SharperDingaan

"if you expect positive GDP growth, the higher the P/E the more of a margin of safety you have". Sorry this was a miss-keying; it should be if you expect positive GDP growth, the higher the GDP growth, the more of a margin of safety you have. The future dated P/E formula is P(1+i)^N/E(1+i+g)^N. P=Price paid today, i=inflation, g=GDP growth, E=current one-year earnings estimate, N=holding period in years. As i is in both the numerator & denominator the formula simplifies to P/E(1+g)^N. I sell a good for $10 that has has a $6 VC; CM is $4. Assume I have 10% inflation & can pass it on to my customer. I now sell at $11.00 with a cost of $6.60; CM is now $4.40. If most of the fixed cost is depreciation or amortization (doesn't change with inflation), & labour cost raises are 'sticky' (usually the case), most of extra $0.40 in CM will flow to the bottom line. Earnings go up. To buy any business is to speculate that its future growth will be at least the GDP growth rate. Buying NT at 120x earnings is to speculate that NT's future earnings are going to 10x what they today (if a 12x P/E is reasonable), & in pretty short order. Ridiculous of course, but par for the course when looking at start-ups! Cheers SD

There were 3 things to note: (1) Doubling or halving the multiple effectively produces the same MOS (barring a very small mathematical delta). ie: The MOS is almost entirely a function of expected GDP. (2) Both inflation, AND deflation, reduce the day-1 multiple the longer you hold; & they do it by about the same amount (slightly more for deflation). ie: The MOS is almost entirely due to the length of the holding period. (3) If todays GDP growth is negative - the multiple is actually much higher than it looks. Here endeth the lesson. SD

Hate to tell you this, but we bought most of our shares in at about the same level - & still have 'em ;) SD

Revaluing or imposing a border tariff achieve the same result, but have very different optics. Can you really see the US government almost instantly raising the sale price on the goods sold at WallMart (which are primarily imported) because they suddenly put a tariff on them? And when those most reliant on those low prices, are the populations in the S & SE who've just lost the Health Care debate? China slowed its roll-overs this week, & the T-Bill market almost went no-bid. If you want to trade; then learn some cultural manners. Employing a little 'face' could go a long way! SD

"Please could you elaborate as it flies in the face of conventional wisdom that the lower the multiple the more the marign of safety" Assume inflation is 2% & GDP is 2%. If you simply bought & held for the entire payback period the P/E you paid today, recalculated at the end of year 12, would fall to 9.51x from the 12.00x that you actually paid. If nothing changed, & you held for the full term, the 2% GDP growth alone would give you a 21% margin of safety [1-(9.51/12)]*100. Recalculate using the same 2 & 2 assumption, & a multiple of 25. Then recalculate using a multiple of 12; & a -2 & 2 assumption. Very different effects. You're looking at what GDP does, deflation does, & the length of the holding period does. Then look at WEBs actual practices ('buy & hold forever' & Burlington Rail). The old guy aint bad. SD

Always keep in mind that even if the P/E multiple (assume 12x) for both a casino operator, and a big integrated oil, are the same; it does not mean that they are priced equally (despite what the textbook says). It really means that if you bought today it will take 12 years to get your original investment back, without regard for inflation (2), and only if the future earnings are the same as todays (1). (1) Earnings volatility. The business cycle produces higher earnings at the peak vs trough; some industry cycles are shorter & more extreme than others, and some industry earnings are more predictably reliable. Your purchase locked you in to a certain point on the business cycle for the next 12 years;tears if you locked in at peak earnings. You also locked in an annual $ amount of earnings, & an early shortfall will hurt; volatility is not your friend. The integrated oil is the better choice. (2) Inflation. Assume average inflation over the 12 yr period of 2%/yr, & GDP growth of 2%/yr. The future value, adjusted for inflation, of today’s $12 investment is $15.22 [12*(1.02)^12]. Earnings should increase by at least the inflation + GDP growth rate, or 4%/yr. The future value, adjusted for inflation, of today’s $1 of annual earnings investment is $1.60 [1*(1.04)^12]. All other things equal the P/E multiple at the end of year 12 should be 9.51x [15.22/1.60]. Points? (A) if you expect positive GDP growth, the higher the P/E the more of a margin of safety you have [ WEB’s Burlington Rail] (B) If you expect deflation (& economic intervention) you want the lowest P/E possible as the future P/E multiple will be less than what you paid; ie: FI becomes the better bet [Hoisington]. The lesson here is recognizing that there are 2 applications; 95% of the population will do nothing more than calculate the industry multiple, develop a company specific earnings estimate, & multiply. Buy if the shares are underpriced, sell if they are overpriced. But maybe 5% of the population goes that extra mile to actually understand the ratio. Nothing magical. Guess where WEB is. SD

Yes they were imperial bastards, but they were also extremely good at what they did - & the basic model worked in pretty much any location (India, South Africa, Canada, Hong Kong, etc.) Some of the 'unpopular' but extremely practical legacies, have been English as the 'language of business' - & the 'colonial' universities using the 'English' educational system as the matriculation screen for an extremely limited number of places. Graduate only the best & the brightest, in something very similar to the old Chinese 'madarin' system, & have all your future leaders in one place during some of their cultural 'formative' years. Of course if you're in the 98% that didn't make it - this is a terrible system! Most local indians speak the common language of their state, & English; without English, even talking to the guy in the next state would be extremely difficult. Rather than reinvent the wheel, learn from those who've allready worked the bugs out! SD

Hoisington has a very good article in this month's CFA Institute Conference Proceedings Quarterly that lays out the technical case, in simple terms, for US deflation. While not new to this board, the case is pretty compelling. Even we're starting to see lots of small caps with solid managements & great potential, that are quite literally going for a song. We're also seeing mid/large caps being ignored because investors dont fully understand the seasonality and/or temporary changes in their business (PD.UN). And if even retail can see it? But.... we're seeing very little on the FI and/or cross-currency side. Given that the probability of Cdn rate hikes is now far higher than it was, there should be a rash of refinancing - yet there hasn't been. The $C has appreciated 13% against sterling over the last 90 days - yet there's been no rush to UK gilts. The clear inference is that treasurers either cannot re-finance (unlikely), or they must think that their real cost (rate+sweeteners) will be lower in the future. Same as Hoisington. There's a tendency to see only equities, look at fixed income. You may be surprized at what you see. SD

Keep in mind that P&P is a cyclical commodity business; no different to mining, oil/gas, etc. It is inherently unstable, & you're really investing in the current cycle (point within it, relative strength) versus the individual coy. Its buy & sell; not buy & hold. However were the industry to restructure & consolidate there would be a sizeable & permanent capital gain, over & above this cyclical gain. But to get this gain you had to be institutional, have bought in sufficient quantity to effect change, & bought some time ago. Its a small club, & the players know each other. We`re comfortable as we`ve long recognized that there are 2 cycles here; & todays pulp prices & conversions are making it far easier to execute. We`re not that concerned with todays model (other than its sufficiently profitable at current levels) as we don`t expect SFK to still be independent over the next down-turn. As we can easily hedge, we also don`t need either of a merger or a high pulp price. However, we do need to be able to recognize when the cycle is turning; & we think we have some time yet. SD

We hold both common & debs, in a concentrated portfolio. By definition, we're overweight. The positions were added to some time ago, & we have not added since. SD

In practical terms SFK should move up, simply because of higher pulp prices & the global shortage of pulp. A higher average sales price, & a lower fixed cost/ton from higher throughput; should have increased margin quite a bit. Add the CM from additional volume, plus labour & pension savings, & we should have enough of a good Q1 to go > $2.00/share. But they aren't going to run-up until they can show positive earnings, a healthy EBITA, & an end to the 'kitchen sink' charge-offs. An early end to the charge-offs will a game changer, & go some way to demonstrating managements intent & confidence. We would actually prefer to take CFX stock - but not until we know the outcome of the reorg & whether they've been able to refinance at a lower cost (Q3). In theory a 1:50 yr cycle should have legs, so merging now is to sell out too early; alternatively a merger soon after re-org (for CFX stock) would maximize short-term value (direct P/E comparisom if SFKs post re-org structure is the same as CFX's), & extract consolidation savings/security of supply benefits for all (shareholders, management, & labour force). If nothing changes; > $2/share post the Q1-2010 earnings announcement. If the charge-offs stop; > $3/share. SD

$1,000/ton for NBSK may be a little closer to reality than was peviously believed ;) SD

Isn't this really just a debtor (US) saying to their lender "If I go [because you didn't revalue], you go", & the lender telling the debtor "I'll survive, but you will not". Lots of threats & grandstanding, but behind the scenes ... they eventually reach a compromise. No one can get anywhere by publicly calling the other guy an idiot. SD

You might want to look at how this selling model has evolved over the years. Your underlying premise is that because you dont need 'bricks & mortar' storefront you have easy scalability & minimal infrastructure. Yet today, most vendors selling primarily through the net - have at least a few bricks & mortar stores. Sales just work a whole lot better when folks can see/feel the product, & the store showing them has your logos all over it (even if you're just transactionally 'renting' the storefront from someone else for a fee). What's more profitable? Long or short There's a valid case for long term hedging, & covering the hedge at a gain every time bad press hits them; ie: competitors, reputational risk, adverse earnings surprizes, & leverage now work for you, vs against you - so long as there's a reasonable probability of ongoing 'events'. Putting an idea to scrutiny is about generating alternate insights that would never have been otherwise considered. Keep an open mind, & possibly learn a thing or two. SD

There's something they aren't telling you. Put up $2 today to buy $10 of stock with $8 of loan (loan at 80% of MV) Tomorrow they call your loan in at $6.4 (80% of the $8 loan). You're sold out at a $3.60 loss (6.40-10.00), but you only put up $2 of equity - so who took the other $1.60 of loss? If this is truly non-recourse it can only be the lender, & that makes no sense at all. Or is it really ... Put up $10 today against which you can borrow $8 to buy some other asset, so there is now $18 of asset (10+8) supporting $8 of loan? If the lender is adament that its the former, you'd buy something risky at a little less than the highest leverage possible - put no new cash in, & let the lender eventually call you. SD

This is an everyday margin loan callable at 80% of MV. In Canada its callable at 70% & you pay floating rate on the amount borrowed. In the US - look at TD Waterhouse. It is recourse. If you cant repay within 5 days of the margin call, the broker can sell the stock & use the sales proceeds to repay the loan. If the proceeds aren't high enough to repay the loan, the shortfall is the brokers problem. The lender in your example is making a fix-float spread on 80% of the market value & hoping its more than enough to compensate for the higher shortfalls that they will encounter because they're lending at 80%, vs 70% of MV. The client is virtually certain a higher cost than would otherwise be the case. SD

Keep in mind that FFH is a long-term investor & many of these other bids are effectively straw-men. If they buy now they are buying at liquidation prices, averaging their cost down, & essentially just re-cycling their portion of the sales proceeds. As long as you know how to actually produce & distribute newspapers (Torstar), a newspaper is actually a cash cow; you blow up when you over-leverage against that future cashflow, & forget that it can materially vary. 5 years out the purchase will look like a steal, FFH's cost base will be well below the then market cap, & the story will be all about how prescient FFH was. They will have avoided a permanent capital loss, & hopefully sold to escape drinking the cool-aid. This is what FFH does, & it does it very well. Good on them. SD

Slightly different perspective: If this is a good business then why is it distributing 100% of net earnings every year ? As most business do not have a payback of < 1 yr their expansion related working capital can only be debt financed. Thefore the bigger they get the more leverage there will be, & at the same time that the business is becoming harder to manage. Tears are almost enevitable. It’s a tough business & they are selling on price to either those whom the factory will not sell to directly (retail), or those who don’t want to go to a bricks & mortar store. So wouldn’t there be above average credit risk (factory refused because of the clients bad credit) ?, & above average reputational risk (their 3rd party distrubuted sub-standard tyres because they didn’t think they’d get caught) ? Drive on enough rocky roads & you will get a puncture. The payouts could be interpreted as a slow liquidation - either because the majority owners are overinvested (capital re-allocation), the business is effectively not marketable, or the banks will not lend any additional $ without additional collateral. Be sure you know what it is. SD

http://www.foex.fi/ NBSK forwards indicate global prices > 900 for at least the next 6 months, peaking at a little over 940 in April-2010. You have to think that if they have any spare production capacity at all, they will selling forwards - & using that surplus capacity to meet their commitments. Maximum throughputs & rock-bottom cost of sales coming up ? SD

Over the next 6 months why would you NOT expect to see a fall of at least another 25-35%?, esp once the costs of the recalls/damage control starts showing up on the financials. And at that level wouldn't you expect to see a little strong arming of domestic pension institutions? Much too early yet. SD

Very impressive numbers going forward, but you really have to treat 2009 as an outlyer. If nothing else happened in 2010 there will 4.8M of savings/yr (4.0 operating, 0.8M pension). Given their now much stronger financial position, we think they can also refinance the 156M of LTD upon conversion at roughly 150-200bp less than they currently pay (2.3M/yr, or 1.1M over the last ½ of 2010), & they will also make some healthy savings on the commodity inputs (assume 0.85M). Net result is a fairly reliable 6.75M saving, or $0.07/unit. They have tight inventory & both Chile & Norway will be out of service for a while. If NBSK averages 880/ton for 12 months they’ll take in an extra 22.8M [(880-820)/10x3.8]; if RBK averages an extra $20/ton, there’s an additional 7.6M. If you assume FX parity for 6 months there will be roughly <8.5M> of offsetting FX loss [(.0563/.01)x3x6/12]. Assuming no production ramp-up - a net incremental 21.9M of revenue, or $0.24/unit. Most bankers would negotiate a sliding scale penalty for refinancing. Assuming that the debs end up extended/re-opened/’re-termed’ during the process – an incremental 4-6M charge on conversion is a distinct possibility. Charging vs capitilize also reduces thepotential need to pay a balancing distribution on conversion. If they ran the plants flat out to capitalize on the Chilean & Norwegian misfortunes, much of the penalty charge would be covered by incremental margin(s). Notable is that we’ve excluded any electricity margins, & have used a ‘low’ 2010 average price for NBSK. If we got $900/ton for 9 months, there would be an extra $5.7M [(900-880)/10x3.8x9/12]. IE; there’s a healthy margin of error. Assuming base 2010 CF of $.44/unit, adding the $.31 (.07+.24) of increment produces $.75/unit. At $1.25/unit we’re only paying 1.67x CF; we should be paying at least 6-8x. Notable is that 7x CF is $5.75/unit, & above the debs conversion price. Re disclosure. We hold long positions in both the debs & common at cost bases materially below the current market values. We live in interesting times ;D SD

You might find the last few pages of this very useful http://www.ciaa.org/Luncheon%20Speech%20Why%20insurers%20fail%20Lessons%20for%20the%20current%20environment%2011May09%20FINAL.pdf SD

Schooling (MBA, CFA, etc) can make you a more effective investor, but you also need the innate ability to come up with your own applications/innovations. You have to have both, & be mature enough to realize it. You also need interest & competency. We’re accidental investors, as we don’t have the capital to buy adequate owner-manager stakes in the companies we like. Taking the business versus investment view lets us practice, & if we’re any good – build the necessary capital the old fashioned way. By extension - we might do well as CFO, but suck as PM; similar skill-sets but different application. SD

Its usefull to think of it in 2 seperate streams. Long-term its pretty clear that FFH will trade higher & double roughly every 4.5 years (72/16). Better than the index, & denominated in CAD. The broadly comparable US equivalent is WEB. Short-term you may want to look at hedging the multiple into the AGM, & covering over the summer doldrums. Just be sure that you're comfortable with the Zenith exposure. SD

Couple of first impressions: - Q4, & 2009, looked a lot worse than we expected - but an awful lot of it is cosmetic. Suspect they've taken every provision/write-down possible to get the taxable income to zero. Great going forward, not so hot for the current quarter/year. - Conversion timing is pretty much dictated by CFX & resources. There are only so many appropriately qualified accountants to go round (200+ trusts converting over 2010), & SFK can't afford to have CFX convert before they do (accessing new capital that will virtually guarantee a raid). - Tone, messaging, focus on charge-off vs capitalization, forthrightness have changed. Long overdue, but judging from the MD&A content its highly likely that SFK is 'in-play'. Too early to assess eventual outcome, but they seem to be listening to this board. - Don't knock the analysts. Worst case we lose $ if we're wrong, they will lose their jobs - a very different risk/return profile. Their impact will become obvious once results start showing. - Interestingly there's no discussion around their sensitivity to interest rates. The conversion timing makes it highly unlikely that they'll be paying higher rates from July 2010 onwards, & virtually all the debt could be refinanced at much lower rates (assumes no major interim changes). Given the demonstrated charge-off vs capitalization preferance, a Q2 'refinancing penalty' charge-off on conversion - & a 75-150bp interest saving going forward? SD