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Q1 2020 Results


bearprowler6
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Taking a quick look:

 

Valuing associates at fair value, book value is $390 per share as of Q1. Bigger hit than expected.

 

How in the world are they able to lose money on the shorts in Q1? Shorted Amazon?

 

Vinod

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My guess (hope that is not true) is that they shorted Netflix and Amazon, as listed in the annual letter, based on their higher old-school valuation ratio of P/E ** SIGH ** But let's give them the benefit of the doubt.  Or lets not

>:(

 

 

Where did you get $390 for BV ?

it says => Book value per basic share at March 31, 2020 was $422.03

 

it says $122.3 (unrealized short) that means it wasnt close as of March 31, when the market bounced back.

 

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Valuing associates at fair value, book value is $390 per share as of Q1. Bigger hit than expected.

 

I don't think this is a surprise. They'd already disclosed Eurobank had moved to associate accounting. By my rough maths that puts it on the books at $36 per FFH share vs a current market cap of $14, so it's the single biggest reason for the discrepancy.

 

I tend to ignore associate accounting, which can lead to almost random carrying values, and focus on market value and look-through book value. I think one needs both to get the full picture. If we value everything at market the BVPS is actually below $390, because several of the consolidated entities (FIH, FAH etc) are trading well below book. But if we value everything at look-through book value (i.e. as though every stake were consolidated) the picture is very different. At 1x post-deal TBV Eurobank is "worth" $54 per FFH share. That alone takes the $390 number to $430 ($390-14+54=430).

 

However you look at it, it seems to me there is a margin of safety with the shares at $280.

 

(And before you ask why I don't just own Eurobank, I'm trying, but my broker keeps cancelling the order and I haven't yet found out why.)

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My guess (hope that is not true) is that they shorted Netflix and Amazon, as listed in the annual letter, based on their higher old-school valuation ratio of P/E ** SIGH ** But let's give them the benefit of the doubt.  Or lets not

>:(

 

 

Where did you get $390 for BV ?

it says => Book value per basic share at March 31, 2020 was $422.03

 

it says $122.3 (unrealized short) that means it wasnt close as of March 31, when the market bounced back.

 

Or they closed most of their shorts in the first part of the quarter...being just sick of losing money on them

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I hear you on the depressed share price that dropped even more today. Shareholders that have been in the past 5 years didn't reap any benefit from FFH. Patience is running low on my end, buy hey, aren't we suppose to be long term ;) That keeps me cool, but for how long? I was silly enough thinking to add more today at this depressed price....

 

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I took a quick scan of Q1 results, and it's more or less what FFH had telegraphed through its April press release and through Prem's comments at the annual meeting.  But, nonetheless here are a few comments/observations from my scan:

 

 

1) What's the deal with the CR? - Okay, so net written increased considerably (page 35 of Q1), but aren't the CRs just a wee bit disappointing (page 37 of Q1)?  We have been led to believe that much of the increase in net written was the result of price increases.  Price increases ought to fall directly down to the bottom line, meaning that CRs should have decreased markedly.  In actual fact, the consolidated CR dropped from 97% to 96.8%, which doesn't really show much of a price increase, and this is mostly due to the current accident year -- this is not a case of being hit by skeletons in the closet.  In fairness to FFH, Odyssey booked 6.1 CR points for Covid and Brit 6.2 points (pages 41 and 44 of Q1) which inflated things a bit for those two subs, but the underwriting overall has been a bit of a disappointment.  The "Other insurance" grouping is once again a bit of a disappointment with an Accident Year CR 100.6...once again, why bother taking the risk of doing business in shit-hole countries if your result is an underwriting loss?  At least the kleptocracies of Eastern Europe seem to have done a shade better.

 

 

2) Shift into corporates - It's not really news, but the shift out of governments and into corporates is quite visible (page 12 of Q1).  Corporates are now $12.3B compared to 9.9B on Dec 31.  Total investments are still $33B or $34B, so the corporates have been bumped up from abut 30% to about 36% of total investments.  FFH suggests that credit quality is generally pretty good but it has visibly declined as a result of this process of reaching for yield (page 24 of Q1). I wonder what their comfort level truly is?  Would they go to 40%?  How about 45%?

 

 

3) Debt levels and the revolver covenants - in February, I did a bit of ranting and raving about FFH's reliance on its revolver because revolver covananents tend to bite you on the ass at the worst moments.  FFH did the right thing by drawing its revolver before its lender could concoct a reason to pull it.  But, the displacement in markets has resulted in some of FFH's assets being marked down, and the covenants are becoming more of a thing.  FFH is permitted a maximum debt to equity of 0.35:1 (see page 19 of Q1), and they are currently at 0.34.  So, do a little bit of school-boy arithmetic, and it's evident that FFH is a bit tight on its convenant.  What size of asset impairment would be required to take you from 0.34 to 0.35?  A reduction of equity of about 3% would make FFH hit that threshold.  As we know, total consolidated equity is $16.2B (page 2 of Q1), so an asset write-down of ~$500m would be enough to force FFH to either make some decisions or to have a chat with its lender.

 

This is not an urgent, end-of-the-world type of situation.  The first obvious thing that FFH could do would be to sell some of the holdco bonds that it purchased with the revolver draw, and then use the proceeds to repay the revolver, and that would be enough to put it back "on side" with its covenant.  What is more, most of the equity positions have had favourable marks since March 31, so the situation is probably less tight than it was a month ago.  But, a $1B hit to assets or to insurance liabiities could become a cause for scrambling at FFH ($1B is just a couple of bad hurricanes in the US, right?).  FFH probably should be holding some proactive conversations with its lender...

 

 

4) Why aren't things worse at Zenith? - Am I alone in being surprised that Zenith's results were actually not that bad (page 43 of Q1)?  The accident year CR of 104.7 strikes me as lower than I would have expected.  I had imagined that there would be a heavy amount of claims due to doctors, nurses and personal service workers who allegedly caught Covid while working in nursing homes or hospitals.  Similarly, slaughter plants, public transit facilities and other employers all have heightened rates of Covid.  Is it the case that this is not material?  Or is it the case that Zenith is refusing to pay and losses will only be recognized after employers/employees sue Zenith on the argument that employment related Covid clusters are sufficient evidence that workers comp indemnities should be paid?  I was also a bit surprised that Zenith's net written hadn't really declined that much in Q1 (page 39 of Q1)...maybe it was too soon to expect that and we'll see a hit in Q2?

 

 

5) Subs' Revolver Usage - The subs are starting to draw pretty heavily on their revolvers.  Brit drew $83m and Recipe $210m (page 19).  For non-Canadian readers, almost all of Recipe's restaurant dining rooms are closed right now, but they are doing a bit of take-away and delivery business.  The revolver draw likely reflects the continued fixed costs with very little contribution margin to cover them.  When Recipe's dining rooms re-open, will it require an external cash source for working capital?  Would any lender other than FFH provide that cash?

 

Returning to point #3, FFH needs to manage its consolidated debt and its consolidated equity.  The subs have generally had a free reign to manage their business, but going forward, greater coordination from the holdco might be required to ensure that the actions of one or more subs does not trigger one of the holdco's revolver covenants.

 

 

6) Piling more money into Seaspan? - During Q1, FFH piled another $100m into Atlas (page 16 of Q1).  Seaspan has been one of FFH's few success stories in recent years, but returning to my traditional rants and raves about position-sizing, is this really wise?  Seaspan seems to be in good shape with much of their capacity under medium term contracts, but what residual risks remain (ie, counterparty risk, events eligible for declaration of force majeur, etc)?  FFH has now piled a total of $1.5B of its capital into Atlas.  Is this a reasonable risk from a position-sizing perspective?  Returning to point #3, a write-down of ~$500m would be inconvenient.

 

 

SJ

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I think I should stop listening to the conference calls.  :)

 

Every time I listen, I get encouraged and buy more shares. Purchased more at CAD$360 today. I don't think I've ever seen this kind of discount to book.

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6) Piling more money into Seaspan? - During Q1, FFH piled another $100m into Atlas (page 16 of Q1).  Seaspan has been one of FFH's few success stories in recent years, but returning to my traditional rants and raves about position-sizing, is this really wise?  Seaspan seems to be in good shape with much of their capacity under medium term contracts, but what residual risks remain (ie, counterparty risk, events eligible for declaration of force majeur, etc)?  FFH has now piled a total of $1.5B of its capital into Atlas.  Is this a reasonable risk from a position-sizing perspective?  Returning to point #3, a write-down of ~$500m would be inconvenient.

 

 

SJ

 

Hi SJ, I don't have answers for all of your questions, but I do have a response for #6:

 

I'm comfortable with them piling into Atlas.  I think Atlas will be a wholly-owned Fairfax Company one day like Mid-American became under Berkshire.  With Paul Rivett showing signs of moving into semi-retirement and spending more time with family, Prem and the old guard aging, Andy Barnard not being much younger than Prem, I like the idea of Bing Chen and Wade Burton sharing future duties at Fairfax in terms of a succession plan.  One handles operations and one handles investments.  That may change depending on what happens, what acquisitions are brought in, what leaders emerge, but I think shareholders could be comfortable in that pairing.  Cheers!

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There is no evidence that Sanjeev's "theory" concerning Fairfax and Atlas longer term has even been considered. Furthermore, if it has been consider than Sanjeev should not have any knowledge of those discussions. Until than, the best that can be said is that Atlas is yet another oversized under performing investment made by the existing investment team at Fairfax.

 

Prem's stated reason for investing in Atlas was to back and benefit from the investment prowess of David Sokol.  Ridiculous reason for investing $1.5 billion but those are Prem's words. Sort of like taking the equity hedges off because of Trump's election win, investing big time into India because Modi's election win would be transformative and buying into Exxon because of the 10% common stock dividend yield it offered at the time of investment.

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6) Piling more money into Seaspan? - During Q1, FFH piled another $100m into Atlas (page 16 of Q1).  Seaspan has been one of FFH's few success stories in recent years, but returning to my traditional rants and raves about position-sizing, is this really wise?  Seaspan seems to be in good shape with much of their capacity under medium term contracts, but what residual risks remain (ie, counterparty risk, events eligible for declaration of force majeur, etc)?  FFH has now piled a total of $1.5B of its capital into Atlas.  Is this a reasonable risk from a position-sizing perspective?  Returning to point #3, a write-down of ~$500m would be inconvenient.

 

 

SJ

 

Hi SJ, I don't have answers for all of your questions, but I do have a response for #6:

 

I'm comfortable with them piling into Atlas.  I think Atlas will be a wholly-owned Fairfax Company one day like Mid-American became under Berkshire.  With Paul Rivett showing signs of moving into semi-retirement and spending more time with family, Prem and the old guard aging, Andy Barnard not being much younger than Prem, I like the idea of Bing Chen and Wade Burton sharing future duties at Fairfax in terms of a succession plan.  One handles operations and one handles investments.  That may change depending on what happens, what acquisitions are brought in, what leaders emerge, but I think shareholders could be comfortable in that pairing.  Cheers!

 

Parsad

Hypothetically speaking, why would the Washington family would want to let go of Atlas, if it is a great bet? FFH would be better off in having a controlling position but probably no more as that type of business in not in their circle of competence.

 

Going to mid-American comparison, if a potential intent is the get the whole of Atlas, and if that bet is a function of David Sokol ability to stay and continue the good work, shouldn't Sokol have a Atlas-only stake, like Greg Abdel does with BRK Energy.

 

For the record, I personally believe in Sokol and his work and Atlas.

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There is no evidence that Sanjeev's "theory" concerning Fairfax and Atlas longer term has even been considered. Furthermore, if it has been consider than Sanjeev should not have any knowledge of those discussions. Until than, the best that can be said is that Atlas is yet another oversized under performing investment made by the existing investment team at Fairfax.

 

Prem's stated reason for investing in Atlas was to back and benefit from the investment prowess of David Sokol.  Ridiculous reason for investing $1.5 billion but those are Prem's words. Sort of like taking the equity hedges off because of Trump's election win, investing big time into India because Modi's election win would be transformative and buying into Exxon because of the 10% common stock dividend yield it offered at the time of investment.

 

I have never heard anything related to this.  I'm just going by what I see...the amount of mutual respect between David Sokol, Bing Chen and Prem, and the fact that Paul has said that he wants to step back.  It was pretty clear that Paul and Andy Barnard would have led Fairfax previously if something happened to Prem.

 

Now with Paul stepping back and Andy getting older...I think they've probably put some recent thought into succession.  From this year's letter, it seems clear that Wade is being pushed as head of Hamblin-Watsa, and Bing would be a natural choice to take over in terms of operations.  The bench is deep enough where it could be possibly someone else, but the fact that David is at Atlas, he understands insurance as well as anyone. 

 

To me, after watching Fairfax for 20 years, it seems that if something happened to Prem, David would be a natural choice for Chairman, Wade overseeing Hamblin-Watsa and Bing overseeing operations.  Cheers!

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6) Piling more money into Seaspan? - During Q1, FFH piled another $100m into Atlas (page 16 of Q1).  Seaspan has been one of FFH's few success stories in recent years, but returning to my traditional rants and raves about position-sizing, is this really wise?  Seaspan seems to be in good shape with much of their capacity under medium term contracts, but what residual risks remain (ie, counterparty risk, events eligible for declaration of force majeur, etc)?  FFH has now piled a total of $1.5B of its capital into Atlas.  Is this a reasonable risk from a position-sizing perspective?  Returning to point #3, a write-down of ~$500m would be inconvenient.

 

 

SJ

 

Hi SJ, I don't have answers for all of your questions, but I do have a response for #6:

 

I'm comfortable with them piling into Atlas.  I think Atlas will be a wholly-owned Fairfax Company one day like Mid-American became under Berkshire.  With Paul Rivett showing signs of moving into semi-retirement and spending more time with family, Prem and the old guard aging, Andy Barnard not being much younger than Prem, I like the idea of Bing Chen and Wade Burton sharing future duties at Fairfax in terms of a succession plan.  One handles operations and one handles investments.  That may change depending on what happens, what acquisitions are brought in, what leaders emerge, but I think shareholders could be comfortable in that pairing.  Cheers!

 

Parsad

Hypothetically speaking, why would the Washington family would want to let go of Atlas, if it is a great bet? FFH would be better off in having a controlling position but probably no more as that type of business in not in their circle of competence.

 

Going to mid-American comparison, if a potential intent is the get the whole of Atlas, and if that bet is a function of David Sokol ability to stay and continue the good work, shouldn't Sokol have a Atlas-only stake, like Greg Abdel does with BRK Energy.

 

For the record, I personally believe in Sokol and his work and Atlas.

 

Do you really see Kyle Washington running and overseeing all of the Washington family's holdings?  If you live in Vancouver, you know that would be a bad idea!  Dennis Washington is like 86!

 

Over time, their stake will shrink to 20% like it did with Mid-American when Berkshire first bought...eventually they will sell out completely or take Fairfax shares to minimize tax and retain interest.  Kyle will oversee the family trust like most wealthy families do with someone managing all of the assets.  Cheers! 

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I think I should stop listening to the conference calls.  :)

 

Every time I listen, I get encouraged and buy more shares. Purchased more at CAD$360 today. I don't think I've ever seen this kind of discount to book.

 

I have to admit it is very cheap at this level, about a 9-10 year low. Will they ever be back at 660ish again (52w high) in the short or mid-term? I have nothing less than the expectation it does within 12-18 months. Irrealistic ?

 

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I think I should stop listening to the conference calls.  :)

 

Every time I listen, I get encouraged and buy more shares. Purchased more at CAD$360 today. I don't think I've ever seen this kind of discount to book.

 

I have to admit it is very cheap at this level, about a 9-10 year low. Will they ever be back at 660ish again (52w high) in the short or mid-term? I have nothing less than the expectation it does within 12-18 months. Irrealistic ?

 

I think it depends on whether we have rounds of the Pandemic hit us as things start to open up.  If we have a V-shaped recovery, I can see Fairfax stock and the market in general, back up around where it was.  If the Pandemic leads to a more wider recovery over say 2 years, then it might take longer.  Regardless, buying Fairfax at 60% of book value historically has never been anything but a good thing!  Cheers!

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Listened to the call. My comments:

 

- Main focus seem to be to make it clear that the hold co liquidity is there.

 

- Looks the feeling is that the window of getting that widening spread on fixed-income is largely a March event. (if i understood correctly)

- No question on position sizing of Exxon, Google etc. At this point i am guessing minor until 13F comes out.

- Looks like they bought (i think) bonds issues from Berkshire Hathway Energy and Walt Disney (although DIS was mentioned in the AGM)

- Half of the question seem to be from individual investors

- COVID seem to be minimal impact for now (naturally covid related question mostly seem to come from analyst who know better)

- Poor Prem, he has to keep telling people that buybacks are not priority. Probably his fault as he made big deal in talking about Teledyne some years back.

- Pretty funny when he asked if anyone on the phone has investment ideas they should let FFH know

 

Good call, but i think it is for each to figure out if 60% discount to BV equals 60% discount to intrinsic value.

Or there has been major impairment like Recipe and such, which was on a secular decline to begin with.

 

 

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Listened to the call. My comments:

 

- Main focus seem to be to make it clear that the hold co liquidity is there.

 

- Looks the feeling is that the window of getting that widening spread on fixed-income is largely a March event. (if i understood correctly)

- No question on position sizing of Exxon, Google etc. At this point i am guessing minor until 13F comes out.

- Looks like they bought (i think) bonds issues from Berkshire Hathway Energy and Walt Disney (although DIS was mentioned in the AGM)

- Half of the question seem to be from individual investors

- COVID seem to be minimal impact for now (naturally covid related question mostly seem to come from analyst who know better)

- Poor Prem, he has to keep telling people that buybacks are not priority. Probably his fault as he made big deal in talking about Teledyne some years back.

- Pretty funny when he asked if anyone on the phone has investment ideas they should let FFH know

 

Good call, but i think it is for each to figure out if 60% discount to BV equals 60% discount to intrinsic value.

Or there has been major impairment like Recipe and such, which was on a secular decline to begin with.

 

Well, not sure 60% of either necessarily matters. I made the point in the other thread that, at these prices, Fairfax need only generate 2.5% annualized on their float, debt, and equity to achieve 15% compounded returns from here.

 

No worrying about the accuracy of BV or IV or any of that necessary. No wondering if permanent impossible or a return to prior values. All of that is basically in the past. Do you think they can do 2.5% per year? If so, you get 15+% return on your capital.

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https://www.bnnbloomberg.ca/video/the-markets-are-picking-winners-and-losers-coming-out-of-this-crisis-mccreath~1950578

 

FFH not his cup of tea...hummm

 

Although a very short term view, I kinda agree on the poor investment results comment.

 

His comments are accurate, except for the fact that no one, including McCreath, expected a global pandemic to hit.  Look Markel lost like $1.4B as well, but their insurance business was at a 110% combined ratio...it's still trading near book.  Berkshire is going to get hit too this quarter, and has plenty of operating businesses that were shut down...it's trading just above book.  Fairfax never has gotten the same sort of respect or overvaluation, except in 1998 when it was 4 times book.  With insurance doing great, a hard market at our backs, an investment portfolio that should rebound and trading at 0.6 times book...I think McCreath is looking at things with a glass half-empty perspective.  Fairfax will do very well over the next 5 years.  Cheers!

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Well, not sure 60% of either necessarily matters. I made the point in the other thread that, at these prices, Fairfax need only generate 2.5% annualized on their float, debt, and equity to achieve 15% compounded returns from here.

 

No worrying about the accuracy of BV or IV or any of that necessary. No wondering if permanent impossible or a return to prior values. All of that is basically in the past. Do you think they can do 2.5% per year? If so, you get 15+% return on your capital.

 

How are you getting 15% with portfolio investments returning 2.5%?

 

I understand you are using $255 stock price as your capital base, but are you taking into account interest expenses, corporate expenses, preferred dividends? Even 3.5% pre-tax return does not get me to 15%.

 

Vinod

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Well, not sure 60% of either necessarily matters. I made the point in the other thread that, at these prices, Fairfax need only generate 2.5% annualized on their float, debt, and equity to achieve 15% compounded returns from here.

 

No worrying about the accuracy of BV or IV or any of that necessary. No wondering if permanent impossible or a return to prior values. All of that is basically in the past. Do you think they can do 2.5% per year? If so, you get 15+% return on your capital.

 

How are you getting 15% with portfolio investments returning 2.5%?

 

I understand you are using $255 stock price as your capital base, but are you taking into account interest expenses, corporate expenses, preferred dividends? Even 3.5% pre-tax return does not get me to 15%.

 

Vinod

 

For a shorthand analysis like this, it would not be entirely unreasonable to net underwriting profits against head office costs (incl interest) and simply look at investment return/stock price.

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2CC, you stated this on the other thread:

 

"With $835/share in float, $420/share in equity, and $337/share in debt - it's hard for me to come up with a case where returns aren't going exceptional @ $260/share.

 

That is $1500+/share earning you a return. 15% compounded from these depths only requires an annualized return of 2.5% on the float/debt/equity to get 15% ROIC for your dollars. Such a low bar! Particularly in an environment that is being disrupted where investment grade corporate debt and high-grade equities/preferred yield quite a bit more than that."

 

To me, Prem's promise of 15% return over the long term is a return on BK not market value. The fact that the stock is at deep discount, although good from a new investor point of view, is (1) less good for existing shareholders that don't plan to take advantage of the discount, given other market opportunities (2) also less good for existing shareholders, if Prem doesn't take advantage of the downturn and (3) completely unrelated to the 15% return over the long term BV.

 

For sure, the stock will at one point bounce back like an elastic from a discount of 0.6 to a discount 0.9 (as an example). But just like the downdraft was not Prem's fault and was market's doing, the bounce back is not a Prem's win ... unless he takes advantage of it in a major way.

 

But i agree that it is doubly good for new investors with a new entry point. Basically market is treating Prem Watsa as a risk thus paying new investors a discount for taking shares at this point.

 

Unrelated, i was thinking about Petec comment about lumpy return from a different thread. Taking that point of view on the FANGs names, i would characterize Alphabet and Apple as the ones with reliable return whilst Amazon is the one that has lumpy return, which i am happy to stomach, every time spigots get turned on or off. FFH's lumpy return however hasn't been there on the upside. And any excess return I get here as an existing FFH shareholder by buying the dip, is a market return as oppose to fruits of FFH investments from the past.

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https://www.bnnbloomberg.ca/video/the-markets-are-picking-winners-and-losers-coming-out-of-this-crisis-mccreath~1950578

 

FFH not his cup of tea...hummm

 

Although a very short term view, I kinda agree on the poor investment results comment.

 

The BBN analysis is good one.

But I would just say that FFH is not a conventional name, so i don't really count on BNN or their analysts to say Strong Buy.

I bet if i were to go on BNN archives in the years 2004-2010, you don't get too much Strong Buys from BNN on technology names, with the analyst keep referring to the spectre of the Dot.com bubble.

 

Not saying FFH is the new high-tech in the making. All i am saying is that BNN has a conventional main stream view with a certain framework and FFH is outside the norm.

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