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2016 Annual Letter


ValueMaven
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I think I met the loyal shareholder label.  I remember very well when I increased my position in 2003 (even in my kids’ portfolios) without even blinking. I had remained confident and optimistic despite the shorts, the restatements, the material weaknesses and the rest. In the last 15 years, investment in Fairfax varied but ran as high as 40% of my net worth. Over the years, some significant investments looked unusual and the Blackberry twist raised an eyebrow but I respected the long term track record and remained optimistic. The cautious approach  made sense given the definition of risks that they saw.

Yes the world is changing but the change did not occur on election day.

I just cannot incorporate this presidential volte-face into an intellectually honest framework. Apologies. Maybe, I am not bright enough.

The easy thing is just to sell, which I did and will say no more.

Fairfax used to be my flagship holding and now it stands in my cigar-butt bin. Sad.

I sincerely wish them good luck.

The sun also rises.

 

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The question you need to ask yourself about the Trump issue is if the candidate who won had Trump's popularity but not his personal negatives would you have made the same conclusion about Fairfax's decision.  There is alot of media induced negative sentiment towards Trump.  This is consistent with Prem's actions in India were a business friendly politician won election & the same happened in the US with the US candidate having personal baggage, much like Bill Clinton.

 

Packer

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I think I met the loyal shareholder label.  I remember very well when I increased my position in 2003 (even in my kids’ portfolios) without even blinking. I had remained confident and optimistic despite the shorts, the restatements, the material weaknesses and the rest. In the last 15 years, investment in Fairfax varied but ran as high as 40% of my net worth. Over the years, some significant investments looked unusual and the Blackberry twist raised an eyebrow but I respected the long term track record and remained optimistic. The cautious approach  made sense given the definition of risks that they saw.

Yes the world is changing but the change did not occur on election day.

I just cannot incorporate this presidential volte-face into an intellectually honest framework. Apologies. Maybe, I am not bright enough.

The easy thing is just to sell, which I did and will say no more.

Fairfax used to be my flagship holding and now it stands in my cigar-butt bin. Sad.

I sincerely wish them good luck.

The sun also rises.

 

Well said Cigarbutt.

 

Their underwriting have improved very significantly over the years. That's a huge gain. But investing have been mediocre over the last years. We have the opposite situation than in the lean years period. I like the underwriting, I like Fairfax India, Africa, the investments in operating businesses like Cara, etc. but their cigar butt style investing haven't been good with a huge portfolio like they have now. And the ark that they built came at a huge price...billions. I've kept most of my investment, but I'm not adding to it anymore. Me too Fairfax been 40% of my net worth or so at times, but the % is gradually decreasing.

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prem said in his letter that the intrinsic value is much higher then the market value .

I have followed Whitney Tilson calculations over years on Berkshire and found that the market value has always caught up with his calculations.

Can somebody in this group , who is a long term follower - can calculate the value of units/businesses in Fairfax and come up with a fair market value .

 

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Packer:

 

The question you need to ask yourself about the Trump issue is if the candidate who won had Trump's popularity but not his personal negatives would you have made the same conclusion about Fairfax's decision.  There is a lot of media induced negative sentiment towards Trump. 

 

I agree with you here generally.  I think certainly some folks are more put off by Prem's actions because they blindly hate Trump (some may sightedly hate him too...)... and those same people may not look at / care about the favorability data from small biz's or consumer confidence etc, which tend to be real data points leaning toward more economic growth.

 

This is consistent with Prem's actions in India were a business friendly politician won election & the same happened in the US with the US candidate having personal baggage, much like Bill Clinton.

 

Well... yes, directionally this is consistent.  I think where perhaps some disagreement is cropping up by those on these boards (myself included) is more the magnitude of the change, vs. the directionality.

 

In May 2014, being bullish on Modi and buying a few more Indian shares, and launching a CEF where you charge hedge fund like fees to invest other folks (and some of your own) money in India... well that seems pretty decent to me.

 

In Nov 2016, buying in a net nearly $10B in US stocks?  Not sure I follow the logic the same way - but directionally, yes, Prem and team are being "consistent".

 

I will note since Modi's been elected (just under 3 years ago), that the total return of Indian indices is <15%, or about 5% annualized.  I get that Prem isn't saying this will make stocks great again, but more that biz friendly leaders reduce the downside risks for stock selection, but still, I think this is mostly an excuse.

 

I say this all as someone who, while not a supporter of Trump, is generally supportive of many of the policies highlighted by Prem / You / Others being positive for economic growth in general...

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Putting aside the abrupt change of course, I have a couple of questions as I am trying to gain a better understanding of things.  Prem has mentioned several times that the indices may not continue to go up but that it is a 'value investors market'.  I am trying to grasp this...  In the annual report he mentions buying back stock -

 

'

Having said that, we are raising our threshold for acquisitions now so as to benefit from the

ones we have already made – and to buy back our stock. Our hero, Henry Singleton, whom I have mentioned before in our Annual Reports, built Teledyne by taking shares outstanding from seven million in 1960 to 88 million in 1972 and then down to 12 million in 1987 – an 87% drop in shares outstanding.

'

 

With FFH priced at a reasonable, but not cheap, 1.3-1.4x P/B, would this be an efficient use of capital?

 

Similarly, Prem mentioned lowering debt -  'We are focused on getting these ratios down as soon as we can'.  Fairfax does not have the greatest credit rating.  Could they use this as an opportunity to bolster it?

 

Many of the recent investments described on page 23 were put into 5-6% preferreds that are exercisable in 5+ years and totaled ~500mil.  Help me understand, is the benefit of this to produce a return but not be subjected to near-term market volatility?

 

Lastly, all of the talk today is about Trumpflation in the US, and therefore the CPI bets are discussed much less (lets just say the US has inflation during the next several years).  The weighted average for these CPI bets (shown below) are not very far off for many of the locations.  It is very difficult to predict 6 years out, but if France or UK were to meet the strike price, this would be quite a windfall:

                       

                                    $bil          Strike            Dec31,2016

United States – 0%      46.7        231.39        241.43

United States – 0.5%    12.6          238.30        241.43

European Union            43.6        96.09            101.26

United Kingdom          4.1          243.82        267.10

France                          3.3          99.27            100.66

 

Though, if this doesnt happen the unrealized loss is pretty substantial at 586mil.  If things works out in Fairfax's favor, would gains from this bet only be realized in 5-6 years?  What are the potential outcomes for this bet if any of the locations were to have cumulative deflation?

 

Lastly, nice shoutout to Parsad!

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FFH was heavily criticized for closing out the hedges based on an election. The shift in philosophy was mind-boggling to say the least and compelled many on this board to call into question the decision-making. No disagreement with that. And, I too really wanted to hear Prem say “Yup, we thought this way and thinking that way cost the company money” or some such thing. Based on what I know about Prem, I did expect that. But, while Prem is verbally beaten up on the hedges being a disaster in retrospect, it should be noted that they would have been more of a disaster had they held the positions rather than succumbing to the “Trump-sale”. The losses over the ensuing 4 months would have been huge…major salt in the wounds. So, criticize the decision to buy, but give credit for selling when he did and not hanging on stubbornly longer.

And, while we’re at it, let’s talk Fixed-Income. The sale of the LT Fixed-income trove in early November has proven to be quite positive as well as they could, at current rates, buy back the entire position for a heckuva lot less than they sold said position for. They made a boatload on the LT bonds over the years so while they did not sell at the bottom of the valley, history will show that they sold at a good or very-good time.

That’s all history…where do we stand now?

This is now a company whose underwriting abilities look to be good, if not very good, if not excellent. The financial position is not a Berkshire-esque fortress, but they’re going to be able to pay claims. And, they’ve got a lot of dry powder. The $64K question is investing…have they learned anything? I am not looking for FFH to shoot the lights out going forward, IF they can execute an investment strategy akin to hitting singles and doubles on the fresh powder and underwriting profits then this is a winner. Toss in the occasional acquisition (Zenith has been OK J) and this story gets even better.

Like anything, it’s a Risk-Reward analysis. IMHO, the scales tip to the “reward” side moreso than “risk”.

-Crip

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Agree with Crip.

 

We've all discussed the reasoning for the hedges.  Whatever you think on that, they are gone, and although there wasn't the apology some wanted, there were several parts of the letter in which Prem acknowledged how costly they have been and also how their stockpicking hasn't been good enough.  With the hedges gone, it should be possible to compound book value at 8-10% with underwriting and say 3% on the investment book, with significant leverage to that number if investing is better than that, which it usually was prior to the hedge period.  I was also struck by the suggestion that they would raise the bar on acquisitions and emulate Henry Singleton's record at Teledyne, which implies that the days of big deals and rising share count are gone for now and that the share count might fall.

 

I was also impressed by the value of Quess within TC India, and by the Fairfax India letter.  Seems to me FFH has created significant value in India.

 

I remain a very happy holder.  My only problem is that now my downside protection is gone ;)

 

P

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My only problem is that now my downside protection is gone ;)

 

My downside protection is the meaningful fcf the businesses I privately own and manage generate at the end of each month.

And I don't know of any other kind of downside protection that really works.

 

Cheers,

 

Gio

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My only problem is that now my downside protection is gone ;)

 

My downside protection is the meaningful fcf the businesses I privately own and manage generate at the end of each month.

And I don't know of any other kind of downside protection that really works.

 

Cheers,

 

Gio

 

I would entirely agree if I was in that position ;)

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I took the time today to read the full FFH 2016 Annual Shareholder Letter by Mr. Watsa and the 2016 financials.

 

For me and my family, this is a position nearer 4 per cent than 3 per cent right now. Return so far after holding it for almost four years, adding bits along the way, is a negative zero ex dividends.

 

I feel the market price of FFH.TO right now is rich, bordering to silly.

 

However, I feel it right now would be about the worst thinkable time to jump off the wagon. The equity hedges are now gone, the prospects of the international insurance business - especially in Asia and Africa - seem to have a an enormous potential going forward for the long run. Add to that the AW merger/aquistion.

 

It will be a totally different company going forward the next few years. I'm willing to buy more, if the share takes a material plunge going forward.

 

Like posted earlier by many other fellow board members I would also like to see a change in the investment style by HW.

 

- - - o 0 o - - -

 

I saw Sanjeev mentioned in the Shareholder Letter by Mr. Watsa. Yes, Sanjeev, you are a truly outstanding human being. Good luck with all your endavours in making life better for other than your self, and may your God be with you in those endavours.

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petec,

 

It's only based on rough and primitive P/B considerations. Please consider me a FFH amateur.

 

I have tried several times to do IV calculations for FFH. I can't. Despite being a mini - compared to i.e. BRK -, FFH is now a so complicated structure, and the complexity is increasing year by year.

 

Position size for me and my family is closer to 4 per cent than 3 right now. [based on accordingly degree of conviction, where I'm about 25 per cent in BRK, and sleeping well at night with that].

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Entirely fair - it is very difficult to calculate an IV and I don't try.

 

But, nor do I think the current p/bv (I include goodwill at 1x for this calculation) is unfair.  There is clearly franchise value here, and I can see how the company can compound healthily with reasonable investing.

 

Cheers

 

Pete

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