SharperDingaan

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

Just back from vacation in the GCC. Will post once we've had a chance to go through the numbers. SD

Much of the reason for the Japanese experience dragging on so long was the refusal to write-off debt, as insisting on debt repayment by force feeding public sector borrowing (koo approach); meant that it took years for private sector liabilities to decline. As debt repayment, & no new borrowing, dramatically increases regulatory capital; there is a growing & more than ample capacity to write off/restructure bad debt. Furthermore there is no income loss if the debtors are forced to issue warrants as part of the price. Do this with AIG & you'll have new owners. Whether you'd do it or not depends on what AIG's existing interests put your way, to persuade you that its a bad idea. SD

Keep in mind that non-owner-occupied is typically a condominium bought off plan with maybe a 30-40K DP (7-10%). The non-owner-occupied bought early (to get the project off the ground), & probably received free upgrades, GST rebates, 1st time buyer (one per kid) credits, & 2 rounds of inflation increases during the 2+ years that it took to get built. There is a strong incentive to buy the biggest/glitziest condo possible, retain it for 6 months following possession, & then sell it off for a tax free gain. At 5% DP the non-owner-occupied didn’t need to put up any additional cash on possession as the initial deposit covered it. Now that non-owner-occupied suddenly needs to come up with a lot of new cash, & the bigger/glitzier the condo the more that’s needed. Either the non-owner-occupied almost immediately prices down & dumps (increasing inventory & deflating the bubble), or puts up more capital/condo (reducing the overall risk in the market). Notable is that the 5% DP still applies to 1st time buyers, but is subject to the tighter means test; so for now - our flipper has a market for their more basic condos at lower prices, but not their glitzier varieties. Once the turn-over has occurred, most expect that minimum 5% DP to change to a 10% DP & a maximum 30 yr amortization; another round of market risk reduction. Very elegant. Of course if you’re one of non-owner-occupied with a big & glitzy condo you might have a different opinion. As might the army of ‘designer’ folk whose job it is to make your place look glitzy. SD

Keep in mind that this debt is relative to income & it doesn't have to be paid back strictly from cashflow; debt to equity swaps, asset sales, & higher income would all contribute to a solution. The issue is not new, & there are many well worn local level solutions. Eg: A common failing in many 2nd world countries is debt overextension by younger couples, buying all the 'must haves' being sold to that generation. Big wedding, Mc Mansion, 2nd car, etc with negative cashflows financed via various forms of credit. The solution is usually a 51% sale to 'family', at market price, with the 'family' paying the bank vs the couple. The couple gets told to put up some nephews (so they can get a job, & pay the 'family' rent) & use their cash flow savings to pay down their debt. The couple either accepts or goes bankrupt, if they change their mind/divorce the 'family' uses the majority control to sell the Mc Mansion. Deleveraging, moral suasion, additional income (nephew earnings), etc ... & the same end solution. Of course the couple isn't thrilled, but the 'family' didn't f**k *p either. SD

Look a little closer at the debt #’s of Greece, & compare them to the State of California - they are effectively the same. Then add to it that Greece’s place in the EU is very similar to California’s place in the US. Virtually everyone recognizes that the Greek standard of living is going to drop, quickly, & with a lot of civil unrest. So why is California so ‘special’ ?? A couple of hedges on Californian banks could be a lifesaver. SD

FFHWatcher: The economics are really more comparable to a drilling company; feast for a period when the commodity is booming & starve when it isn’t. The multiple moves with position in the cycle, industry herding, and the pace of investor turnover from value to momentum. Most would top it out at roughly the directly comparable CFX cap of 346/92M (3.75/Unit). To get more they would effectively need to merge, & do it at a price that also reduces debt ($4.90 for the debs). Were it CFX there would be no tax hit, CFX could make higher distributions, & the CFX cap would rise; were the cap to rise 106M (31%) to 452, SFK would top out at 4.91 (452/92) & the 47M+ of debs would convert to equity. If there’s a 10% (35M) merger premium & a minimum 25M in distributable SFK cash, we’re pretty assured of conversion. Both companies would get more if they sold to a new entity, & that entity used the consolidation/savings to change the capital structure. Given the players involved, & that both entities have to come out of the trust this year, fine minds may well come up with something. Speculation at this point, but it would seem fairly likely that 5.00/unit is quite doable. The real question is whether it will actually occur or not. SD

Myth: A scan through the last years worth of SFK threads, & the Sedar AIF, will give you a fairly good background. Valuation is in the eye of the beholder. SD

"A herd instinct dominates the money management industry. ... if you were among the 5% who went against the herd and bought stock B, and it goes down, everyone says that you are a dummy. The reputational and career risk of being a contrarian is far greater than the risk of going with the flow." Source: The Little Book of Value Investing, Chapt 20; You can lead a horse to water, Chris Browne, 2007 I'm pretty sure I know who the 5% are! SD

Al The working number is roughly 10x FCF of .45/unit, or market cap of 414M. At 5.50 the market cap is > 500M, starts to materially exceed CFX - & changes the buyer/seller. Good/bad depends on how soon CFX comes out of its trust, & in what form. Re SFK, it can only be good. Its highly likely that fine minds will add value well beyond the $5 mark, but the days of < 2.00 are pretty much over. The problem is going to be safely managing the price expansion :'( SD

They will need to bring their 2009 taxable earnings to zero, & do it via reserving or write-offs. Debt defeasement (qualifies as reserves) to retire debt early is the preferable route to draining off excess earnings. They have to come out of the structure by 12/31/2010, & will probably deal with the 2010 build-up as a one-time payout on dissolution. Because they are effectively unable to distribute (covenants), they make an especially good (self financing) takeover candidate. Unlikely we'll see distribution here, its going to be share price appreciation instead. $5-$6 on a take-out is quite realistic. SD

You might want to keep in mind that 'value' benefits are almost always referenced in terms of a compound return relative to the index. Perfectly correct, & looks great, but glosses over the very lumpy & often negative returns incurred along the way. The reality is that you'll make errors, they'll be costly & potentially even fatal; you'll look like a dunce. You'll look like a hero if you recover; & if you're good at recovering you'll look like a hero more often than you look like an idiot. Taleb's just looking at the errors. SD

The reality is that we'd all be a lot better off if the shares traded at about the price of Sched-A banks & the traditional 'widows & orphans' stocks. TSX index membership, broader institutional ownership, greater liquidity, higher float, etc, etc. But it also means change. No more multiple voting stock, less influential control blocks, less family & more public ownership, etc. The baby's growing up & its control structures need to grow with it. An eventual share split is probably enevitable (even BRK split), but in all likelihood a good decade away yet. SD

You might want to reconsider AIG. Selling the parts puts them into stronger hands & increases the competition. Keeping the parts ensures that we continue to get stupid policy pricing for a couple more years yet. At best, constrained top line growth. Costs continue to escalate at inflation+, there is stronger incentive to defraud, & little prospect of industry consolidation. Short-term assets are earning minimal returns, business is not stable enough to warrant mismatching asset/liability terms, & for many (net of investment writedowns) - reserves are on the 'light' side. Yes they are cheap, but cheap enough ? unlikely. Worth writing out-of-the-money puts on ? possibly SD

We would be very dissappointed if CFX didn't place a call, but .... Going from CFX's #'s we'd expect SFK to trade north of $2.00 almost as soon as they announce their Q4-earnings. We'd also expect to see the forward co-generation earnings priced in, & a healthy 'merger' premium attached. Then a discussion starting at something above the $5.00 range, so that deb holders can convert. Most folk would likely sell if they saw $6.00 again by year-end, & use the opportunity to rebalance in 'new' CFX. Leaving a 6 bagger ((6.00-.85)/.85) on the table, doesn't make a whole lot of sense. We're always hopefull ;D SD