SharperDingaan

bg What happens if the tipping point is a move from being re-active to pro-active ? He will have to go proactive at some point, & AIG has inadvertantly made itself the perfect target. All he need do is take the $ that AIG are now trying to give back & do a tender offer at $1/share

You have to understand that to do oil/ng drilling successfully, you need at least 4 things to come together: - You need a oil/ng field close to an existing pipeline network, & a (preferably nearby) market at the end of it. If the field happens to be in a 'safer' part of the world you also get a pricing premium for 'security of supply'. Market. - You need bankers willing to lend against variable & depleting reserves. If the formation is porous you can suck up all the oil/ng within maybe a 100 foot radius of your holes oil/ng zone, if the formation is tight its maybe 10 feet. The maximum loan is typically no more than 50% of the estimated remaining oil/ng volume in that 10-100 foot radius around that holes oil/ng zone x the estimated oil/ng price over the expected depletion life of the well, discounted at some risk adjusted rate. Geology & Price. - You need technology. Horizontal drilling puts more hole in the oil/ng zone (increasing loanable reserve) & lets you do many holes from one central collection point (reducing infrastructure cost). Fracturing increases porosity (increasing loanable reserve). Water/gas sequester increases reservoir pressure (increasing loanable reserve). Ability & Reputation. - You need reasonable drilling rates. The lower the cost/hole, the more holes/budget, & the better the odds of getting enough economic wells with a total reserve big enough to at least cover the drilling costs. Strategy, Risk Management, Total Cost. WRT to Precision Drilling itself - The GW acquisition has made Precision Drilling a 'top of list name' in the Western Canadian & NA Gulf Coast basins. They have proprietary horizontal drilling capability, & pricing power in that speciality. The speciality results in more revenue/well, but dramatically lowers the development cost/loanable reserve ratio, & is applicable to both on and off-shore drilling. - Their NA market is a 'safe' market & commands an indirect 'security of supply' premium. ie: Tar Sands is uneconomic at current prices but is continued because of its size & the security it offers - the ng to power the extractors comes from the Western Canadian basin, using wells that were in part drilled by PDS. A floor to drilling activity. - They have cut drilling rates & retain sufficient CF to cover their obligations. Other drillers will also be forced out of the business before they will, which will bolster that CF. They are increasing market share because of the value advantage to their technology. - The current industry low is a combination of low prices (reducing loanable reserve) & restricted lending under much tighter conditions. Smaller budgets, excess drilling capacity, & cut-throat pricing on 'simpler' wells that don't require sophisticated technology. But look forward a few years ... - If oil is USD 60/barrel on average, Tar Sands will be economic, & loan value will increase by 33% [(60/45)-1]. At USD 75/barrel loan value increases by 67%. More money for drilling, spread over fewer drillers, & at a time when a small increase in the price/barrel rapidly increases loan value. - If CO2 sequesture is the green solution to Tar Sands, resevoir pressure will go up & loanable reserves increase. Even more money for drilling. - The drilling increase will come at a time when PDS is more leveraged than normal, which will exaggerate the early eps & significantly improve CF. CF that has then historically gone to debt reduction to significantly reduce risk. Higher EPS, higher multiples, & rapid pricing growth. While the symbol will show up on the Graham screens, almost none of the business strength does. Don't automatically dismiss the cyclical commodities businesses out of hand. SD

PDS Great value by pretty much any measure, but you must understand their business. Very likely a 10-15 bagger within 3-4 years.

Thanks for your responses. We're inclined to think that he's going to make a deliberate example of somebody, & use it to establish historic precedent. AIG would seem to have burnt its bridges, its execs appear to be aware of it, & the culture seems to be that with 170B of fed money invested they are too big to fail. ie: Moral hazard. We suspect there will be a forced tender for the rest of AIG (citing legal requirement), an immediate revocation of the approved bonus payments (firings & lawsuits accepted), a fairly rapid anti-trust breakup, & a forced asset divestiture to the worlds other major carriers. Popular on main street, but death to Wall Street. - It would set a US precedent for nationalization, & stengthen the mechanism by which to force it. - It would set a US precedent for forceable breakup, when a company becomes 'too big to fail'. - It would establish US precedent as to when the fed can call the markets bluff. - It would add a blanket national interest override to compensation contracts. - Moral hazard will be contained, & there will be bodies to prove it. - The super-regulator will have teeth. He is also about the only person in the world who could do this - as it can only be done by someone openly transparent, who is very well schooled on the depression era, well versed on the streets 'culture', & who will never need to work on the street again. It would seem likely that he would also go on to become the super-regulators founding chair, & most likely lead a re-write of the Investment Act of 1930. May we all wish this man the greatest of success. SD

htttp://www.theglobeandmail.com/servlet/story/RTGAM.20090315.wbernanke0315/BNStory/Business Notables are the 'apparent governmental PR offensive', 'carefully hedged' very rare discussion in 'extraordinary times' with a media outlet, & a 'lack of political will'. AIG's 165M weekend bonus, & big banks won't fail on his watch though if neccessary the government should try to 'wind it down in a safe way' We realize that to some extent Bernake needs to 'talk up his book', but any thoughts as to why he needs to have this 'rare' discussion with the public ? It would seem to us that the Fed has reached a tipping point, beyond which the world is going to look very different (& for which there needs to be some political investment). Perhaps a very good time to be hedged both ways ? SD

Related to Cheap Guy Long time ago I moved from a competitor to a 'darling' company, & bought its stock. Peer pressure, knew the company, etc. - but unlike everyone else I also held puts on its major competitor. Every time my coy did a new issue & drove up the market, I rolled the puts up & out. Reality caught up & many of my co-workers became either deep underwater, or near bankruptcy in some cases. After curious questioning, & in sympathy, I quietly let it emerge that I had the puts & they were deep in the money. In hind sight it was about the worst mistake that I could have ever made, & eventually I had to leave the company. Lesson? We're all going to learn new/clever techniques that will save our financial ass, but which most of the general population will not know. Hopefully we'll get rich relative to everyone else because of it. Stay humble & don't tell anyone about it! SD

Keep in mind that Fitch is in a lose/lose proposition, & needs to minimize damage. They are not seen as credible as if you have to have a rating you go to Moodys or S&P, or you don't sell/roll the bond. A Fitch rating is an admission that you're desperate, & couldn't get what you wanted - & therefore of minimal use. Realistically it is hard to see how anyone other than a sovereign could have a AAA rating. The rating can also only set the base credit rate in that country, and a AAA rating across sovereigns is not comparable. ie: A US Fed AAA rating is clearly not the same as Chilean Central Bank AAA rating, yet they are both sovereigns, & they are both the best credit quality in each of their countries. The best public rating should really be no more than AA+ The best Fitch can do is come up with a new rating system, & take some hits along the way to re-establish credibility in how they get there. SD

Bit of a stretch but Canada may be a usefull example. The big money are the pension funds and almost all of them were down 15%+ last year; some were down almost 25%. Most of the big DB plans are being reviewed, & there is real possibility of contribution increases & reduced benefits. The first wave of boomer retirees is in 5-10 yrs, the viability of the long term investment rate growth assumptions is being questioned, & there is rising concern that ALM mismatch volatility (averaging net gains/losses forward) is not being adequately addressed. ie: The climate is demanding that asset managers deliver reliable returns with minimal downside volatilty. Fail to deliver, & you're gone. While most recognize that there are some terrific bargains, your career will not tolerate one of these bargains having an adverse credit event. It will also suffer some damage if you have a CDS to cover the downside risk, as you're only as good as that counter-party staying out of the bad press. ie: Dont touch unless absolutely positive (hedge), & keep each holding as small as possible to minimize exposure (career diversification) So what ? Pension funds will not go running, but they will very likely be super cautious. ie: Writing puts to acquire the underlying, cash + call combos to cover break-outs, quick to put on hedges to lock in a minimum level of gain, etc. Small repeat gains versus the big & widely dispersed gains of the past. Long tail investment 'float' funds will very likely be less cautious simply because they can afford to be. Especially when convertible cash yields are so high, there is a hardening market (same premium, but lower payouts from higher deductibles), & you also have the ability to lower UW standards if neccessary. ie: WEBs & HWs shifts are no accident, but they are also at the aggressive end of the current spectrum. The more pension $ in the institutional 'pool' the more caution - in Canada, pension $ dominates. Small rallies, & choppy trading, untill the career risk goes down SD

T-Bone we hear you. Our point is that should the run-up over the last 2-3 days turn into a 20% rally, don't go rushing all-in because you think we've hit bottom

Be cautious of the impending 'bump' as there are a lot of logic flaws. -An awfull lot of people need a big rally in order to recover cover losses YTD, but the intent is to hedge/sell into it so that further drops will not be as damaging. It can only happen if the money on the sidelines is dumb; & much of it is far from dumb. -We rally because 1-3 months of profit at certain key banks clearly indicates that the turnaround is working. But at any other time this would not be seen as a 'trend', especially when the underlying problems are still there. In the 1930's it was Morgan proclaiming in the pit, how is todays 1-3 months of profit not the same? - It is implied that only existing participants will sell/hedge, & that somehow dumb money will not short or write puts in any major way. Dumb & dumber is not a great way to sustain a rally. The opportunity may well be very short lived SD

Much of the price drop was technical - 02/23 it broke through the 50day moving average. Since 02/24; Volume accumulation has been volatile, but net neutral. Typically short covering. Market sentiment has flatlined (probably CDS/UW discussion). Upticked in the last day or so.

The less charitable might simply see a journalist hack attempting to curry favour with whom she perceives her next boss might be. I understand that the she is also thinking of writing a new book, which will sell considerably better if there are 'approved' references to certain individuals. A puff here, & a flatter there, ... or a well worn route dating back to Conrad Blacks time running the FP?

Its spilt milk at this point. The greater value is what would entice those folks back in. - From the roughly $400 high, todays close is down 31%. The 2008 low was roughly $225, 44% below the $400 high, & 18% below todays close of $275. The market as a whole was also a lot more buoyant when it made that $225 low, than it is now. - Q1 is usually FFH`s best quarter, but these folk have little reason to value at anything other than the average industry multiple (at best). Q2,Q3,Q4 are the more volatile quarters, & most economists are calling for further economic deteriation as we move through the year. Therefore bias to continuing multiple contraction. Best guess is short term stabilization in the 250-275 range untill after Q1 results are out, then more downward drift. You cant buck the market indefinately. SD

Pay more attention to liquidity as you will need to maintain around 130% of the contract value. If you're also doing this entirely with margin recognize that you're leveraging up your risk, so assume that the portfolio you're margining against will be down 30% on maturity date. As Eric has alluded, margin driven premature sales can really wreck your day. Assume: 1 short put @ 50 - It generates a put margin requirement of 6,500 [100x50x1.30] - At 70% margin, the 6500 requires 9,285 of unencembured marginable portfolio assets [6500/(1-.3)] - Anticipate a 30% portfolio decline & you need 13,265 of assets [9250/(1-.3)] But ... holding a significant portion of the 130% margin requirement as cash, will significantly reduce your portfolio risk. Liquidity. SD

Not that slippery, & its really only feasible if you're private money. Its essentially a version of the 'paradox of thrift' & its not untill too many people (public money, mass market, etc) do it that it becomes a problem. For the most part the first time you get whipsawed (hopefully at an inflexion point) you will be back in the security, however there is nothing to say that it might not drop again right afterwards. Its just a one-time mutually exclusive purchase, based on the best information that you have today. Its also self correcting as the lower the price goes, the more market $ on the sideline waiting for that 'trigger' event, the bigger the subsequent rebound, & the greater the market incentive to trigger it.

Eric: All we have is todays price & a chart of the historic price; you have to look at the chart & decide on what the trend is. Depending on your historic timeframe (minutes, weeks, months, etc.) you'll get different results. Look for the lowest point on the historic trend & set at 10% above that. Essentially using the technical approach where its best at. JR: You remain focused on the business & you've allready decided to own a piece of it. The only issue is whether you can reasonably expect to get it for even less. No different to waiting to replace your wardrobe untill Jan/Feb, in anticipation of a 30-40% off sale because its a slow time in the retail year. The sale might not happen, or may even be for less than 30-40%, but most would think it worthwhile to wait.

Consider what market timing really is. Assume the IV of coy X is 600, the fundamental value is 400, & it trades at 200. I dont buy today because I think it'll be lower tomorrow - & tomorrows open will prove it. It is effectively a casino bet on either higher/lower. In fact, this is extremely rational behaviour - We live in a world of business cycles & they bias the daily quote direction. In a down cycle even if I'm wrong today, tomorrow & the next day; I'm still likely to be right more times than I'm wrong. Therefore I have an incentive to wait. - 200 reflects a logic error in the market view. Not buying today is a bet that the error will still be there tomorrow & possibly more irrational still. A reasonable risk as logic errors typically take same time to recognize. Or in market parlance 'no change untill you can show me the money' - Worst case I'm wrong, & the price starts going up drastically. An automated buy at 10% above the low will cut the opportunity 'loss' to -20 (200-220). Against the opportunity 'gain' of 200 (400-200) Value investors suffer downside volatility because we typically buy too early. - We'd buy at 260 & gloat that we have a 35% MOS to fundamental value, & a 43c $ relative to IV. Then suffer buyer remorse because a market timer subsequently picked it up at 220 on a bad day, & we have a 15% unrealized loss. Most of the investment world are not value investors SD

CDS's should be banned entirely, & made prosecutable under RICO laws. Simple example. - Buy an insurance company with longer tail business - Pump up its premium by UW badly - Reach for yield & write CDS's to boost P&L & raise cash to cover the UW losses - Do successive equity issues to fund acquisitions & capitalize costs, further boosting P&L - Buy a CDS on yourself, put the coy in Chapter 11, & put the book into runoff. You walk away scott free, as the guy who sold you the CDS covers your losses. You knew the CDS purchase was integral to your strategy. It could not be executed without it. It is hard to see how this is not white collar criminal behaviour. The CDS enabled & abetted a criminal act.

Quick mechanical example: Assume head-office (HO), & 3 seperate legal entity subs: Asia (A), Europe (E), Canada ©. Each sub controlled by the local regulator, & each sub holding an asset reserve to back poilcies written in that market - assume 104% of the liability for Asia, 102% for Europe, and 103% for Canada. Assume hed office has 50 in assets & that local regulators generally defer to the 'home' US regulator. Assets: A (104), E (102), C (103), HO(50) Liabilities: A (100), E (100), C (100), HO(40) Equity: A (4), E (2), C (3), HO(10) Now assume HO decides to do CDS's with the market. There is relatively little risk involved, & material additional income - so they do it using 10 of equity & get 2 of premium. What happened ? They securitized the equity. Because this is off BS, HC liabilities stay at 40, assets increase to 52, & equity increases to 12 (20% increase). The original equity investment is still there, but its now really zero because of the additional 10 of off BS liability. Bonuses get paid. Assume the P(x) of having to actually pay the 10 of HO equity is 5%. The strategy is working, there is no bad experience, so go to 200 in CDS notional value [10/.05] over 2-3 years. Bonuses get bigger. What works for the HO portion of equity also works for subs, & HO is doing fabulously well. HO issues A, E, C a high yield internal receivable for their equity & does 180 in new CDS notional value [9/.05] over 1-2 years. Regulators have little say as the equity is 'cushion' & the credit rating of AIG is better than the equity they've given up. What happened ? 380 in CDS notional value, supported on 19 of equity in generally poorer investments (assumes cash from the premiums pays bonuses, raises, etc). Bonuses continue. AIG has a series of off BS liabilities at varying terms to different counterparties. As A,E,C are seperate legal entities they are also potential counterparties, therefore some of the A,E,C assets could go into this scheme. Requires regulatory approval, but the 380 of existing CDS exposure will be less risky as its now supported by 19 of equity + some assets. Assume the home regulator permits 100% of assets C's regulator baulks, & wants MTM on the equity investment. A & E's regulator defer. 4120 in new CDS notional value [206/.05] over 2-3 years & bonuses get really big. What happened ? 4500 in CDS notional value, supported on 225 of equity, HO is so big a part of the CDS market its now a price setter, A & E's assets to support their business is illiquid, & there's extreme reliance on the premium cash flow continuing. Markets start tanking, the P(x) goes from 5% to 10%. The 4500 of CDS notional value now requires 2250 to support it, & AIG is technically insolvent as it only has 225. Worse still, the 225 is rapidly falling as AIG is having to make good on its promises. Major names start falling & AIG starts selling. Premium declines & P(x) increases to 15%. AIG hits up the fed Assume the fed did mirror swaps to get the HO derivatives out of A & E & prevent these units from collapsing. The units then go on the block. Assume A gets sold. A's buyer would have 104 of assets (a fed backed notional CDS notional value of 2600) and 100 in liabilities, but would have to take all the liquidity risk on those liabilities suddenly claiming (hurricane, etc). IE: You would not pay much, but if the fed didn't sell - that liquidity risk would be theirs as well. There is a lot more here than meets the eye. SD

Each national regulator where AIG operates will have 'tied' reserves, to back the business done in that country. But most national regulators also allow derivative 'netting' to include the notional amounts, which effectively transfers that 'tied' reserve to head office in return for a head office derivative receivable. And if head-office craters .... those head office derivative receivables become worthless. IE: You're suddenly UW with a near zero reserve. As Canadian regulators typically don't permit the inclusion of notional amounts, the Canadian exposure is limited to the MTM - which limits the Canadian contagion. Most folks haven't realized how adversely volatile AIG really is, & why. - Essentially every time there's a 'normal' UW loss almost anywhere in the world it will require a new fed bail-out as there's no reserve. And we're approaching spring/summer when weather gets more volatile. One disaster almost anywhere and ? - That AIG head-office derivative receivable is now a fed obligation untill the last head-office derivative matures, & while the buyer of a unit will effectively substitute their credit rating for AIG's - they will not reassign those head-office derivatives as the fed rating is better than theirs. IE: Free reinsurance, in huge quantities, for a very long time. WEBs weapon of mass destruction ? SD

61%, but we have some synthetic hedge committments. We just do not see much reason to hold equities or FI at this point. Once inflation starts to bite in 18-24 months, yes, but in the meantime what's better than cash?, & at a <1% opportunity cost !

You might want to keep in mind that these are two masters at their own facet of investing, & that their processes both rely on human frailties in order to work. WEB essentially waits for the price to fall below, & then rise above, his estimate of IV net of MOS. A static approach that uses time as its major variable. Soros essentially looks for inductive logic fallacies & takes the other side of the trade. A dynamic approach that uses human behaviour as its major variable. Both use 'Mr Market'. WEB takes him up on his 'irrational' offers, Soros takes the other side of his trade. Then consider that Graham was in many ways a combination of the two. He essentially challenged the accepted convention (Soros?) & came up with a different approach that has since been improved on (WEB?) Who's better? is not really a fair question. SD

We rather think that the panic has now become self generating. Have you noticed that everytime you do an option tree, the downside P(x) and downside $loss keep getting bigger? ie: The incentive to stay in T-Bills & use options is increasing, pushing equity markets downward, & reinforcing the T-Bill decision. Have you noticed that everytime CNN/Rueters/Bloomberg reports, its sensationalized bad news - but very sanitized news?. Deliberate avoidance of the 'Depression' word ? Deliberate avoidance of the 'Nationalization' word ? - despite ownership positions so large in some cases, that takeover bids are actually a legal requirement. Have you noticed that market 'circuit breakers' are either suddenly not working, or not being reported ? Is it really coincidental that every circuit breaker around the world hasn't tripped in the last 4 months, despite record falls ? Have you noticed that for all the G8, interest rates are now pretty much as low as they can possible go ? & at this point about the only thing Central Bankers can do is print money & nationalize. Hard to see how one gets out of this; but a week long simultaneous closing of all global financial markets, concurrent with nationalizations, & a media reporting ban - has to be getting some play now. The ultimate 'circuit breaker'. Most folks are very short-term orientated, & simply 'taking the cheese away' will set them off. The media also has a vested interest in seeing it happen. Keep your eye on what happens if you wake up one morning, & suddenly find everything shut for a while. SD

Quick reply - you will need to go through the SEDAR records to get more accurate numbers. The debenture prospectus should give you some more names. There are a number of parties with a just under a 10% holding. Significant as if you hold below 10% your name doesn`t have to be disclosed in the annual AR meeting notice. The end of 2008 saw Cundill rebalancing. Don`t know where it went but its likely that other significant holders used the opportunity to average down. Abitibi took 25% of the units when the trust was established in 2002. Assuming there were only nominal interim sales, they have roughly 9%. We would suggest that they would very much like to get rid of them now, & that there are currently no buyers. Most of the debs are very likely held by the under 10% holders, & they are unlikely to convert before they mature. Deb to pref conversion & repricing will continue the status quo & improve certainty. Debt to Total Capitalization is very likely the covenant ratio, & as such is a little `looser`(includes plant `valuation`). A wise banker would prefer the `tighter`Debt to Equity covenant & would likely insist on it come 2010 - in return for allowing the current portion of debt to roll-over. I would expect that management is looking very closely at the P&L & inventory levels. Pulp swaps are probably very high on the list (ie: you run your plant flat out for X weeks, meet my new orders from it, & allow your workers to qualify for EI - then I do the same for you with my plants) followed by FX hedges, interest rate swaps, gas hedges, consolidated chemical purchases, & electricity. If they can burn waste oil or bio mass for energy (essentially free) I would expect they will. Cheers SD

What's your mention of problem re current securities laws about? If your direct common holding exceeds 'X'% of the total common outstanding, you're required to make a bid for the entire company. In practical terms if one of the existing investors simply bought the other out, they would exceed the threshold & have to make an offer for the entire company. However, if that investor had a convertible with a conversion price above todays price - they wouldn't have to make an offer, as theoretically the share price may never get to that conversion price. Hence the need for SFK itself to act as intermediary. The rule exists to stop creeping takeovers. While a takeover is not the intent here, there will however probably need to be a higher than average conversion premium because it converts to a control block. SD