SharperDingaan

We went back & re-read the terms of rights offering. Nothing happens untill SFK files the final prospectus, & nothing requires them to file it by June-30 (which starts the calculation now). The market has assumed that they need the cash right now; they don't, so why would a rational management not simply delay the filing by a month so that all the calculations will be post conversion closing, & presumably a lot higher? We bought the debs < 40 & sold > 98. If you think the debs might get taken out at 101 within 3 months, the best you can do is another 5% [(102.75/98.0)-1]. If Mr Market is being manic we can very easily do 50% in the common, & don't have 10x the risk. We haven't sold all our debs (we could be wrong), just reinvested 1/2 the proceeds in the common. As the remaining proceeds are in cash, we're happy with the incremental risk. SD

Re disclosure; we've taken some $ off the table, & rebalanced between debs & common. SD

The market cannot tolerate the fact that we don’t know the price of the rights offering, & hence the dilution that it will generate. .... (1)To continuously sell is to lower the price, drive up the potential dilution, & further drive down the price; ie: self-fulfilling momentum trading. (2) Analyst cannot ‘sell’ the deal until the price starts rising & the potential dilution starts declining; eliminating price support. But ....... (1) We also know that pulp prices have been rising over Q2, & the average FX rate has fallen; most would expect Q2 EBIDTA to be at least comparable or better than Q1, & positive net earnings. (2) We have agreements to refinance & extend the debt terms at far lower rates; ie BK threat removed & material interest savings. (3) We have 40MM in additional equity, & more operating cash, that should increase the EBITDA/EV valuation (all else equal). We also have a very carefully structured deal with FFH’s hands all over it, but we think FFH has suddenly become exceptionally dense? (because we haven’t seen all the pieces yet) (4) Debs are trading like the BK threat were removed, and the Deb to common arbitrage is looking increasing promising. Given the nature and materiality of the plusses, most people would value the stock at a premium to the 1.85 it traded at prior to the Q1 earnings announcement; but because our manic Mr Market is suddenly offering it at 25% less, we’ve phased? All Mr Market has shown, is that this stock can easily move down 25-30% from pre-announcement; it can also move up 25-30%. And FFH seems to have anticipated at least a 20% reaction. Assume we’re totally wrong ..... & there is no reengineering in the background. Isn’t 25%+ off still a gift, versus what you’d rationally expect? Enjoy the opportunity; they don’t come by that often. SD

Think we're getting old; agreed BV only goes up 40M. Redo the calcs at todays rates & going upwards. If FFH backstopped the entire issue at 1.23 (80% of 1.53) we end up with 122.99M shares (36% dilution) & a BV of 3.84; but to get this there have to be no other buyers, & how likely is that ? given mgmts recent statements about greater liquidity, marketability, etc ? If FFH backstopped at todays price of 1.53 (80% of 1.83) we end up with 112.33M shares (24% dilution) & a BV of 4.20; but to get this we have to rise 20% & still have FFH take up the entire issue. We effectively just start from where we were pre Q1 results release; but again, how likely is it that there are no other buyers out there ? SFK has gone out of its way to structure this offering with FFH having parity with any other buyer above 1.83, & any price rise above 1.83 benefitting all shareholders through reduced dilution. Then keep in mind that this is effectively a control block, were ONE new buyer to take up the entire rights issue. One has to think that the narrowing gap between increasing market price & reducing BV/share (via dilution) isn't accidental. Now assume that the US mills were sold, but the consideration was paid in both cash & a return of newly issued SFK shares. The share price rises, the share count goes back to where it was, debt gets repaid, the buyer can afford to pay a little more as they have an offsetting gain on their share holding, & SFK could do the share repurchase as a general buy-back benefiting all. Obviously we think there are more shoes to drop. SD

Quick back of the envelope to explain the dilution. 90.473M shares x 4.78 = 432.46M of BV. Sell 10.7M shares x 3.74 for 40M & retire 52M in Debs Share count rises to 101.173M; BV rises to 524.46. BV per share becomes 5.18. Non Dilutive. But if you sell at 2.08 or less .... Share count rises to 109.72M; BV rises to 524.46. BV per share becomes 4.78 or less. Dilutive. 2.08 is 44% of BV, & 36% higher than todays 1.53 close. Do you really think that after conversion the share price is NOT going to rise by at least 40% when all these transactions, & another good quarter are going through the books ;D SD

We hear you, but it really comes down to whether you see them continuing as is. Sell the units at 3.74 to call the deb, & the 10.7M units of dilution is no more than you were allready expecting. And to get 3.74 the transactions only need reduce the BV discount to 22% from the existing 68%; even the EBITA to Enterprise `floor`value is around 55% of BV. Yes there will be net dilution, but there will also be another 92M of equity to dilute. By year end most of Chile`s production should be back on, & we will have still more supply from the restarts that are allready in progress. If they are to restructure there`s no better time than near the top of an extended cycle, but the result has to better than liquidation. Process & timing are of course no more than a rational best guess, but at this point - a liquidation vs earnings valuation does seem to make the most sense. SD

May-25. Assume conversion. Currently restricted buyers can start to accumulate on May-26. What stock they can't buy outright they can buy later via the warrants, but untill the warrants list they can only get those shares from the limited float. If there is additional demand, the share price can only rise. Jun-30. Deb holders receive a 30-day call notice along with their interest payment. Jul-20 + a few days after. Rights offering executes, debt is refinanced, Q2 results released, Debs called. August/September. US buyer does a cash bid for the US plants & the sub they're in (tax losses). Cdn buyer does a cash/share bid for Fibrek itself (St Felicien + tax losses). Shareholder approval required for the Fibrek sale, but not the US plants. Vote is sometime in mid November, delisted by Dec-31. Then keep in mind that the sale of the US plants to a US buyer will eliminate much of the FX volatility, & the proceeds will be more than enough to retire all of SFK’s debt. Receiving your proceeds as either shares/cash also allows the buyer to pay more, & you to execute a taxfree roll-over ... and when the target is debt free, it can effectively finance its own takeout. SFK paid relatively little for those US plants, & has taken a couple of years of depreciation against them; NOT getting a healthy ‘gain on sale’ is going to be almost impossible. Same thing for St Felicien except that now it also comes with a power plant, massive incremental cost savings if you have chips, 2 yrs worth of tax losses to shield the record income, & a whack of unspent ‘green’ grants. Christmas could be looking very good this year! SD

Very, very interesting Notice that all the LT debt is essentially being refinanced, including that due within 12 months. If nothing else happened we probably have a material easing in covenants, at least a 250bp reduction on the Term Loan, & a 287.5bp reduction on the Revolver (Q1-2010 financials, Note 3). A minimum saving of 742K/quarter [108,826*.025/4+34,615*.02875/4=742], but realistically something higher still. It's also now virtually certain that the debs will be called, saving another 905K/quarter, materially improving the debt/equity ratio, & eliminating 10.7M shares of potential dilution. Total interest saving of 1600-1750K/quarter. Notable is the dates, & the terms. 1) The pricing period hasn't started yet, 2) The 20% discount suggests they expect a potential price spike well beyond the intrinsic value. Most folks would infer that they are aware of a new buying interest that can only come in post conversion; material enough to overcome the rights dilution & still drive the price up. Very elegant. SD

Keep in mind that if 'criminal probe' turns into 'criminal prosecution', they are dead in the water. Primary dealer status goes almost immediately, restructuring/new issue flow dries up, & they're left with only trading; which is in fact what they effectively do. If you deal with a criminal organization, you're also innocent untill proven guilty; but you dont presume that anyone else will touch you untill you can prove your innocence. They are locked into the streets culture, & both them & the street haven't been able to adjust to the obvious reality; they've screwed up so badly that re-regulation is now a given, & its not going back to what it used to be. Probably too late to cave now. SD

You might want to consider what happens if it only takes 4 months to cap this thing. - At 5000 bbls/day its 600,000 bbls; or 2 1/2x the Exxon Valdez. But unlike Alaska this seabed is porous, so oil will stay in the seabed & the gulf seafood industry will be wiped out for a good decade or so. - BP has self insured this. Every $ spent on shut-off & clean-up, anywhere, is coming back to them.... & every $ of loss from the seafood industry as well..... & every $ in other 'related' losses. Black hole. - Financial relief can only come from the insurance industry (via HAL or CAM), the UK &/or US government, corporate profitability, or the financial market (via new debt/equity offerings). Regulatory dealing is going to be par for the course, but untill we know the likely outcome; any firm/industry related to this incident is going to take a hit. - You still need oil, but if you cant drill off-shore (global moratorium) you can only drill on land. So why wouldn't some of the (reduced) offshore drilling budget not shift to land drilling, esp when its comparatively cheap? Most would be hedging BP & going long the land drillers & oil sands. SD

Interest and dividend income are now high enough to more than outweigh the effect of high (110%) combined ratios . . . Look closer at the Q1 earnings: Q1 had a fortunate offsetting gain that generated a net 278.8M (415.6M investment gain - 136.8M Chilean charge). Subtract the 278.8M from the total 290.2M reported & only 11.4M is attributable to everything else. But what if HW had only been able to realize 30%, or less, of the investment gain in Q1 (125.4)? That Q1 BV change would have been 0, or even negative, & the multiple would have dropped. 11.4M isn't enough of a MOS to absorb the adverse normal course quarterly MTM-UW variation, when it invariably occurrs. Agreed its artifically low because of higher than normal expenses, but to get a healthy cushion we really need additional interest income (either more $ to FI, or a higher cash yield). So long as rates are low the odds on a specific quarter generating a negative BV hit are higher than normal. We're offsetting that with HW's ability to realize enough of a gain in that same quarter; somedays we'll win, other days we will not. Different take. SD

Cardboard: Very good posts. Re UW: There are only 3 ways to increase UW gains (1) Higher Premiums (2) Lower expenses (3) Higher Income. Sustained premium growth is highly unlikely; AIG is still out there, & most will cut rates to generate float as soon as there is any market hardening. Expenses are growing at > inflation, & we're pretty much at the limits of consolidation. Income can realistically only increase if interest rates rise. If we have a global rise in interest rates, UW profitability should be more reliable; but how likely is this when almost every global sovereign badly needs low rates to minimize the debt service on their inflated borrowings? And in the meantime ..... why would you NOT expect higher volatility from erratic UW results? Buy & hold, vs buy & hedge, just does not make a lot of sense. SD

Interesting AR. Notable is the practice of taking deposits from customers, guaranteeing the principal & stated return, then investing the proceeds in greek government bonds. Ordinarily the bank would make a healthy spread - but if the bonds ever took a haircut ... its NBG's problem & not the customers. Pg 39 shows assets by rating. If most of their assets move down one category (probable), they also have a material hit on their regulatory capital. Either they get more equity (dilution) or they start foreclosing (writedowns) SD

(1) Realistically, NBG's credit rating can be no better than the sovereign; so a downgrade to junk (2) With junk ratings NBG can't access global markets without a higher rated sponsor; so why would there not be all kinds of writedown surprizes, & indirect EU guarantees, over the next little while? (3) At its 2.60 low NBG had lost roughly 68% of its value in 6 months, yet today (3.38) its 30% above that low?; risk isn't being priced in. Against that .... a very useful TSX listing with pricing in USD Lots of possibility here, but not until the knives stop falling SD

Assume: Price of $C368, BV of $C370, 15% ROE, rational hedging long-term shareholder, seasonal BV multiple variability of +- 10%, 60% average idea capture, today’s multiple is 1x (368/370), 1 yr holding period, no dividend. The rational shareholder would hedge at 1.1x BV, re-purchase at .9x, & use a stop-loss at 1.1x BV (just in case there’s a surprise). If it were a ‘normal’ year & you hedged today, bought back in 6 months at .90x, & resold in another 6 months - you would make 75 or 20% (75/370) & be in cash over the riskiest part of the insurance year. [[370-(370*(1+(.15/2))*.9)]+[(370*1.15*1.1)- (370*(1+(.15/2)]]*.60 To be fair, MKL etc. has to offer you at least a 20% return to be comparable, & they essentially have to do it through better UW. You really need to compare the rational shareholder motivation for the buy & hold of MKL to the buy & hedge of FFH. SD

Keep in mind that not discounting the reserve, & reinsuring, are additional costs & revenue haircuts that MKL doesn't bear. The result is a lower CR for MKL offset by greater cat risk (which Mr Market attaches no 'value' to) & MKL effectively having a higher operating leverage than FFH. To compare fairly you really need to leverage the FFH holding to make the (FL+OL) of each company comparable, then look at successive (yearly share price change x #of shares)/starting equity. They're probably about the same, but with FFH having more volatilty. SD

We hear you! 2/3 of our rebalancing is to other cyclicals, & there's lots of quality going very cheap. The rest is looking for a FI home .... & if it takes a year, no big deal. SD

Just because ... Keep in mind that the sovereign needs to reduce its funding shortfall & debt service requirement, when nobody wants to lend new money to it; therefore it can only squeeze existing debt holders (1) On maturity take 80c - or rollover into a low coupon 12yr bond guaranteed by the EU (2) On maturity take 80c - or rollover into a higher yield zero coupon, callable (at a % of the IV), sovereign 10 yr bond. Most sovereigns finance at an average 5-7 yr term; if they get into trouble they extend the average term to 9-12 yrs. Assuming a 10yr term that zero would issue at between 46-56, if the yield were between 8-6%. You would be unhappy, but you’d take the zero because it matures sooner, you don’t need the coupons, & there’s a chance it could get called earlier; but you’d also sell it if you could. Assuming an average 25% liquidity discount these things would trade in the secondary market at around 35-42 Euro + accumulated interest. Because this threatens the integrity of Euro land, & the Euro, most would also expect additional Euro depreciation. If its 10% you’d actually pay 90c in the $, & there would be no repatriation FX risk if the proceeds from the maturing euro bonds were spent anywhere in Euro land (ie: a villa). On day 1 you’d actually buy the zero for 31-38 (46*(1-.25)*(1-.1)=31). If it got called the next day you would make at least [50%] 15+ (46+call premium-31). If it’s called 5 yrs hence you’d get more, get the proceeds when the economy is turning (otherwise the sovereign wouldn’t call), & would be reinvesting when property prices were still low. ..... Gives a whole new meaning to property management. SD

Keep in mind that the cost base, the quality of the security, the amount of run-up, & the degree of overweighting should be the key variables. ie: a 70% weighting to FFH is very different to a 70% weighting in SFK. We hold a very high weighting only because we hold both common & debs, we bought them at close to their lows, & the run-up has made it extreme. We also have a long time horizon & a higher risk tolerance. The only reason we haven't rebalanced yet is because we'll see another 100-200%+ appreciation on our cost base, if the quarter is a good one. SD

First of all, thanks for your analysis on SFK. I truly hope that you will make a killing on this one as you likely helped many board members making a lot on this idea. We've allready done very, very well thanks; if the PIIGS cooperate the 'retirement cottage' could well up being a modest 'villa' on the southern european coast.Whatever additional we earn from new issues/takeouts, etc. will essentially be insurance./i] All that we actually know, per managements statements, is that SFK has been receiving various expressions of interest.Mar-25 Press Release: it is anticipated that the reorganized structure of the Fund as a corporation will attract new investors, including non-resident investors, and provide, in the aggregate, a more active, attractive and liquid market for the common shares of the new corporation (the "Common Shares") than currently exists for the units of the Fund (the "Units"). There was also a reference as to who that might be on one of the other SFK strings (since deleted). Suffice to say this statement could not be made unless there was something to back it. 3 ‘seeds’ in the last 2 weeks Stockhouse Board: 04/07, 10:27, huge profit coming Yahoo Boad: 04/23, 1:31, Buyout rumour mill Stockhouse Board: 04/26, 10:121, SFK Buying Rumours SD

The net thrust of the various rumours is essentially this: (1) The St Felicien plant is sold to Company A (Domtar?) for something (presumably cash?) (2) Majority ownership in the remaining 'shell' is sold to Company B (Boston interest?) for cash (presumably via an augmented treasury offering). (3) The Debs are called in to remove their blocking interest (implied, not stated). All that we actually know, per managements statements, is that SFK has been receiving various expressions of interest. What if it were true? - The shell would have 2 US plants, significant excess cash on hand, & would be entirely equity financed (St Felicien proceeds pay off the existing debt + leave some change; treasury issue further boosts equity) - Given the players, & the legalities, the buyer would have to make a proportional offer to all the existing shareholders; with any share shortfall coming from a treasury issue. - The shell would go shopping for a debt financed acquisition. The outcome is still a re-engineering; & a re-engineering is exactly what everyone is expecting. It just looks different from the expectation. More importantly - there have now been 3 ‘seeds’ in the last 2 weeks; & whatever the plan, it’s starting to leak. No further comment. SD

Re disclosure We've just found this on the stockhouse board: Posted 04/26 @ 10:12 PM Given that management is currently in Q1 lock-up, we're not going to comment. SD Hi everybody, I have been told that at St-Félicien mill, there is a rumors again that SFK will be buy by Domtar after it become Fibrek INC. Lots of major CIE like Domtar, Bowater were interested in the past to buy SFK, but this was not possible because SFK is a fund. Now with the new Fibrek INC structure, it's gonna be possible. When SFK was created, they bought the St-Félicien mill for 700 000 000 $ but the book value was 400 000 000. So now, 8 years laters, I think the mill itself can worth more than 1 billion $$ + the 2 USA mills (however, value of those 2 mills are way less). So it's a lot of $$$$$$$$$. Only 90 000 000 shares !!!! Do the maths folks.

You might want to look at the better of the PIIGS, particularly in the 4-6yr range, & where there have also effectively been bank nationalizations. Then ask; - Why is it that their economic condition today can only get worse? - Why do you need the coupon? - Why would the sovereign not try to extend maturities with zero coupon bonds, at favourable terms? - Why do you need to repatriate the investment on maturity? If you bought the bond today at 65, & it got re-termed in 2 yrs into a zero-coupon 7 yr maturity at 1.65:1 (165 of ppl on maturity vs todays 100 & bi-annual interest payments), you would have 165 (& a 254% return) in 9 yrs. Would the average residential property in that country have appreciated by as much when their economy was this bad? If you then bought a residential property in that country with your 165 (on maturity), does the FX risk really matter? And if this were your intent; haven`t you really bought that future house today (without the upkeep, & taxes etc) at 40c in the $? SD

Q1-2010 Canfor Results: http://www.canforpulp.com/_resources/news/2010/N100426_Q1_Results.pdf Absolutely stunning. - Higher prices, lower COS, higher shipments, FX offsets; same as expected for SFK - Record production quarter for some mills (tonnes + price); we know St Felicien was going flat-out - Ave price was $880 USD (CAD 916) ton; same as expected for SFK. - $1000 USD ton successfully implemented & they think it'll go higher. - EBITDA up 60% from Q4-2009. - Monthly distribution increased 66%. Similar type increase in distributable cash. SFK's Q1-2010 results are going to be very interesting indeed! May we all do exceedingly well ;D SD

Couple of notables: (1) Time. If you can wait for 'mean reversion' (private $) you'll do well, but if 'marketing' is driving your portfolio you'll get fired (OPM). And it happens because the multiple paid is P/E*(1+g)^n where 'g' is the company specific or industry growth rate (perception of) & 'n' is the number of years. The equivalent OPM market segment is really venture capital. (2) Volatility. If you can tolerate high volatility you'll do well (private $), otherwise you'll get fired (OPM). And the mitigants are your cash holding, the size of your weightings, the quality of your holdings, & the depth/quality/experience of your investment knowledge (ie: its no accident that the 'greats' are old). Notable is that once you have (2), the private $ advantage is a lot more than generally recognized. SD