HJ

Market is acting as if it's MA + COF, redux of the Canadian outcome. There was comment that it's as much as 20% of Amex worldwide loans outstanding, 8% of billing volume, so it's a fairly big deal. Curious how much they will disclose on economics of the winner.

Most of the physical oil trades don't occur on exchanges. They do, however, reference exchange prices. So buyer A in physical world, may just sign a contract with producer B, and agree to take delivery of x MM tons of oil at delivery point C over a perios of time, at prices of NYMEX prices or Brent prices adjusted by cost of transport. The actual value of that physical transaction never goes through the exchange. The exchange prices is purely set by the money that plays in the exchanges, which is a small fraction of actual physical transactions. The $ 260 billion is not a big percent of actual physical transactions in the world every year, but a huge number relative to the money that sets these prices in the exchanges. I think his actual 19 page testimony does the job of explaining why it matterred quite effectively. That said, it doesn't say much of where oil is headed on the exchanges from here. Physically we know that there is a surplus of supply right now, which was stimulated in the back drop of $90-$100 exchange traded oil price prevelant prior to 2014. We know now in physical world, that was most likely too high. We now test if there will be enough physical oil supplied in a $40-50 context. The answer will not be obvious for a couple of years. And it's a dynamic process, where productivity gains, technological changes might affect this physical supply demand balance in all sorts of different ways. The crazy thing is they skipped a $70 range all together, and headed right to $40-50. Meanwhile, buyers and sellers trade the heck out of it.

http://www.hsgac.senate.gov//imo/media/doc/052008Masters.pdf?attempt=2 This is the testimony the guy gave to congress referenced in the ft article. If you go by the testimony, $260 billion was in the financial commodity business. In most commodities, the incremental financial demand from 2008 to 2003 was by multiples of 3-5 times. And the point of financial commodity is precisely that it doesn't need to get settled physically. You just roll it forward. In fact not that much commodity contract actually settles physically even during normal times. That price is simply used as a reference price for contracts between physical buyers and sellers off the exchange. So the physical infrastructure is hardly a constraint to the financial demand. The market structure used to be that producers sell short, with speculators on the long, on significant leverage. When there's an influx of price insensitive financial demand, the speculators in the pit will just comfortably take up the contract during the day, knowing there will be orders to take them out of the positions at the end of day at whatever the close of the day is. Dan Dicker wrote a book called "Oil's endless bid" that describes this phenomena in some detail.

http://ftalphaville.ft.com/2015/02/03/2109272/a-conversation-with-michael-masters/ One man's take on the mechanism of oil price setting.

The origin of Shake Shack, from the horse's mouth. If you subscribe to Charlie Rose, get on to his website, and later on in that same interview, he talks about why he thinks it's such a huge success: "People just want to hang out and watch other people". All of this is way before they decided to make a financial go of it and scale it up big.

Could be, but then again in 1979, oil peaked at 39.5 per barrel, only to decline to $9 per barrel 20 years later in the aftermath of the Asian crisis. That crisis might have been artificial, but if you use, say CPI in Dec. 1979 at 72.6, and 236.74 at the end of 2014 as a guide, $39.5 would be the equivalent to $128.8 per barrel today, not far from where we peaked in 2008. When this slump is over, oil price may very well be higher than $100, but the slump may go on for well more than a couple of quarters.

That's what I thought would happen with shale gas. In fact, it turned out to be economic at much lower prices than this analysis suggested. Isn't the lack of exports holding down shale? prices are like 4x as high outside the US... It seems once the government stops blockign those terminals, prices would shoot up. As demand could not meet supply at those lower prices? Gas transport by sea is through LNG, a significantly more expensive proposition as a percent of the product transported compared with oil transport through VLCC. You need to build refrigeration infrastructure to liquify gas on the export terminal, and then build infrastructure to receive liquified gas on the importing side. Those add to landed cost of gas significantly. Gas will never be as internationalized a commodity as oil.

I kind of did exactly that this past year with one of my PA accounts. I didn't buy a put and bought warrants and options to a 2x leverage. It is not even on an underlying that I believe will necessarily have the best stock market return. The thing with leverage is that even if the underlying deliver something like 10%+ return, a 2x leveraged position will get you high teens to 20's in today's environment, and that's just fine. It's a little bit of an experiment for me, and 1 year out, so far so good. I basically have leaps and warrants on 2 stocks, COF and DFS. More or less in the same line of business, which I like quite a bit. Not that I am necessarily convinced the stocks will be 2-3 baggers within the near future, simply that I believe they will deliver solid ROE's over the foreseeable future, and compared with today's valuation, the stocks should do just fine. Will I get the best return every year? No. But will returns be satisfactory if held over long term? I believe so. What if they don't? Well, that's the thing. It's just like someone deciding to start a business. How does one know if it's going to work going into it? Is this necessarily worse than say, me buying into some Hong Kong conglomerate believing in their P/NAV story and that the management won't screw minority investors? To have a real good answer to that, one also really need to understand the real estate holdings that they have on mainland, which are subject to all sorts of whimsicals of the Chinese government, both central and local. And they don't own the land, but 50 year leases, which renewal is also potentially subject to them having the connection to the right politician. How does one handicap that? I don't know, but I kind of don't care. And to the families who are the controlling shareholder, they just do the best that they can with whatever hands they will be dealt with down the road, just like I will need to do with my 2 positions. People in the institutional money management business need to be bound by "fiduciary duty". Behavior as this would be considered reckless. But it's an institutional imperative that has some how infested into people's thinking when investing their own money. I think leverage being applied to good businesses is exactly the right formula. The question is not just what percent of time are you right, but also (perhaps even more so) that when you are right, how much did you have on the line. Think Fairfax making 10's of billions on subprime CDS, or putting on 10's of billion CPI puts, or George Soros putting on billions of notional to break the GBP/USD cross in 1990, or Ackman starting a fund with only call options on Target. Are those reckless behavior when positions were put on? You just deal with it, whether it works or not. So you don't "beat the market" over 5 years, there are worse things in life that can happen to you. One thing about this extreme concentration that I noticed is that it make it easier for me to buy on dips. So when the whole market was trading down 4Q because of oil, I noticed that I was much more inclined to buy than before, because I know the fundamentals of the only business that I am focused on may get a bit of hick up when the oil companies pull back in the oil/gas producing states, but also ought to get a boost further out when the population in the non-oil producing states feel the benefit. The decision was simply surrounding how much cash would I prefer to have in that account. When one pulls up a chart of COF from its IPO, there are probably only 3-4 instances over the past 20 yrs that you should sell (assuming, say a 5 year holding period), and that's the question that I try to figure out diligently. For now I like them, but when and what should I watch out for to walk away. Buffett sold Freddie way before the crisis, noticing that they owned some Italian bonds. That's the trade I hope that I have it in me to make with these two positions.

Was there a good discussion on the board about this acquisition? I'm no expert on oil & gas economics, but I believe the XTO acquisition can only be characterized as a $40 billion mistake. It was negotiated in the middle of a financial crisis, but before shale gas economics became clear. Long term nat gas was trading in the $6-$7 / mcf, acquiring proven resources in the ground for $3 / mcf might have been ok back then. Today it's $4-$5 / mcf, and for the forsseable future, the incremental supply is going to be from Marcellus, not where XTO is trong. I've read somewhere that Marcellus produce good economics even if nat gas go down to $2-$3 / mcf. I think XOM basically missed shale gas completely. Taking decade+ view, the acquisition may yet produce a positive IRR, but I think even XOM management themselves would readily acknowledge the economics of that acquisition is suspect in hindsight. I read up on Mcdep analysis that Kurt Wulff produces once a while, and attached is the write up he did on the acquisition at that time. While generally bullish, you can see the datapoints at the time. He calculates a "Mcdep" ratio of 1.07 for the acquisition, when a ratio of 1 indicates return of 10% using long term gas price of $8 and long term oil price of $75. Long term gas is now $4-5, with guys like Range Resource looking to double or triple their out put over time. mr91215.pdf

Even for XOM, there was an XTO.

http://blogs.barrons.com/stockstowatchtoday/2014/11/26/why-losing-costco-would-matter-for-american-express-discover-sues-visa/?mod=BOL_hp_blog_stw Earlier this month, news broke that Costco Wholesale (COST) was considering dumping American Express (AXP) as its credit card of choice in the U.S. Susquehanna’s James E Friedman and Xin (Joey) Yang explain why Costco is important to American Express: Costco Cobrand Is Important, Especially for Small Business. The big-box retailer does nearly $113 bln in annual revenue, almost 75% with small business owners. American Express has two co-branded, cash-back credit cards with Costco in the US. And these American Express cards are the only credit cards accepted by Costco in the US. As such, in-store American Express competes with only debit and cash. In exchange for this exclusivity we believe that Costco has negotiated a lower discount rate from American Express (vs. the current 2.49% average). As such we estimate Costco generates ~$100 mln of discount revenue for American Express, and another $60 mln in interest income… We believe Costco also helps the perception of American Express “coverage.” A continuing goal of American Express is to increase merchant “acceptance” (currently lowest when compared with Visa (V), MasterCard (MA) and Discover Financial (DFS)). This is particularly relevant for their B2B franchise. With almost 75% of Costco’s spending from its Executive Members (mostly small business) and American Express strength in small business cards, Costco has played a major role in bolstering this perception among business users. Costco’s heavy foot traffic and American Express signage likely drive American Express sign-ups as well. Merchant acceptance of Amex is actually lower than DFS, something not surprising when thinking through, but I did a double take when first reading it.

Thank you, gentlemen, for your response. As I look at that Value and Opportunity blog, one thing I'm not particularly crazy about is how they arrived at the conclusion that CFG is cheap. They take a bunch of bank's trading P/TBV ratio, do a simple average, get to 1.58 times, and Citizen is currently at 1x, so they argue there's 50% upside. When I look into the sample, I basically see a bunch of banks trading around 2x TBV or higher, and a bunch trading right around 1-1.3x TBV. The ones trading around 2x TBV all have something special to them, whether it's a favored geography / loan growth profile in Cullen Frost and Signature Bank or specialized lending model in the case of NY Community and SVB, MTB is Buffett's bank, no more statement needed, etc., etc. So I kind of feel like an average bank is supposed to trade around 1-1.3x TBV. If you can articulate something special, then you may get sponsorship among the investor community to trade you closer to 2xTBV. Drawing the conclusion that an average bank is supposed to be at 1.58x is kind of too simplistic for my taste. That said, I don't have any insight to Citizens book of business or management quality. Would love to learn any interesting tidbits.

Why do you think CFG is significantly better than mediocrity for it to be the best long-term idea today? Something about the management? Business mix? Just curious. Thanks

http://www.bnn.ca/News/2014/11/5/Costco-could-drop-American-Express-in-US-after-Canada-switch-report.aspx

To our friends in Canada, how do you view this piece of news? According to Wikipedia, there are 87 Costco stores in Canada. How common is Capital One credit cards up North? I know that a couple of years ago, Capital One did a deal with Hudson's Bay to issue their store cards. What kind of significance do you give to this piece of news on the relevant compaines involved? Is it fair to say this probably is more meaningful for COF than either Costco or American Express? Disclosure: I am a long time COF warrant holder

On the one hand I certainly agree that American Express attracts the most affluent customers by far. Years ago when Discover was part of Morgan Stanley, Morgan Stanley tried to get some of their employee to use Diners Club as their corporate card. As you can imagine, the bankers were embarassed to use it. The experiment was finished before it was fully launched. The hook up with corporate travel does wonder to drive transaction volumes, Amex also carries a different level of prestege especially in places like China and Russia. The well to do's carry the black card as proof that they've arrived. But I'm also very leery about the long term implication with something like Apple Pay. When you insert another intermediary between your customer and you, it alters the relationship and loyalty. In the Morgan Stanley example above, I'm not sure whether the bankers would have cared as much. Whipping out an iphone to pay an expensive dinner bill just isn't that disastrous. I can't help but wonder if Amex business model potentially has the most to lose with mobile payments, mostly because they had established the best brand in the world of plastics.

1) You are on the front end of hurricane season, people are leery of going long cat risk purely on seasonality. 2) It is generally acknowledged that there is a bit too much capital in the industry, largely driven by influx of alternative capital (cat bond, insurance linked securities, side cars) in the reinsurance business. Worse, those capital have lower return hurdle than trasditional reinsurer ROE's, as these are largely macro / fixe income types looking for uncorrelated returns. And of course, every hedge fund manager wants to run a reinsurer ala Warren Buffett. There is a theory out there that says reinsurance cycle will be structurally muted by capital of this nature. Without the upside, there's little reason to bid these things up above book.

There's very few true "private placement" anymore these days. Most 144A issuers are required to file financials even if they don't have publicly traded stocks outstanding. So you get financials all the same. If you look at bank debt, you can chose to be on the "private" side, and receive additional information, mostly compliance to bank covenants as well as company projections. Outside of financial information, the document to focus on is the indenture for bonds, and credit agreements for loans. And you read it for each class of creditors carefully. If you can't get the indenture, the OM's are supposed to describe the relevant terms, even though they may not contain 100% of the information you want. Especially for distressed debt, one needs to understand all the intercreditor issues, for example, when can a certain class of creditors call an event of default, how can such default be cured, what are the grace period, etc. Every circumstance is different. You need to have a feel for how is a default likely to be resolved coming out of a bankruptcy proceeding. You may think buying a HY bond at a steep discount is cheap on an enterprise value /going concern basis, when the bank agreement may allow another class of debt senior to you foreclose on the asset, sell it for whatever they think it's worth, and wipe you out in a distressed sale, except maybe you have a cure by putting in a bit more money in the company to resolve a technical default on a senior lender persuant to the legal agreements. If you don't have that kind of money, maybe the other guys in the same class of debt as you will do it to avoid losing the asset to somebody else, so you get to ride along their action. It's all about understanding all those relationship, understandign the ownership base, and taking educated guesses on what those ownership base may or may not do, what a bankruptcy judge is likely to approve in a plan of reorganization, and the associated valuation implications.

Happy birthday and best wishes.

For $3~5mm in China, it's almost pure private, pass around the hat type of thing, I think. It's really too small to register on most institution's radar. I know some funds out there, but not sure how they will react to the size.

From a totally different angle, Panera Bread. I noticed that some of my friends in New Jersey have started to use Panera for weekend afternoon get togethers, when before it was invariably a Starbucks. No, Panera is not a coffee chain, and will never compete with Starbucks for real. In fact they have shied away from big cities all together. Their motto is the "suburban cafe". But it's interesting to see different type of establishments that attempt to emulate the "Vibe".

SAM is one I found early, I bought it at $21.50 in 2005, and sold way too early ($113 in 2012). I unfortunately no longer own it. Not that I have that much insight about when to sell vs. hold, but Buffett speaks about holding an investment forever, and in many cases he did, even for the less successful ones. Yet he sold Freddie Mac, which makes it an interesting case study. See the interaction below of him explaining why he sold his position. https://www.youtube.com/watch?v=QrFyo5Ettcw So I think 1) you have to identify the nature of the business, in the case of a "compounder", understand what allows it to generate and sustain high return on equity, (in the case of Freddie Mac, the ability to have a cheaper cost of funds advantage vs. any other financial companies out there), and 2) have that "sixth sense" to see what could alter the risk / return dynamics, and be able to walk away when others are still fully enamored with, in this case, a legislatively mandated "moat". So it requires one to understand the nature of the investment and risk and return dynamics so much that one sees it coming, whether its a certain management behavior, or external factors, a level of understanding probably only possible after observing numerous successes and failures in all kinds of businesses in all kinds of environments. And then, everybody makes mistakes, it's also how you deal with the mistakes and improve yourself that matters. It's not the end of the world if I owned a compounder which, in hindsight, stopped compounding some point after I bought it. Maybe I simply failed to fully understand the dynamics that caused it to have compounder investment characteristics to start with. I just need to sharpen the pencil and read some more K's.

The fall off in performance probably has more to do with the soft insurance market, especially in E&S. It's generally acknowledged that the market peaked in 2005 post Katrina. And has been in a soft market ever since, briefly interrupted by the "Great Recession". But then again, the P/B ratio reflects that, falling off from 2x down to 1.2x. It's a tough environment, and there's something to be said for Markel Venture as a strategy, which diversifies the space where they can get ROE from. That book of business, though is of manifestly lower quality than the ones owned by Berkshire. But evaluated as a pure insurance company, I'd say it's "fair value", in line with the other good underwriters, WRB, CB, etc.

Yeah. I certainly agree with that sentiment. One thing about looking at insurance companies is that it's really hard to look through the filings to get a feel for what's going on in each of the underlying business. Even the regulatory filings doesn't really go to that degree of granularity, and these guys are going in and out of lines all the time. So you just sort of have to go with some level of trusting the management. In a way it makes the job easy, just go with a P/B ratio. But it certainly doesn't satisfy the intellectual curiosity.

Is it the same question as asking what is the fair value for Berkshire? Whatever we think it should be, market has priced it at 1.7 - 2.7 x book back in mid 90's, 1.5-2x book back in early 2000's, 1.2-1.5x since the crisis. And in each case, as long as you have sort of avoided the couple of years where the valuation range took a jump to a different range, the return has all been quite satisfactory. The big piece of it, of course, is also the insurance cycle in the background, and Markel valuation range is influenced by it much more than Berkshire.