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lessthaniv
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90% of the way to completion of "The Bow". I think the units remain cheap. Fairfax is sitting pretty with their 11.5% debentures and their 5yr/ $7 warrants.

 

____________________

 

 

H & R REIT earns $77.61-million in 2008

 

 

2009-03-03 19:17 EST - News Release

 

Mr. Larry Froom reports

 

H&R INCREASED DISTRIBUTABLE CASH 7% IN 2008; PROVIDES UPDATE ON THE BOW CONSTRUCTION FINANCING

 

H & R Real Estate Investment Trust and H&R Finance Trust's combined distributable cash increased by 3 per cent in the three months ended Dec. 31, 2008, and by 7 per cent for the year as a whole, compared with the same periods in the previous year. As previously announced on Oct. 1, 2008, and reported in Stockwatch, H & R Real Estate Investment Trust completed an internal reorganization which resulted in, among other things, each issued and outstanding H & R Real Estate Investment Trust unit trading together with a unit of H&R Finance Trust as a stapled unit on the Toronto Stock Exchange. Accordingly, H & R Real Estate Investment Trust and H&R Finance Trust are providing their financial summary presented herein on a combined basis as in management's view, the value of H & R Real Estate Investment Trust and H&R Finance Trust unitholders' investment is based on the combined financial performance of H & R Real Estate Investment Trust and H&R Finance Trust, and the combined financial information would therefore be the most useful information to unitholders.

 

Financial results

 

H & R Real Estate Investment Trust and H&R Finance Trust management considers H & R Real Estate Investment Trust and H&R Finance Trust's distributable cash to be an indicative measure in evaluating H & R Real Estate Investment Trust and H&R Finance Trust's performance. The following table includes non-generally accepted accounting principle information that should not be construed as an alternative to net earnings or cash flows from operations and may not be comparable with similar measures presented by other issuers as there is no standardized meaning of distributable cash under generally accepted accounting principle. Financial information for the periods ending after Oct. 1, 2008, is presented herein on a combined and/or stapled basis. Financial information for the periods ended prior to Oct. 1, 2008, is presented for H & R Real Estate Investment Trust.

 

 

                                          Three months      12 months

                                          ended Dec. 31,  ended Dec. 31,

                                          2008    2007    2008    2007

 

Combined distributable

cash (millions)(*)                      $ 55.8  $ 54.1  $221.7  $206.2

 

Combined distributable

cash per stapled unit (basic)            $ 0.38  $ 0.40  $ 1.57  $ 1.57

 

Combined cash distributions

(millions)                              $ 52.7  $ 46.3  $204.1  $180.0

 

Combined cash distributions

per stapled unit                        $ 0.36  $ 0.34  $ 1.44  $ 1.37

 

(*) Reconciliations of combined distributable cash to combined net

earnings and to combined cash provided by operations are included in

H & R Real Estate Investment Trust and H&R Finance Trust's combined

management's discussion and analysis.

 

 

Combined distributable cash per stapled unit (basic) decreased 5 per cent in the fourth quarter 2008 (unchanged for the year) due to dilution resulting from the securities offering completed in June, 2008, and to costs associated with H & R Real Estate Investment Trust and H&R Finance Trust's internal reorganization. Combined cash distributions increased 14 per cent in the fourth quarter, and rose 13 per cent (5 per cent per stapled unit) for the 2008 year.

 

 

        RESULTS REPORTED IN ACCORDANCE WITH CANADIAN GAAP

   

                                          Three months      12 months

                                          ended Dec. 31,  ended Dec. 31,

                                          2008    2007    2008    2007

 

Rentals from income

properties (millions)                    $156.9  $149.7  $608.7  $580.7

 

Combined net earnings

(millions)(loss)(*)                      $ 46.0  $ 48.7  $ 98.5  ($2.2)

 

Combined net earnings per

stapled unit (loss)(basic)              $ 0.32  $ 0.38  $ 0.71  ($0.02)

 

Combined cash provided by

operations (millions)(*)                $ 73.8  $ 63.4  $235.1  $196.6

 

(*) Reconciliations of combined distributable cash to combined net

earnings and to combined cash provided by operations are included in

H & R Real Estate Investment Trust and H&R Finance Trust's combined

management's discussion and analysis.

 

 

H & R Real Estate Investment Trust and H&R Finance Trust reported a 5-per-cent increase in rental income in both the fourth quarter and full year 2008, due primarily to property acquisitions. Combined net earnings decreased 6 per cent (down 13 per cent per stapled unit) in the fourth quarter and increased to $98.5-million in 2008 from a loss of $2.2-million in 2007. Combined cash provided by operations rose 16 per cent in the fourth quarter and 20 per cent for the year.

 

As at year end 2008, H & R Real Estate Investment Trust and H&R Finance Trust reported financial ratios of 54.7 per cent for debt to gross book value (calculated in accordance with H & R Real Estate Investment Trust's declaration of trust) versus 58.8 per cent as at Dec. 31, 2007, and 51.4 per cent for non-recourse debt to total debt (49.5 per cent at year end 2007).

 

H & R Real Estate Investment Trust and H&R Finance Trust's audited combined financial statements and the notes thereto, and management's discussion and analysis relating thereto for the year ended Dec. 31, 2008, are available on H & R Real Estate Investment Trust's website and have been concurrently filed on SEDAR, as well as H & R Real Estate Investment Trust's audited consolidated financial statements and the notes thereto, and H & R Real Estate Investment Trust and H&R Finance Trust Finance Trust's audited financial statements and the notes thereto (each for the fiscal period ended Dec. 31, 2008) and management's discussion and analysis relating thereto.

 

The Bow construction financing

 

H & R Real Estate Investment Trust is pleased to announce that it has signed an engagement letter with RBC Capital Markets and TD Securities, which will collectively act as co-lead arrangers and co-bookrunners for a $425-million construction facility for H & R Real Estate Investment Trust's development project "The Bow" in Calgary on a reasonable best-efforts basis. RBC and TD have received all necessary internal approvals to commit up to $250-million of the financing contingent upon securing commitments for the remainder of the financing and certain other conditions. The marketing process for receiving commitments for the remainder of the financing is currently under way. If H & R Real Estate Investment Trust is successful in signing definitive agreements for the financing, it will have satisfied all of the conditions of the private placement with Fairfax Financial Holdings Ltd., pursuant to which Fairfax has agreed to purchase, at par, $200-million of debentures. In combination with the moneys arising from reduced distributions and the Fairfax debentures, and on the assumption that the other strategic initiatives which have been undertaken by H & R Real Estate Investment Trust will be successful, H & R Real Estate Investment Trust believes that the financing (if completed) will allow it to successfully complete construction of The Bow.

 

H & R Real Estate Investment Trust is currently building a two-million-square-foot office building in Calgary's downtown financial district. The real estate investment trust spent $49-million on the $1.5-billion project during the fourth quarter 2008, bringing H & R Real Estate Investment Trust's total investment to $402-million by year end. H & R Real Estate Investment Trust expects to spend approximately $375-million on the trophy project over the next 12 months. Further information regarding the budgeted costs to complete The Bow and actual costs incurred as at Dec. 31, 2008, as well as the estimated moneys required and projected sources of moneys for the 2009 to 2011 period, is available in H & R Real Estate Investment Trust and H&R Finance Trust's combined management's discussion and analysis, and H & R Real Estate Investment Trust's management's discussion and analysis.

 

Monthly distribution declared

 

H & R Real Estate Investment Trust and H&R Finance Trust also announced a combined monthly cash distribution of six cents per stapled unit (representing 72 cents on an annualized basis).

 

 

              Record date    Distribution date

 

March, 2009      March 17              March 31

April, 2009      April 16              April 30

May, 2009          May 14                May 29

 

 

We seek Safe Harbor.

 

 

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Granitepost,

 

Thanks for highlighting this article. I would love to read Mr. Downey’s full comments given his employment at RBC Capital Markets which is also a co-lead in the financing.

 

I am wondering how he arrived at a NAV of $12/units, in particular. That seems to imply a very high cap rate which in turn leads me to believe that Downey feels we could be entering an early 90’s scenario?

 

However, I tend to disagree with this. I don’t think this environment has the same characteristics as the early 90’s at all. In the late 80’s and early 90’s excessive development led to an oversupply situation where national office vacancies exceeded 17%. According to CB Richard Ellis, at the end of Q4/08 we are sitting around 7%. H&R on the other hand has a 99% occupancy rate.

 

In fact when you analyze the main markets where H&R owns property (in Canada) and compare today’s vacancy rates to the 90’s here is what I find:

 

Town: 1990 Now

Calgary 17.7% 6.2%

Ottawa 9.6% 5.1%

Edmonton 13.9% 5.1%

Vancouver 9.5% 6.1%

 

Certainly, I would agree that vacancies could still rise further. However, I don’t see us getting to levels felt in the early 1990’s. In the early 90’s the inventory supply growth was about 6.6%. The current office supply pipeline growth is projected to be around 3.6% through 2011. As many analysts have pointed out, the debt financing situation is also much different. In the early 90’s cap rates were 7% vs. debt financings which were averaging 11% creating a negative leverage spread. In the tail end of the 90’s the cap rates rose to 8%-9%.  This is in contrast to recent years where low debt financings have allowed for a positive spread. Also, Canadian chartered banks have very low exposure to commercial mortgages. A recent stat I read suggested a sum of $25B or roughly 2% of their total loan book. In fact, since the freezing of the commercial mortgage backed securities market in 2007, roughly $4.5B of new commercial loans has been absorbed by the Canadian chartered banks. With very minimal loan book exposure, they have the ability to grow their commercial loans much further. This is a very different situation than the U.S.

 

I am getting a NAV that is closer to $17-$18/unit. Not $12.

 

The larger cap Canadian REIT sector is trading around 8X-10X adjusted funds from operations, which in most cases suggests a 35% discount to NAV using a 7% cap rate assumption. Assuming H&R can produce $1.25 in AFFO (which if very realistic) a relative valuation would suggest a trading range of $10/unit - $12.50/unit. But, in better times the value tends to move towards NAV which I believe (using a 7% cap rate assumption) is closer to $18/unit.

 

Right now the market is implying a cap rate of 11% which in my mind unjustly values their superior portfolio of properties, security of the long term tenants, and strong financial position. IE: Debt/Gross Book Value = 59%. They can go as high as 65%. Weighted average term to maturity on their debt is over 9 years with a weighted average interest rate of less than 6.5%. They have minimal mortgage maturities coming up; 5% in 2009, 4% in 2010, 6% in 2011. As far as their U.S properties go – they have no material maturities coming up until 2012.

 

It’s my opinion that the current stock price reflects the markets perception of the risks involved in financing The Bow. The risks are real. But I think this deal get done with a fairly high degree of certainty (say 80%). If you analyze the LVR that H&R is giving to the banks its less than 30%!  From the banks perspective, they will get; high fees (assumption given credit market conditions); a very low loan to value ratio (LVR); and, the security of knowing the building is pre-leased to EnCana for 25 years. In addition, the bank facility will likely be one of the last funding sources put into the project. The 2009-2010 financings needs amount to $700M-$800M. H&R can accommodate this as follows: $200M from Fairfax Deb, $200M from lower distributions, $200M asset dispositions, $150M from cash and current operating facilities. Therefore, the value proposition being presented to the banks is attractive: High fees, low LVR, and last facility drawn.

 

I believe this is what FFH sees. By giving H&R a $200M unsecured debenture, they have allowed H&R to offer the banks a great deal. For their troubles, they 11.5% on that money but I suspect the real dollars will be made through the warrants. If exercised (which I think they will be) it will add an additional $200M in cash to H&R further protecting their investment positions.

 

When this is all said and done, the distribution cut, necessary to self finance, will be reinstated and the dividend will increase materially.

 

I understand that April 9th is the day when firm commitment letters are due for the syndicated debt. I believe this will be a catalyst to remove the black financing cloud currently overhead. With the financings worries put to bed, I am hopefully that H&R will close the gap between the current market quotation and the real business value.

 

Disclosure: Very long H&R.  ;D

 

<IV

 

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  • 4 weeks later...

Surprise, Surprise! Fairfax is looking brilliant again!

 

Good news for H&R REIT and hence FFH. They have announced the completion of their financing for The Bow project. H&R will forego building the South Tower (Nice job by Neil Downey - RBC Analyst who picked up on this some time ago). They are also actively looking to sell 50% to a joint venture partner with the goal of using that capital to payoff the project debt.

 

http://www.google.com/hostednews/canadianpress/article/ALeqM5jVs9RoXaCpFzL69_f4WC6No8axGw

 

H&R REIT obtains $425 million financing for Calgary "Bow" highrise project

8 hours ago

 

TORONTO — H&R Real Estate Investment Trust (TSX:HR.UN) said late Wednesday that it had obtained $425 million worth of financing for a massive skyscraper project that is to serve as headquarters for one of the country's energy giants.

 

H&R is building the 58-storey Bow, a $1.5-billion downtown office tower that will be EnCana Corp.'s (TSX:ECA) new headquarters.

 

In documents filed with securities regulators earlier this week, the trust said it was deferring construction on the southern part of the complex and expressed concerns about obtaining future financing.

 

H&R released details of the new funding in a statement released late Wednesday, adding financing was being provided through a syndicate of Canadian financial institutions led by RBC Capital Markets and TD Securities.

 

"We are very pleased to have reached this important milestone in the development of what will be the largest office tower in Canada west of Toronto, and a magnificent addition to H&R's North American portfolio," trust chief executive Tom Hofstedter said in the statement. "This major financing is a testament to the confidence that Canadian financial institutions have in H&R's ability to build a landmark office tower successfully."

 

H&R did not offer any details on whether the construction on the south tower would still be delayed.

 

To date, the trust says it has spent about $402 million on the Bow and expects to incur another $375 million over the next year.

 

The north block development and 1,361 parking spaces underneath the north and south towers are pre-leased to EnCana for a period of approximately 25 years.

 

Construction on the north block development started in the spring of 2007 and is expected to be delivered in stages, with the first phases scheduled for completion in the second half of 2011. The rest of the office space is expected to be finished in 2012.

 

H&R units closed down 10 cents at $7.60 on the Toronto Stock Exchange on Wednesday.

 

Late last year, Fairfax Financial (TSX:FFH) agreed to buy $200 million worth of debentures issued by the REIT in a move to help fund the construction.

 

Fairfax agreed to subscribe to the offering, but with certain conditions attached.

 

Chief among those is a cut in the REIT's monthly distribution to six cents from 12 cents as well as the securing of construction financing commitments of at least $400 million for development of the Bow.

 

The Toronto-based investment firm will also be granted warrants to buy 28.6 million stapled units at $7 each for a total $200 million, exercisable for five years.

 

Copyright © 2009 The Canadian Press. All rights reserved.

 

 

 

 

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  • 8 months later...

Fairfax looking brilliant - yet again.

I've cashed in my own chips on my H&R position with this recent pop in price and it appears FFH is cashing in their warrants acquired during the financing noted above, too.

 

Pretty much a double for FFH since April / 2009, and a triple from the bottom in November/08!

 

<IV

______________________________________

 

 

H & R Real Estate to redeem Fairfax warrants

 

 

2009-12-17 08:19 ET - News Release

 

Mr. Larry Froom reports

 

H&R REAL ESTATE INVESTMENT TRUST ANNOUNCES AGREEMENT TO REDEEM THE FAIRAFAX WARRANTS AND A $150MM CONVERTIBLE UNSECURED SUBORDINATED DEBENTURE ISSUE

 

H & R Real Estate Investment Trust (H&R) has signed a definitive agreement that provides H&R with the opportunity to redeem up to 28,571,429 warrants issued to Fairfax Financial Holdings Limited and an affiliate. The warrants were issued to Fairfax on April 24, 2009, pursuant to a warrant indenture, and have an exercise price of $7.00 per stapled unit and an expiry date of April 24, 2014. Subject to regulatory approval, which H&R expects to receive, the redemption will occur no later than Jan. 29, 2010, at a cash redemption price of $6.50 per warrant (representing a fixed reference price of $13.50 per stapled unit less the warrant exercise price of $7.00). The net amount payable by H&R to Fairfax would be approximately $185.7-million assuming redemption of all of the warrants. The redemption of the warrants will simplify H&R's capital structure and is accretive to H&R's net asset value and AFFO on a fully diluted per unit basis.

 

H&R intends to finance the net redemption value with funds available from operations and other available sources of financing, which may include a portion of the net proceeds from the convertible debenture offering (described below).

 

H&R has also entered into an agreement to sell, to a syndicate of underwriters co-led by RBC Capital Markets and CIBC World Markets, on a bought deal basis, $150-million principal amount of 6.00-per-cent convertible unsecured subordinated debentures due June 30, 2017. Closing is expected to occur on or about Dec. 30, 2009, subject to regulatory approval. The net proceeds from the offering will be used for general trust purposes, and to the extent necessary, finance a portion of the net redemption value.

 

H&R's president and chief executive officer Tom Hofstedter said: "We are very pleased to have entered into this agreement with Fairfax, a company that we have worked with for many years and for whom we have the highest regard. We believe that redeeming the warrants and the issuance of cost-effective long-term financing provides significant benefits to our unitholders. In particular, H&R is redeeming the warrants utilizing a reference price of $13.50, while issuing convertible debentures with a conversion price of $19.00. In addition, the redemption is accretive to internal and financial analyst NAV estimates and AFFO on a fully diluted per unit basis."

 

The convertible debentures will bear interest at a rate of 6.00 per cent per year payable semi-annually in arrears on June 30 and Dec. 31 in each year commencing on June 30, 2010, and will mature on June 30, 2017. The debentures will be convertible at the holder's option into stapled units at any time prior to the earlier of the maturity date and the date fixed for redemption at a conversion price of $19.00 per stapled unit. The debentures will not be redeemable on or before June 30, 2013. On and after June 30, 2013, and prior to June 30, 2015, the debentures may be redeemed in whole or in part from time to time at H&R's option provided that the volume-weighted average trading price for the stapled units is greater than 125 per cent of the conversion price. On and after June 30, 2015, and prior to the maturity date, the debentures may be redeemed in whole or in part from time to time at H&R's option at a price equal to their principal amount plus accrued interest.

 

The offering is being made under H&R's existing short-form base shelf prospectus dated May 11, 2009, as amended. The terms of the offering will be described in a prospectus supplement to be filed with Canadian securities regulators by no later than Dec. 21, 2009.

 

The Fairfax agreement also provides that any warrants remaining outstanding after the redemption date will be automatically exercised on a cashless basis, based on a redemption price of $13.50 per stapled unit.

 

 

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"You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right—and that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else."  - WEB

 

Well done lessthaniv!  You nailed that one.

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Thanks!

 

What's truly amazing however, is the outcome of Fairfax's deal. They got $200M in 5yr debentures paying 11.5% AND they got the warrants.

 

With the warrants being redeemed within the first year, Fairfax will make (28,571,429 * $6.50) approximately $186M. Coupled with the interest payment on the debentures, they will have received $209M back from a $200M capital outlay that pays them 11.5% for the next 4 years!

 

Take a look at the return they will make:

(rough approximation)

 

CF0 = -$200M

CF1 = $186M + $23M

CF2 = $23M

CF3 = $23M

CF4 = $23M

CF5 = $223M

 

IRR = 46%

 

WOW! :o

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This one worked out very well.  However, every once in a while, on this board we start bitching and moaning about the mistakes that FFH makes.  We should remember the winners like this when we start questioning the wisdom of investments in Abitibi, Canwest, Torstar or Megablox.  For all of these, the decision making process was characterized by a broad range of potential outcomes (from wonderful like H&R to atrocious like Canwest).  Ex-ante, you really don't know which outcome you will get.  Overall, you hope the winners more than offset the losers.

 

Kudos to the team for this particular decision.

 

SJ

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"Ex-ante, you really don't know which outcome you will get"

 

Stubble, while I respect and appreciate your opinion, I disagree with it. There is a huge difference with a localized cancer operated with a skilled surgeon and a generalized cancer operated by a plumber.

 

Abitibi was a "generalized cancer" situation and it doesn't take a 200 IQ to understand that. Canwest were a grayer situation, but still a generalized cancer with tons of debt on top of that.

 

There is the Berkshire, Johnson and Johnson, Wells Fargo, Walmart, etc." of this world, an there is the "Abitibi, TIG, Canwest, etc." of this world. And...there is the other ones between the two "categories". Some have times on their friends, some have time as their enemies.

 

Cheers!

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"Ex-ante, you really don't know which outcome you will get"

 

Stubble, while I respect and appreciate your opinion, I disagree with it. There is a huge difference with a localized cancer operated with a skilled surgeon and a generalized cancer operated by a plumber.

 

Abitibi was a "generalized cancer" situation and it doesn't take a 200 IQ to understand that. Canwest were a grayer situation, but still a generalized cancer with tons of debt on top of that.

 

There is the Berkshire, Johnson and Johnson, Wells Fargo, Walmart, etc." of this world, an there is the "Abitibi, TIG, Canwest, etc." of this world. And...there is the other ones between the two "categories". Some have times on their friends, some have time as their enemies.

 

Cheers!

 

 

Well, my point really was that ex-ante, we did not know that H&R was better than Abitibi.  On the old board, I recall many people applauding the Abitibi purchase when it was made.  Time has shown that it was a disaster.  Same with Torstar and CanWest.  So in retrospect, we call them "cancer generalise" and shake our heads about those investments.

 

H&R worked out, and so in retrospect, we say that it was obvious.  However, I will tell you, it was not at all obvious last fall.  Nobody would lend money to H&R last fall.  The credit markets were collapsing, everybody was talking about another great depression and 25% unemployment.  There was speculation that commercial real estate would collapse, and vacancy rates would soar.  Putting money into H&R last fall was a risky move.  There was a significant risk of a permanent loss of capital.  If it had not worked out, we would have called it a "cancer galopant" and people would be here posting about how obvious it was that FFH should not have been investing in commercial real estate last fall.

 

The same is true with the credit default swaps.  We have all kinds of people who are now saying how obvious it was to buy the CDS.  I will say, that it was not at all obvious when the purchases were made three years ago. As with all derivatives, there was a significant risk that they would be worthless at their expiration, leaving FFH with a modest permanent loss of capital.  It worked out that credit markets collapsed prior to the CDS expiry dates, and FFH made a ridiculous pile of money.  But ex-ante, there was no guarantee that this would be the outcome.

 

All this to say, FFH takes significant risks on our behalf.  Some of them work out (credit default swaps, H&R) and some of them don't (Abitibi, Canwest).  On the whole, we have a bunch of really smart guys working for us, trying to assess the likely outcomes.  We should give them full credit for their successes, but also cut them some slack for the failures.  The failures are a cost of doing business.  If it was easy, everybody would be doing it.

 

SJ

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I disagree that H&R Reit was equivalent to Torstar, and Abitibi. 

 

H&R had a lease signed to one of the largest petroleum producers in Canada for their new building that was semi-constructed.  Torstar etc. are in secular declines, petroleum is now entering the greatest period of the industry's existence in my opinion. 

 

I didn't voice any opinion on any of these beforehand but I consider H&R Reit to have been a substantially safer investment than many of the grenades Fairfax has invested in the last couple of years.  Some of the grenades could have been purchased at much lower prices had patience reigned king.

 

Nevertheless, I support Fairfax completely and have owned the stock for 3.5 years now.  We all make mistakes!

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It is very easy to look at this with hindsight isn't it?

 

I still think Abitibi is going to work out and Fairfax is going to come out a majority owner in one of the largest p&P/timber companies in the world and it will be profitable.  It's value in the end is anybody's guess.  Similarly I think the Brick will work out, and Megablocks.  Canwest appears to be a mistake, through and through.  With Torstar they will be lucky to get out break even.  

 

It is interesting to note that the crappier investments were made pre-crash.  Obviously FFH was moving down the quality ladder at the time.  Most of the investments made during and since the crash are higher quality.  This speaks to the experience of Warren versus the Fairfax team - Warren was able to wait knowing his time will eventually come.  You can bet that FFH will be better at waiting going forward.

 

 

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I disagree that H&R Reit was equivalent to Torstar, and Abitibi. 

 

H&R had a lease signed to one of the largest petroleum producers in Canada for their new building that was semi-constructed.  Torstar etc. are in secular declines, petroleum is now entering the greatest period of the industry's existence in my opinion. 

 

I didn't voice any opinion on any of these beforehand but I consider H&R Reit to have been a substantially safer investment than many of the grenades Fairfax has invested in the last couple of years.  Some of the grenades could have been purchased at much lower prices had patience reigned king.

 

Nevertheless, I support Fairfax completely and have owned the stock for 3.5 years now.  We all make mistakes!

 

 

It's funny how much the world has changed over the past year.  Time has faded our memory of the fear and panic that prevailed in capital markets during the fall of 2008.  Or maybe the subsequent bull market has caused us to forget?  Outside of a select group of value investors who have big balls, nobody wanted to deploy capital last year.  Most people were cashing out, running to the sidelines. Some large banks and insurers were collapsing.  People were talking of nationalization of the US banking system.

 

With or without a large tenant for the half-completed project, H&R was risky.  Go back and check out the WTI oil price from November or December 2008.  It was ~$40/bbl.  People were scared as hell of an "oncoming world depression" with 25% unemployment.  There was speculation that the WTI oil price could tumble to as low as ~$20/bbl due to drastically lower world demand.  Of course, all of that speculation has turned out to be poppycock, but at the time, the fear was real.  If we had hit $20/bbl for any length of time, the commercial real estate market in Calgary would have collapsed, and H&R's entire portfolio would have been in serious trouble, irrespective of whether they had a major tenant for a half-completed project.

 

NOBODY would touch H&R at that time.  That was how FFH was able to extract 11.5% interest plus the warrants.  The banks wouldn't touch that potentially toxic mess, the Ontario Teachers Pension fund wouldn't touch that mess, the Caisse de depot et placement wouldn't touch it either.  Heavens, H&R has exchange traded convertible debentures that were trading at ridiculous yields, and anyone could have bought them....but evidently, there was insufficient demand to push the price up.  I seem to recall that anybody could have purchased the exchange traded converts for a slightly higher yield than what FFH got....

 

Anyway, if oil had continued to tumble down to $20-30/bbl, we would not currently be celebrating the H&R decision.  In the end it worked out, but that outcome was far from assured.  FFH could have had a permanent loss of capital.

 

SJ

 

 

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"Ex-ante, you really don't know which outcome you will get"

 

Stubble, while I respect and appreciate your opinion, I disagree with it. There is a huge difference with a localized cancer operated with a skilled surgeon and a generalized cancer operated by a plumber.

 

Abitibi was a "generalized cancer" situation and it doesn't take a 200 IQ to understand that. Canwest were a grayer situation, but still a generalized cancer with tons of debt on top of that.

 

There is the Berkshire, Johnson and Johnson, Wells Fargo, Walmart, etc." of this world, an there is the "Abitibi, TIG, Canwest, etc." of this world. And...there is the other ones between the two "categories". Some have times on their friends, some have time as their enemies.

 

Cheers!

Partner, If it is easy as you suggest to identify beforehand which of the Phoenix type of investments that Prem has made will work out perhaps you could identify today amongst the various fallen angels that FFH has exposure to will work out and why.
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Yes, I see exactly where you are coming from Stubble.  I don't disagree with your view at all.  I actually believed that we had much more than minuscule chances of what you're describing and would have made much more money if I didn't.  

 

There were only a select few people throwing cash at new investments, especially real estate last fall.  Perhaps me being one of the few with a Reit specifically (PLD), affords me my view.  I have to say it was weird buying a Reit at the time but I estimated that PLD was selling for about 1/8 of its value under even a somewhat dire scenario (not anything like 25% employment).  I haven't looked at H&R at length but I guess Fairfax was thinking that it wasn't going to get quite that bad and that was my GUESS as well.  I should probably add that I work in real estate so perhaps my view is different than others because of this.

 

As most of the other formerly British countries/colonies would say: Cheers! (I'm U.S)

 

 

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"Ex-ante, you really don't know which outcome you will get"

 

Stubble, while I respect and appreciate your opinion, I disagree with it. There is a huge difference with a localized cancer operated with a skilled surgeon and a generalized cancer operated by a plumber.

 

Abitibi was a "generalized cancer" situation and it doesn't take a 200 IQ to understand that. Canwest were a grayer situation, but still a generalized cancer with tons of debt on top of that.

 

There is the Berkshire, Johnson and Johnson, Wells Fargo, Walmart, etc." of this world, an there is the "Abitibi, TIG, Canwest, etc." of this world. And...there is the other ones between the two "categories". Some have times on their friends, some have time as their enemies.

 

Cheers!

Partner, If it is easy as you suggest to identify beforehand which of the Phoenix type of investments that Prem has made will work out perhaps you could identify today amongst the various fallen angels that FFH has exposure to will work out and why.

 

I actually thought I would get a similar response like this from my post as well.  I think it would be interesting to perhaps vote on each new major investment (perhaps greater than 3-4% of book?) Fairfax makes.  Although, investment durations and opinions might make it hard to have a binary outcome vote be effective.  Perhaps a poll such as the 4 possible returns (or book value growth was it?) polls I think we have had for Fairfax and Berkshire going forward?  And I feel like I should say this again: we all make mistakes!

 

 

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A couple of points on this investment from my perspective as well as FFH's perspective:

 

a) I certainly agree that last fall created significant risks for owners of H&R stock, however, I also think it was clear that market discounted the stock price well beyond what was rational. The market was focused on "The Bow" financing but in my mind failed to account for other possible outcomes. H&R had a few different options. For example; Include EnCana in the financing syndicate to lower the banks commitments;Attain financing through an alternate source (like Fairfax); Selling an interest in The Bow;Selling its Bell development project which was fully leased to Bell for 20 years and held a targeted completion date of January 2009 at the time;Sell or refinance other assets; Raise capital through debt or equity.

 

None of these were "desired" strategies given the horrific state of the markets and most would immediately lower the value of H&R stock upon execution but no matter which way I looked at it the lower value would never come close to <$5/share! At that price the margin of safety was large.

 

B) Secondly, right before Christmas when H&R announced the deal with Fairfax ($200M debenture) and at the same time cut the dividend, any investor could quickly calculate a fairly accurate estimate of what level of financing H&R would require from the banks. From the banks perspective they would get a dream deal: Low LVR, last facility drawn, High Rates. I made a call to two commercial lenders and presented them with this scenario. The both told me it was a deal that had a very high percentage of closing.

 

C) Next, from FFH's perspective: Remember, Fairfax was exposed to a lot less risk that me!  The private placement was conditional upon, among other things, the occurrence of the following events by closing:

 

  1. Receipt by the REIT of construction financing commitments of no less than $400-million for the development of the Bow in Calgary;

  2. Monthly unitholder cash distributions of six cents per stapled unit will be maintained until closing;

  3. Toronto Stock Exchange approval.

 

In other words, Fairfax ensured the bank financing was in place before being committed!

 

D) Finally, remember that when "The Bow" financing did get arranged and announced to the market on April 2, 2009 .... HR.un shares were still only trading at $7.60/unit.

 

Still a double to conservative estimates of NAV!

 

<IV

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"Partner, If it is easy as you suggest to identify beforehand which of the Phoenix type of investments that Prem has made will work out perhaps you could identify today amongst the various fallen angels that FFH has exposure to will work out and why".

 

Well, there is the "home run or 3 strikes/out" situations, there is the base hits and some grayer stuff between the two. I think it's reasonable to say that The Brick is a fixable situation and, based on what I've heard about him, the actual surgeon is a skilled one. I'm not 100% sure that it will work out, but I'm more confortable with that than some others who have poor balance sheet and strong and secular headwins.

 

If you're looking at the safer base hits, Johnson and Johnson and Kraft Foods are among them. Maybe they will not work out, but frankly it's more difficult to me to conceptually "kill" them over the short and mid terms than some others.

 

That all being said, Prem and team batting average is terrific and they mostly invest in pretty different kind of situations that I'm usually confortable with. These situations are mostly within their own circle of competence, not mine.

 

A good tool to figure that out is to ask yourself if you can find a way to conceptually "kill" the business and if you think it would be easy or not. How can you kill Berkshire, Procter and Gamble, Coca-Cola, etc.? Would that be easy? Nothing is impossible, but...

 

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