SharperDingaan

Keep in mind: The risk free rate is the lowest cost of funds for all borrowers in a sovereign state – because the least risky credit is usually the sovereign itself, it is usually the sovereign cost of borrowing. • Corporations within the sovereign can have better ratings than the sovereign itself (common during many of the various Latin American debt crisis) • The risk free rate is not the same for each sovereign (Germany is less risky than Greece) Increase the sovereign cost of borrowing, & you increase the cost of borrowing for most of that sovereign’s citizenry. The US either cuts more spending, or raises taxes, to cover its additional cost of borrowing. But the USD is also the global reserve (store of value) currency. The whole world has to buy USD denominated debt to store its surplus, & it buys the debt of the least risky credit in that USD denomination. The least risky USD denominated credit has to be AAA, it has to be able to issue enough debt to absorb the world investment demand, & it gets to borrow at the lowest cost of all sovereigns - & set the base cost of borrowing for all other sovereigns. • When other USD denominated debt issuers (sovereigns, corporations) have better ratings than you do, the world goes to them first - & only comes to you if those issuers were not able to issue sufficient quantity. If you can get refinancing - your (& every other sovereign with your rating or worse) cost of refinancing goes up (crowding out). • Drop too many ratings, & there are so many better credits ahead of you that you have to outbid competition through rising premiums. Lose reserve status & US unemployment rises. Assuming something approaching the unadjusted 9.5% Eurozone average http://www.bls.gov/ilc/intl_unemployment_rates_monthly.htm, applied to the existing 9.1% rate & 310M US population – about another 1.3M people (+ another 1.5M for every .5% spike in the US unemployment rate). Obvious opportunities, but the long term solution is probably the SDR (Special Drawing Right) as the global store of value, & relegation of the USD, Euro, etc to regional trading currency. Risk calibration returns to ‘normal’, spendthrifts pay their freight, & savers (retirees) earn enough interest on their deposits to retire on (a primary retiree problem in most western nations). The debt limit theatre has demonstrated to the world that the US is incapable of making the societal decisions necessary, & that change is highly unlikely for at least another year. The world is done being held captive, & is moving on. May we all never have to experience it again. SD

The results are actually very good. Full-year EBITA should be about 65M. At 5.5x EBITA, price should be around 2.74 Margin squeeze more than offset by interest saving on the deb retirement SD

7-10 if its very, very lucky SD

http://www.theglobeandmail.com/report-on-business/americans-fret-about-how-to-survive-a-debt-default/article2111459/ Keep in mind that the advisers job in times like this is to spike the panic selling before it starts, & these retail calls are pouring into every advisory firm. We don't need much of a intra-day point drop, for those callers to start refusing the pablum. Most folks don't use advisors - they trade directly, & they don't have a lot of patience. Experience a one-day 300-500 point drop, & almost everybody is going to suddenly be a seller. Back in the day, a JP Morgan could send a message - by standing in the pit & aggressively buying anything that moved. Hard to do today. At best, it will take a day to get an agreement - & another day to vote it into law. Inaction, that can only increase the odds of triggering a panic. You don't call your congressman to vent, you place your sell order or tell your broker to do it for you. Hopefully we don't see it SD

(2) If you have a sizeable weighting, your primary concern is the day-to-day liquidity - not the return on the portfolio. Most people would be hedging this in the current climate SD

High 50%, with all our synthetic shorts covered by calls SD

Every student who ever studied a yield curve has had it drilled into them - the higher the risk, the higher the yield you need to compensate for that risk. As risk increases the longer it takes to get repaid - we get the positively shaped yield curve. The higher the systemic risk (non-diversifiable), the higher the risk free rate that the yield curve starts from. At 1/4 of 1% there is supposedly almost no systemic risk. But how can that possibly be when there have been multiple PIG bail-outs within the last 6 months, & the US appears to under imminent threat of default ? - UNLESS there has been extensive ongoing treasury intervention that is absorbing an awfull lot of risk. Restrict that ongoing intervention & we all see a world of hurt. Reserves rise because either 1) your loanable credits are repaying their debt, not increasing it, or 2) your central bank has required you to (China, & some BRIC nations). When a central bank is doing 2) it is usually anticipating that a lot of its banking systems existing loans are going to default, & that a systemic write off against reserves will be required (hence it wants a bigger cushion to charge against). In the global village, when you summize that the biggest global creditor may have a banking problem - there is no way that you're going to deplete your reserves. We are not going back to the way it was, so welcome to some hurt! SD

Illiquid & lower quality securities to long-term accounts (time as the hedge) All margin retired. Positions reduced to 50% long, 50% cash (cash as the hedge) Optimizes under a moderate market sell-off - re-purchase & re-leverage at lower prices once volatility declines. Deeper the sell-off the more the up-front gain, & the longer the recovery will take (essentially a bar-bell). Moderate opportunity loss if markets jump (assumes nimble repurchase). Small price for dodging the bullet. SD

We all might want to see the opportunity. Irrespective of outcome, the US has been severely damaged, & it is self inflicted. If there is no resolution, or a delay, we have selective default; same as Greece - the US gets downgraded. If there is a resolution we still get a downgrade ..... it just takes a little longer as the ability to reach concensus continues to decay. US rates of 1/4 of 1% are only low because of treasury intervention. Take away that ability to intervene & borrowing costs will quickly approach the 3-4% that PIGS have been paying. 3% is still very low (for the circumstance), but it is 12x the current cost. Even if rates ONLY increase to 3/4 of 1% (under threat of a downgrade), it is still 3x the current cost. When you are having trouble trying to pay your interest bill now, why should I think that it will get easier when that bill is likely to at least triple ? Cash & a few call options has a lot going for it. SD

Its not really a 'limit' when you simply increase it every year. SD

http://fpc.state.gov/documents/organization/105193.pdf It would seem that this is a regular ocurrence that has taken place almost every year since 2001. So why is this time different from all the other times ?, & who benefits by trying to manufacture a 'market' hysteria ? Puts quite a different spin on the issue. SD

Keep in mind that Bernake just announced QE3. To get the funds he will have to print bills, & that will require congressional approval. The real question though, is how far the USD devalues right after the announcement ? - when there are deep liquid forwards & futures markets to sell USD into - If congress approves. USD debases. Buy back the position for a consolation gain - If congress rejects. USD denominated assets sell off aggressively. Buy back the position for real money - Lifetime chance to be beat Soros's bet against the BoE. SD

Depreciation is a non cash expense, but if you're profitable - you recovered the expense when the buyer of your goods/services paid (cash) for them. If the underlying business is not growing - you dont need additional rolling stock, you can use fewer engines (replacements can pull more than the old), & operating costs shrink (fuel & labour savings). Capex becomes NEGATIVE, & the CEO/CFO has a mountain of surplus net cash inflow to bolster results - for a number of years. Agreed, if surplus cashflow is returned to investors via a dividend - they can reinvest in higher yielding assets elsewhere (inflation optionality). However, most CEO/CFO bonus structures favour buy-backs to reduce dilution, increase earnings & multiples, & elevate share price. The surplus net cash inflow is essentially capitalized; & you reinvest elsewhere by selling your shares. The discipline advantage of railroads is that it is difficult to sell the idea of expanding track or buying another rail-road unless it directly connects to you. Authorities do not appreciate monopolists, & most shareholders do not want that surplus net cash inflow going on anything but buy-backs. It also doesn't hurt that to get that adjacent rail-road you will have to over-pay. The operating advantage of onging falling variable costs, & higher freight prices (inflation), just improves margin & further diversifies the surplus net cash inflow (reduced volatilty). Point(s) 1) Yes we like the inflation optionality because we expect it to be capitalized 2) CEO/CFO is incentivised to make it happen. SD

Rules exist to provide a framework. When the rules are rigid, you are not confident in your understanding as to why they are there. Most would not relax the investment quality rules, unless very experienced. Failure results in either a write-off or a long saga of successive decisions that all have to be right - & the smarter thing is usually to write-off & move on. Case in point: FBK At inception this was a trust, returning capital at 5c/month. Competitive plant, iffy management, in a cyclical industry, but at $3.50/share your cost base fell 17%/yr. The MOS (non-financial) was FFH in the backround (capital discipline), & new plant that was one of the lowest cost plants in NA (minimal CAPEX requirement for some time). Should have sold at $5.50 & walked away. Cycle turned, & break-even turned to loss. Should have sold but did not - small % of portfolio, MOS was still there, & we're experienced at recovery. Price fell to 20c, debs fell to < $35, bankruptcy &/or dilution was imminent. The investment became an option on a successfull restructuring. Management/Bank huddle - & they stay alive. We increased the original $ investment by 4x, & injected the new funds into stock & debs. 10x the number of shares, cost base close to market, debs with cash yields > 22%, & a high % portfolio weighting. A FBK recovery mattered to our results. But it was based on evidence the MOS was working, & experience. Rest is history. We've done very well, but its been maybe 6-7 yrs. In normal makets, it would have been far better to walk away at $5.50. By luck, we consequently were not that exposed to the credit crash as our focus was here, & got a opportunity gain as well. Point(s) 1) Relaxing constraints can expose you to a world of pain, but it is how you learn 2) Investment is a art not a science - intuition, application, courage, & experience is also a large part of it. SD

The assumption is that surplus cash buys back stock; it does not repay debt to restore D/E ratios, it does not get paid out in 'special' dividends, & it does not pay carry cost on new acquisitions debt. Industry's that use acquistion as a tool (O&G, resources), lack capital discipline (airlines), & have capital issues (banks) are probably not good targets. Industry's with very high depreciation (railroads) & long-lived assets are probably good. SD

Assume a 25% weighting to FBK, & a double in 1 yr. If nothing else happened, the change in the price of FBK will increase the value of the portfolio 25% [25%+25%+25%+25%x2] = 125%/100% = 25% potfolio increase .... but if you had reduced your FBK weighting by 50%, the change in the price of FBK will now increase the value of the portfolio by only 12.5% [37.5%+25%+25%+12.5%x2] = 112.5%/100% = 12.5% potfolio increase. And if FBK doubled in 2 yrs vs 1 ? .... the portfolio would increase by 12.5% & 6.75% respectively Point(s) (1) Without a very sizeable portfolio weighting to FBK, the effect on overall results is minimal (2) If you have a sizeable weighting, your primary concern is the day-to-day liquidity - not the return on the portfolio. SD

Keep in mind: 1) What needs to happen for a double to 2.70 ? Is it realistic, what is the time-frame, etc. Most would argue that it is when, not if - 100% ROI if its 1yr, a 36% [72/2] ROI if its 2 yrs, & high probability. 2) What needs to happen to double again to 5.20 ? Most would argue that this is hazy - lots of possibilities, very high ROI, but much lower probability. 3) What happens the sooner results start to show ? Most would argue improving EBITA, AND a higher multiple. The less time taken, the higher the ROI, & the greater the momentum pushing the EBITA multiple up - & raising the ROI still further. A virtuous circle. It is highly likely that management does read this board, & are well aware that patience is limited & that failure will result in asset sales - not a bad thing. They will also be acutely aware that without FFH's graces they wouldn't have this 2nd chance. There is still risk, but most of the FBK specific risk would seem to be behind us. Today, the main risk is probably the selling down of a high portfolio weighting too early. SD

Assume that with no changes, they expect 38M in EBITA with an multiple of 4.5 (38x4.5/130=1.52/share). They've said that a significant portion of their RBK mill production will be sold on a cost+ basis starting (roughly) 12-18 months out - materially reducing EBITA volatility. They've also said they expect an extra 6M in EBITA from power sales commencing Jan-2012. Most people would pay an extra 10% for less EBITA volatility (ie A multiple of 5.0x vs 4.5x). 12 months forward EBITA is maybe 44M? (38+6). A patient person might thefore expect at least 1.70 (28% above current price); 12 months out - & under very conservative assumptions. ... and all of this assumes no asset sales, overly conservative pulp revenues (volume+price), & no benefit for the 3.5M of interest expense they've just eliminated with the Deb retirement. Patience. SD

Over the longer term, spot gas prices can only rise appreciably as the $ for new drilling dry up & the spikes of new (temporary) supply dry up with it. When the bubble bursts there will be tears, & those shale fields will get sold to the majors for cents on the $. It will all be proven reserve, & buyers will have no qualms shuttering the wells to improve the economics. Hard to say why you wouldn't go with the drillers. Money thrown at them today (from market financings) & money again tommorrow (from higher commodity spreads). Maybe 1-2 quarters of disruption when the bubble actually bursts but that's about it. Normal part of the process. SD

+5%, but the real message is no margin. SD

We actually prefer Mercedes. But since the car is ‘used’ - consider the ‘c’ in Porsche as depreciation ;D SD

Agreed with FFHWatcher There is nothing wrong in taking Mr Market up on his manic moods, we just don't have to be like him. Our longer time horizon, & insistence on physical stock vs put/call options, lets us smooth out the volatility. In option terms we're essentially doing volatilty arbitrage, & leveraging liquidity. When Mr Market is depressed &/or illiquid, he is going to pay us a lot for our cash. Conversely, when he is happy & flush - we'll have a very easy time selling. Mr Market drives the new porshe (& pays the depreciation), we just drive the re-posessed one SD

Sold MFC on the run-up. Reinvested in PD & sold into Q1 seasonality. Reinvested in NEM & 1 other. FBK was a 40% unrealized gain at one point, but is now only 20%. We are longer term investors with a roughly 3-4 yr horizon over which we expect at least a double. If we were wholly unleveraged & did nothing, we would expect a compound return of at least 18%/yr (72/4). With very moderate leverage & seasonal trading we expect to do materially better. In the bad years, we may lose maybe 25-30%/yr. In the good years, we make well over 100%. To ensure that we don't blow our brains out (casino effect), every time we double we withdraw 45% of our total capital. SD

Up 30%+ on realized seasonal sector rotations & unrealized gains. Unrealized gains are down by about 50% but we see it as being largely temporary. If something doubles in 3 vs 2 years its still a compound ROI of 26% SD

3 things missing What do you want the funds for ?, when do you want them ? , & what is your risk tolerance ?. Defines where you need to be (stock vs bond weighting), your time-line (2,4, 6yrs?), & how much loss you're comfortable with (-40% the day after you buy is OK?). Holding the greatest stock in the world is pretty useless to you if you cannot handle its inherent risk & can only hold for 6 months. Filter for the worst sectors over the last year, not security, & go with the best quality in that sector. Both the good & the bad fell with the tide, but all tides eventually rise again - & the good continue to float. 1 company per sector - & only 1. SD