimum of A level financial strength." I would expect that once the A level is reached and if share prices are well below book value (80% or less) and if there are few high quality insurance companies available and if we're still in a soft market, then the share repurchases will start to go ahead. It looks like it's still some way off. -O

Great quote from Munger. There are lots of examples of good companies weakening their franchise with the purchase of lower quality businesses. http://www.rationalwalk.com/?p=6087 Buffett's call-out of Kraft's CEO was classic where a solid pizza franchise was sold at a tax disadvantage to raise capital along with the use of undervalued Kraft stock to pay for the Cadbury purchase. Canwest Global just recently went into bankruptcy where they diluted a television content provider business (20%+ returns) with a newspaper business (sub-10% returns which only got worse) and used a boatload of debt to do it. -O

http://choufunds.com/pdf/AR09.pdf After the distribution of $1.53, the net asset value (“NAVPU” or “NAV”) of a Series A unit of Chou Associates Fund at December 31, 2009 was $68.46 compared to $53.96 at December 31, 2008, an increase of 29.7%; during the same period, the S&P 500 Total Return Index increased 8.6% in Canadian dollars. In $US, a Series A unit of Chou Associates Fund increased 51.1% while the S&P 500 Total Return Index increased 26.4%. After the distribution of $0.52, the net asset value (“NAVPU” or “NAV”) of a Series A unit of Chou Bond Fund at December 31, 2009 was $8.51 compared to $6.34 at December 31, 2008, an increase of 42.5%; during the same period, Citigroup WGBI (World Government Bond Index) All Maturities ($CAN) was down 11.5% and Barclays U.S. Corporate High Yield Index ($CAN) returned 34.4%. In $US, a Series A unit of Chou Bond Fund returned 65.9% while Citigroup WGBI All Maturities returned 2.6% and Barclays U.S. Corporate High Yield Index returned 58.2%. -O

ABC Funds sold out their ELF position and posted a writeup on their reasons for selling: http://valueinvestigator.com/en/valuefavourites/elf.php#update -O

Buffett agrees and buys more Munich Re, now 8% http://www.reuters.com/article/idCNLDE62O1JY20100325?rpc=44 Allianz believe catastrophe reinsurance rates will rise http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aSvL5JjBaYgc

http://www.cfapubs.org/doi/abs/10.2469/cp.v27.n1.3

Rosenberg makes a good point on income. The income point also applies to the US mortgage markets as well. When lenders such as BofA are willing to cut principal to ensure monthly mortgage payments continue to roll in, there is some certainty introduced to the credit markets. Much of the uncertainty at the macro level is based on the premise that the US consumer will not recover. But, if you start digging, the macro picture has improved tremendously in the last few months (viz. employment, housing, exports, etc). Are we out of the woods - likely not, but we're approaching the clearing. There are good reasons why deleveraging will continue to occur, but let's not forget that deleveraging has many sources, not just principal repayment (the slowest form). If lenders are willing to reduce principal directly, then debt/asset ratios will improve much more quickly and more consumer discretionary income becomes available for either further principal reduction or for consumption. Buffett indicated this month in the BRK AR that housing would start to recover in 2011 and I tend to agree that there is a slow-sloped recovery underway that will continue. Housing is a proxy market for the health of the consumer and most individual RE markets have stabilized. Commercial RE is still dodgy. Not all industries have been as heavily impacted as autos, durable goods, etc, so other consumer-oriented industries have weathered the storm better and will continue to generate good margins. Best values at the moment are in small capitalization stocks and insurance. I'm still finding small-cap companies with long histories of high ROE/good FCF that have "glitched" short-term and have recovering/increasing margins. From a portfolio perspective, a good-sized cash weighting is still valuable for those "wall of worry" moments that Mr Market is bound to have. -O

http://www.calculatedriskblog.com/2010/01/new-research-on-mortgage-modifications.html http://www.calculatedriskblog.com/2010/03/report-bofa-to-announce-mortgage.html So, the Ranieri/Milken crowd are probably onto something. On the premise that others will follow...Now Bank of America is getting into the principal reduction game in order to get existing homeowners to keep paying their mortgages. They take a haircut on the principal, but continue to have cashflow. More pieces falling into place for housing price stability and a housing price bottom. Another market that stabilizes and puts some certainty into household budgets and enabling a consumer recovery to be possible. The way that BofA has structured their program, they have a five-year window where principal will be reduced which presumes they are trying to get some upside if housing prices recover a bit. Other banks will follow these leads if the economics make sense... -O

Bill Berkley may get his scenario for greater reserve releases. http://www.businessweek.com/news/2010-03-16/insurers-may-see-disaster-costs-surge-this-year-swiss-re-says.html “We have already seen significant events in 2010,” Thomas Hess, chief economist of Zurich-based Swiss Re, said today in a statement. “The industry is therefore well-advised to prepare for much higher losses.” In the first two months of 2010, an earthquake hit Chile and European Windstorm Xynthia struck France. Insured losses from the 8.8-magnitude quake in Chile on Feb. 27 may be as much as $8 billion, catastrophe modeler Eqecat Inc. said on March 1. Xynthia, which killed at least 47 people, may cost insurers as much as 2 billion euros ($2.75 billion), according to Risk Management Solutions. Costs to insurers from natural disasters totaled a below- average $22 billion in 2009, Swiss Re said. Only two tropical storms hit the U.S. last year, compared with 2008 when Hurricanes Ike and Gustav contributed to more than $44 billion in insured losses from natural disasters.

Good point, but how does one value this invested capital? If one looked at total invested capital in railroads, it probably dwarfs the total valuation of the industry. The liquidation value of the assets is probably how this company should be valued and these assets definitely have value to a private buyer, just not $25B, but likely much higher than $2B equity value and possibly higher than the $8B enterprise value. -O

http://www.theglobeandmail.com/report-on-business/torstar-among-final-bidders-for-canwest-papers/article1499394/ Torstar, which is believed to be backed by Fairfax Financial Holdings Ltd., will now compete with a group of other bidders that is said to include several industry heavyweights. B.C. newspaper proprietor David Black, and newspaper executive Paul Godfrey backed by Onex Corp. and Alberta Investment Management Corp., have been mentioned as bidders so far.

twa, Even in the distressed areas, there may be market forces coming into play. Here's a Fortune article on an $800M fund that is buying distressed homeowner debt and getting homeowners to begin paying by reducing the principal. Cashflow on distressed debt workouts can provide decent returns if the debt is bought with sufficient discount. Where one market player is successful, others will follow. http://money.cnn.com/2009/12/08/real_estate/lewie_ranieri_mortgages.fortune/index.htm -O In the spirit of inversion, let's flip the prevailing wisdom and see how the worm has turned. Four years ago, the sell side was whistling in the dark and telling the public that housing was a local market and that there had never been a nationwide decline in housing prices ( conveniently ignoring the massive, nationwide US mortgage defaults of the 1930's). Now, the prevailing wisdom is that housing really is a nationwide market. The truth is that in normal market conditions, it's OK to think of it as a collection of local markets, granting that bubbles and crashes do occur. Objectively, the housing market is now in transition to a still depressed local market normality. We live in an upscale exurb of a major metro area. The overhang of houses here has been extinguished and prices are beginning to rise. Soon, the local construction of new homes will be picking up. Two counties away, there was massive overbuilding, houses there are much cheaper than anywhere in the metro area. Pricing there is attractive, they are not inconveniently located and they may continue to have an overhang for another year or two. What I'm describing is one of the better growth areas in the US. Aggregate housing in the US is a long way from another boom, but it is beginning to sort out into the normalized regional and local differences.

libor, I'm with the "too hard" group when looking at commodities. Here's a good quote from Montier on current global mining company pricing. He explains his modelling process to get to his opinion. Montier recently joined Grantham at GMO, so now you get 2 curmudgeons for the price of 1 ;). -O http://www.simoleonsense.com/miguel-barbosa-interviews-james-montier-part-1-value-investing-tools-techniques-for-intelligent-investing/ James Montier: In theory DCF is a great way of valuing a company (in fact, the only way). However, it’s implementation is riddled with pitfalls. With enough creativity a DCF can turn out any answer you like. So rather than try and combat this, I prefer to use reverse dcf. This effectively takes the market price, and backs out the growth that would be required to justify the current price. I can then compare that implied growth against a historical distribution of all company growth rates over time and see whether there is any chance of that growth actually being achieved. In terms of the mechanics, these things can be a simple or a complex as you like. I tend to use a three stage model, I use the analyst inputs for the first three years, and a trend GDP related growth rate for the terminal years, and then imply what the market implies for the middle period of growth. For instance, at the moment the mining sector implies 12% growth p.a. each and every year for the next two decades! That is a cyclical sector with an implied growth rate double a generous estimate of nominal GDP growth. Cyclicals masquerading as growth stocks rarely end well for investors.

It's common to smokescreen in public comments. Palm is an older position. If T2 is establishing new positions (long or short), they won't talk about them publicly until the full position is established. T2 has talked publicly about housing weakness and shorting opportunities for housing-related industries. In the spirit of Munger's inversions, why does T2 not talk about the cost of replacing housing assets in any of their public chartware? Eventually housing will put in a floor below replacement cost of housing assets (some intrinsic value level). Buffett talked recently about the sources of demand and estimated that there is another year or so to soak up the excess stock. T2 has a thesis and is seeking confirming evidence (confirmation bias). I hope that in their private thoughts, rather than their marketing materials, they consider the inverted argument. T2's public appearances are marketing junkets, so pay attention to the T2's bias (Klarman has lots to say on this). Compare T2's thesis in 2010 to Watsa's thesis in the Fairfax 2007 AR. Watsa was thematically correct because of the overbuild in US residential housing stock using leverage, T2 has much less room to play with in their thesis. If you continue marking to market, the counter argument is mark to asset value which ignores the marginal seller and looks at the underlying value of the asset. I realize that this counter argument is a bit more subjective, but replacement values (marked asset values) can be estimated. New households being created this year are getting a bargain of a lifetime if they can maintain steady employment. The size of Watsa's margin of safety was very large (roughly 10x return on investment in CDS swaps). -O

http://www.marketwatch.com/story/shareholders-foundation-announces-investor-lawsuit-against-zenith-national-insurance-corp-board-2010-03-10?reflink=MW_news_stmp The Shareholders Foundation, Inc. announces that a lawsuit has been filed in California State Court on behalf of current investors in Zenith National Insurance Corp., who purchased their ZNT shares before February 18, 2010, alleging that the defendants' attempted to sell Zenith National Insurance to Fairfax Holdings Limited and Fairfax Investments II USA Corp., by means of an unfair process and for an unfair price.

Clarke is a transportation company (mostly trucking) which has invested excess funds in undervalued small-cap positions. They had a rather spectacular wipeout and likely carry some substantial NOLs. CEO George Armoyan has an eye for undervalued positions and takes an activist role. It's difficult to value their portfolio since there is inadequate disclosure for an outsider to determine value. http://www.google.ca/finance?q=TSE:CKI&fstype=ii

Good article from Ravi Nagarajan... http://www.rationalwalk.com/?p=5586 The process of estimating the ultimate losses resulting from an insurance company’s business is one of the most important tasks facing management. Many types of policies expose an insurer to liabilities over a very long period of time where the ultimate payout to policyholders will not be certain for years or even decades. Despite this uncertainty, management must estimate loss reserves for each financial reporting period. The credibility of these estimates depends, in part, on management’s track record with prior estimates.

This is a large catastrophe. Has anyone seen other estimates? What exposures are being projected for major insurers/re-insurers? http://news.bbc.co.uk/2/hi/americas/8542122.stm One US risk assessor, Eqecat, put the value of the damage at between $15bn and $30bn (£9.8bn-£19.6bn) or 10-20% of gross domestic product.

http://www.searsholdings.com/invest/ Chairman's Letter February 23, 2010 To Our Shareholders: Today we announced our financial results for our 2009 fiscal year. I am pleased to report that we delivered both stability and progress, resulting in roughly $1.8 billion of Adjusted EBITDA, an improvement of more than $200 million over 2008. While this may be surprising to some, it isn’t to me. The dedication of our associates and leadership team led by Bruce Johnson and the diversity of the Sears Holdings business portfolio—Sears Full Line stores, Kmart stores, our Home Services business, Sears Auto Centers, Outlet Stores, Hometown Stores, the Kenmore, Craftsman, DieHard and Lands’ End brands, our majority interest in Sears Canada, and our online business properties including sears.com—have allowed us to successfully manage through the economic and financial crisis of the past two years. Today, the United States stands with an unemployment rate close to 10%, a housing market that appears to be stabilizing at depressed levels, and uncertainty over government policy and geopolitical events. Despite this, Sears Holdings continues to make progress against our strategic initiatives and our long-term financial goals. I recognize that our financial results, while substantially improved from 2008, remain well below where we would like them to be. At the same time, we have seen significant improvements in our focus on customers and the transformation of our culture. I would like to do several things in this letter. First, review 2009 at Sears Holdings. Second, look ahead to 2010 and beyond. Third, discuss some policy issues generally including job creation, and finally, address some consequences of ecommerce tax practices. ...snip...

Roger, Another insurance company buyer would certainly pay a similar valuation. Seth Klarman wrote about this in Chapter 8 - The Art of Business Valuation in his book Margin of Safety. It's worth the time to read if you can. On this type of valuation, he writes: "While the stock market's vote, especially over the long run, is not necessarily accurate, it does provide an approximate near-term appraisal of value." Similarly, Fairfax could be considered the sum of its parts and a control buyer would likely pay a similar premium. It's an indicator of a discount to intrinsic value at current market prices. -O

http://4.bp.blogspot.com/_pMscxxELHEg/S4LJXi9Fo4I/AAAAAAAAHj8/7ICtxGRaPKs/s320/MITCREPrices.jpg http://www.bloomberg.com/apps/news?pid=20601103&sid=aQhk75562R7Q U.S. commercial property values had their biggest monthly rise on record in December as the number of transactions jumped, according to Moody’s Investors Service. The Moody’s/REAL Commercial Property Price Index climbed 4.1 percent from November, the second straight monthly increase, Moody’s said today in a report. Transaction volume rose more than 75 percent from the previous month. Values, which fell to a seven-year low in October, are down 29 percent from a year earlier and are 41 percent lower than the peak in October 2007. “Two months of positive returns and one month of higher transaction volume does not allow us to discern a trend just yet, particularly in light of the fact that year-end commercial real estate activity can distort the true condition of the markets,” the report said. Landlords came under pressure in 2009 as rising joblessness cut demand for apartments, offices, retail space and distribution centers. Office vacancies jumped to a 15-year high of 17 percent in the fourth quarter, according to Reis Inc. While the period of “large” price declines is over, it is too early to say the market has bottomed, Moody’s said.

Surprise! S&P and AM Best have a different opinion on Zenith/Fairfax. http://www.insurancejournal.com/news/national/2010/02/22/107526.htm Neither Standard & Poor's Ratings Services nor A.M. Best are currently expecting to change their ratings on Zenith National Insurance Corp or on Toronto-based Fairfax Financial Holdings, following the announcement on Thursday, Feb. 15, that it will buy all the shares of Zenith that it does not already own in a deal worth about $1.4 billion [see IJ web site - http://www.insurancejournal.com/news/national/2010/02/18/107455.htm ]. S&P affirmed its 'BBB-' counterparty credit rating on Zenith and its 'A-' counterparty credit and financial strength ratings on Zenith Insurance Co. and ZNAT Insurance Co., which are the members of the Zenith Insurance Group Intercompany Pool. Best commented that the financial strength rating of 'A' (Superior) and issuer credit ratings (ICR) of “a” of the operating companies of Zenith National Insurance Corp. and the ICR of “bbb” of Zenith "remain unchanged" following the announcement of the Fairfax deal. Both rating agencies also stated that the outlook on all of Zenith's ratings also remains stable.

Fitch isn't fully on board. It's the usual knock on Fairfax by the rating companies. Even with FFH's track record of investing since 1976, the rating companies prefer to have bond coupons matched to liabilities. http://www.businessweek.com/ap/financialnews/D9DVHJT00.htm Fitch Ratings on Friday said it has placed the ratings of Zenith National Insurance Corp. on watch for a possible downgrade because it expects the company that wants to buy Zenith to manage its investments more aggressively. Fitch said it expects Fairfax to leave Zenith's management in place, so operations shouldn't change much. But Fairfax will take over management of Zenith's investments, which have been run conservatively in the past, Fitch wrote. Fitch wrote that it put Zenith ratings on "watch negative" because of concerns about Fairfax's "more opportunistic investment philosophy, as Fitch expects a gradual migration toward a riskier investment profile for Zenith." Fitch wrote that Zenith's investments are just 3 percent equities, with 90 percent in investment-grade bonds. Other Fairfax subsidiaries put more of their money in stock, "and while this could potentially bode well for long-term performance, it also introduces increased volatility and risk to the balance sheet," Fitch wrote.

In previous acquistions, Watsa obtained margin of safety by buying below book value and then executing the fix. It worked on some acquisitions, but there were some large failures which contributed to the "seven lean years". Buying while pricing is weak seems to be a better way to obtain the margin of safety since this Zenith asset is high quality. Also, with Fairfax having done a sniff test on Zenith over the past decade as a large minority shareowner, they know what they're buying. http://www.marketwatch.com/story/fairfaxs-zenith-deal-fuels-insurance-rate-hope-2010-02-18?reflink=MW_news_stmp "Widely followed market surveys indicate property and casualty rates continue to fall. But on an individual company basis -- and especially with smaller insurers -- we're seeing signs that rates are going up," Stewart Johnson, a portfolio manager at insurance-focused investment firm Philo Smith, said in an interview. "Maybe Fairfax believes rates have hit bottom and are headed up again." Workers' compensation insurance covers the cost of medical care, lost wages and rehabilitation for on-the-job injuries and provides benefits for the family of any employee killed in work-related accidents. The workers' compensation market has been plagued by intense competition, spiraling medical costs and fraud. Prices have been falling steadily in recent years as the recession and rising unemployment reduces demand for coverage. Zenith focuses on workers' comp markets in California and Florida, which have been more troubled than markets in other parts of the U.S. However, the company, run for decades by Stanley Zax, has a reputation for pulling back if it can't charge high enough premiums to make money. Weak premiums have hit Zenith shares, even though the company may be avoiding future losses by rejecting lower-priced business.

Just over 6 years ago, Buffett warned about going to Squanderville. http://money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm In evaluating business options at Berkshire, my partner, Charles Munger, suggests that we pay close attention to his jocular wish: "All I want to know is where I'm going to die, so I'll never go there." Framers of our trade policy should heed this caution--and steer clear of Squanderville.