Tuesday, March 11, 2008

We have moved to a new website

here's the link http://www.insurancestockinvestor.com

& check out my new book review on successful value investor Sir John Templeton

Friday, March 7, 2008

Prem Watsa -" Regression to the mean has begun - but only just begun!"

This quote is from Prem Watsa's annual letter to shareholders for 2007 released today. The performance for Canadian insurer Fairfax Financial(FFH) for 2007 was excellent and I have discussed this in earlier posts. I think there are only a handful of companies in the world that can boast of a 26% compounded return in book value over 22 years.

But I want to focus on Prem Watsa's outlook as he discusses in his annual letter.

"We have witnessed credit spreads widen dramatically for mortgage insurers, bond insurers and junk bonds, reflecting mainly the problems of the housing market. We remain vigilant for the spreading of these risks into all credit markets, because the same loose lending standards and asset backed structures have been applied to these markets"(Prem Watsa 2007 annual report)

This concern has certainly been reflected in the credit default swap index that has widened out to over 180 basis points as of yesterday according to Bloomberg up from 29 basis points a year earlier.

Prem Watsa is clearly concerned that defaults will spread to credit cards, auto loans & so on.

"BenGraham made the point that only 1 in 100 of the investors who were invested in the stockmarket in 1925 survived the crash of 1929 – 1932" (Prem Watsa annual report 2007)

Imagine going to a financial advisor to put some money into a mutual fund and him or her advising you that equities can be risky investments and ,by the way, only 1 out of 100 investors survived the 1929 - 1932 crash. This was a fascinating piece of historical perspective.

"In our 2005 Annual Report, we also discussed the Japanese experience from 1989 to 2004 when the Nikkei Dow dropped from 39,000 to 7,600 while yields on 10 year Japanese government bonds collapsed from 8.2% to 0.5%. With the Federal Reserve dropping the Fed Funds rate down to 3% from 5.25%, we might be witnessing a repeat in the U.S. of the Japanese experience. In spite of record lowinterest rates and record high fiscal deficits, Japanwent through years ofmild deflation. The feelings at the time in Japan were that they were different andwould not allow stock prices andland prices to fall – not dissimilar to the sentiment currently prevailing in the U.S.!!" (Prem Watsa 2007 annual report)

Could the US face the Japanese experience all over again. Deflation is definitely under way with falling asset values and rising commodity prices. Its a scary thought and would have global stockmarket implications.

"We continue to protect our shareholders froma 1 in 50 or 1 in 100 year financial storm by hedging over 80% of our equity exposure against the S&P 500 (mainly), by holding approximately 80% of our investment portfolio in treasury bills and government bonds, and by our $18 billion notional CDS position." (Prem Watsa 2007 annual report)

Prem Watsa has built the defences for Fairfax Financial to protect the company if we are in fact going into a 1 in 100 year storm. Even though the insurance industry and Fairfax are facing lower premiums from a softer insurance cycle , I still like the way Fairfax Financial is positioned and if credit markets continue to deteriorate Fairfax could end up making considerable investment gains on their credit default portfolio that will more than compensate for an inevitably softer underwriting performance.

Disclosure: I own shares of Fairfax Financial (FFH)

Sunday, March 2, 2008

Warren Buffett’s discussion on See’s Candy - Berkshire Hathaway Annual Report 2007

I felt this was a really interesting part of Warren’s annual shareholder letter this year.

Here are a few of my takeaways with quotes from Warren’s annual report…

1. The best businesses can be found in really slow growing industries (Classic Peter Lynch)

“The boxed-chocolates industry in which (See's) operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn’t grow”. Since 1972 See’s sales have grown at at “ only 2% annually.”(Warren Buffett – Berkshire Hathaway Annual letter 2007)

2. They have a moat or durable competitive advantage & great management…

“Yet (See’s) durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire.” (Warren Buffett – Berkshire Hathaway Annual letter 2007)

3. They throw off a lot of cash with little capital reinvestment required.

“We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million….

Last year See’s sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion” (Warren Buffett – Berkshire Hathaway Annual letter 2007)

4. And of course selling a great product & recognized brand that people love. Who doesn’t like chocolate!

Disclosure: I own shares of Berkshire Hathaway (BRK-B)

Friday, February 22, 2008

Value investors crowd around Sears

I just wanted to update a January article I wrote called "Media Hype" that included a discussion about Sears Holdings (SHLD) . (quick note - My normal focus for my blog is the insurance sector , you'll have to forgive me for digressing occasionally).

As you recall I compared the media attack on Eddie Lampert & Sears Holdings to what happened with insurer Fairfax Financial & Prem Watsa (& Berkshire Hathaway & Warren Buffett.)

Well it seems that some of the very best value investors around are loading up on Sears stock based on the latest 13Fs.

Here is my list of long term, top value investor stakes. Holdings of Tisch & Perry are as reported in a Barron's article "A Storied Name on Sale?" (Oct07) & neither of these insiders have sold stock since.

Eddie Lampert & ESL 65.6 mil
Bill Ackman & Pershing 6.1 mil
Thomas Tisch & family 4.2 mil
Richard Perry 2.7 mil
Bill Miller - Legg Mason 12.7 mil
Bruce Berkowitz - Fairholme 6.2 mil
Mohnish Pabrai funds 516 thous
Chris Davis- NY Venture fund 1.2 million
Michael Price & Whitney Tilson NM

total 97 mil

Now the total share float is around 137 million but may have been reduced through more Lampert repurchases. I would regard the 97 million shares listed as in long term hands , generally loyal to Lampert. All of these investors are very unlikely to want to sell any shares at current levels.

As of January 25, around 26 million shares of Sears were held short, 20% `of the available float. Based on my rough calculations there are really only 40 million shares the shorts can cover with & this is shrinking with Lampert's repurchases. Further, with Sears hitting new lows down in the $80s it is very likely one or more of the above value investors have materially increased their stake in Sears. This would have further reduced this 40 million share difference.

So the upshot of all this is that individuals/hedge funds shorting Sears Holdings may soon find themselves unable to buy back or cover their short positions very easily. When this situation is combined with some good news or a sense that Lampert & Sears Holdings could see an improved outlook, then potentially there could be a dramatic short squeeze in Sears stock, assuming the amount of shorts stay at their current levels.

Disclosure: I own shares of Sears Holdings (SHLD)

Disclaimer: This article should not be relied upon as investment advice and is not intended as investment advice.

Thursday, February 21, 2008

Interview with fixed income guru Bill Gross

I will warn you that this interview is actually quite depressing, yet worth listening to. Bill Gross is consistently right on the mark and his views mirror Prem Watsa's interview comments from my last article post.

Below is a link to the interview on Bloomberg. But first a few take aways from the interview -

- We're facing an environment where assets such as houses,shares are experiencing deflation while commodities (oil & food) are rising rapidly and creating inflation. The net effect being a real erosion of wealth.

- Bill Gross (citing Peter Bernstein) says the unwinding of the global derivatives and massive debt leverage globally will be akin to "water torture" both slow & painful. (I immediately had a recall to Warren Buffett & Berkshire Hathaway's nightmare with Gen Re & the un-winding of Gen Re's derivative portfolio. It cost Berkshire hundreds of millions in losses and was nothing compared to the global derivative trade we now have)

- cheap credit is over , the ability to obtain credit & the cost of credit will be higher in spite of recent interest rate cuts .

-the total losses from subprime will be $400-$500 billion but when combined with other corporate loan losses, losses in mututal funds & hedge funds , the total losses could be over $700 billion.

- Bill Gross didn't suggest there wasn't value in banking stocks. He did say Pimco was investing in corporate bank loan bonds paying a nice 8% yield.

-Bill Gross did suggest eventually there will be value in mortgage loans but only after the great unwinding happens and we are still yet to see that completely play out.


Prem Watsa (CEO Fairfax Financial -FFH ) says credit losses are far from over

from Bloomberg today - some interesting quotes

-``It's still early days,'' Watsa said in an interview today from his Toronto office. ``This is a very extensive credit problem.''

-``We're just rolling through mortgages right now, but we haven't gone through all the other areas yet,'' such as credit- card debt, commercial real estate loans and automobile lending, Watsa said.


-``We have sold most of our monoline insurers,'' Watsa said. ``You figure out risk versus reward, and you might well decide to sell. We've done that with monolines, but the others we're continuing to review.''

here's the link


Disclosure: I own shares of FFH

Fairfax's blowout year

Canadian insurer Fairfax Financial (FFH) has just reported its year ending December 2007 results and they are extraordinary. Normally I don't get carried away with a quarter's numbers but what is significant here is that an investment strategy brilliantly conceived by Prem Watsa and his team over the past few years has paid off handsomely. The simple premise was this, risk had been undervalued by the credit markets for too long with little to no distinction made between a safe AAA treasury bond and a AAA rated CDO that included unsafe subprime loans. Fairfax made its bet that risk would be repriced at a higher level, by using credit default swaps. In the last year, Fairfax was proven right as credit was dramatically repriced.

Driven by huge gains on this credit default swap bet, Fairfax ended the year with $4.1 billion in shareholders or $230 in book value, a 49% increase year over year. This closing book value was more than my more conservative estimate of $220 (see my article from earlier in January).

Further, there is clear evidence that Fairfax is finally getting its reserves under control with a solid 93% combined ratio for the quarter & 94% for the year.

Fairfax's credit default swap gains continued during the first quarter of 2008. A total of $151 million in realised gains & $596 million in unrealised gains up to February 15 2008. That puts Fairfax's book value north of $270 so far this quarter. A truely great result.

Prem Watsa and Fairfax Financial have suffered under a torrent of press criticism and outspoken Fairfax shorts over the last few years. Surely justice has been dealt today and Fairfax shareholders have been vindicated.

Disclosure: I own shares in FFH

Monday, February 18, 2008

Bond insurer split up could attract lawsuits

Interesting article from Bloomberg. Essentially they are saying that Investment Banks who own insured subprime investments would be able to sue where they suffer losses & make a claim but there are not enough funds available due to the insurer moving its assets to another entity (holding their municipal liabilities).

Here is a quote...

"Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity,'' analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is ``likely to lead to significant legal challenges holding up the resolution of the monoline issues for years."

Here is the link


I wonder if the investment banks will give their consent to the proposed split up. They probably won't? The alternative might be as Warren Buffett proposed to re-insure these municipal bonds, effectively protecting policyholders even if the mono-lines can't pay at the end of the day (due to CDO loss payouts). But the mono-lines have already said no to the deal?

This is a very tricky situation. Of course, all of this resulted from the Insurance regulators letting the mono-line insurers write CDO insurance in the first place!

Saturday, February 16, 2008

Looking at interesting insurance stock buys and sells during 4Q 2007

By region

US & Canada

Lets start of with Markel Corporation (MKL)(led by Chief Investment Officer Tom Gayner) . Markel found investment opportunities in the US title insurance sector which has been suffering from the housing recession. Markel initiated a new position of 930,500 shares in LandAmerica Financial Group (LFG). Markel also raised their stake in Fidelity National Financial (FNF)by 125% to 1.68 mil shares.

Mohnish Pabrai sold his stake 17,500 BRKB shares in Warren Buffett’s investment holding company Berkshire Hathaway, retaining just one BRKA share. Berkshire’s shares have seen a decent run up over the last few months as investors have sought refuge from the credit crunch in Berkshire’s rock solid balance sheet which is a genuine AAA (unlike others!). Mohnish kept his stake in Canadian property and casualty insurer Fairfax Financial Holdings (FFH) largely unchanged selling around 1,900 shares to end the year with 314,165 shares. Fairfax Financial’s large credit default swap bet , on a decline in the housing sector and the repricing of credit risk, has worked a treat over the last 6 months.

New York based Alleghany Corporation(Y) led by CEO Weston Hicks made a foray into the distressed mortgage insurance sector picking up 1.65 mil shares in Chicago based Old Republic (ORI). Old Republic have a more diversified book of business than their other mortgage insurance competitors.

Bruce Berkowitz and the Fairholme Fund (FAIRX) team who practice the investment philosophy of ignoring the crowd certainly did when they embraced controversy and bought a new stake of 7.65 mil shares in Wellcare Health Plans (WCG). This Florida company has been under investigation by federal and state authorities. Fairholme also initiated a small 4.16 mil share position in auto insurer Progressive Corporation (PGR). This is an interesting buy given the poor performance of most auto insurers and Progressive in particular which has been facing tough competition from Geico, a subsidiary of Berkshire Hathaway (BRKA,B). Do Fairholme feel that the market may harden and premium rates could start to improve for the auto insurance sector?


Mackenzie Cundill Value Fund with famed value manager Peter Cundill took advantage of market volatility in 2007 to add to their position in the world's second largest reinsurer, German based Munich Re AG (MUVGN.DE - XETRA). According to their fund's annual report, it is now the fund's largest position.

Post year end , Warren Buffett and Berkshire Hathaway snapped up 3% of Swiss reinsurance giant Swiss re (SWCEY-Depository receipt; RUKN.DE - XETRA) , which has been caught by the subprime crisis, and will take one-fifth of all Swiss re's property & casualty premiums over the next 5 years in return for providing one-fifth of the risk. This deal looks to be more than just an insurance stock buy and more a stategic reinsurance partnership.


The successful Third Avenue International Value Fund (managed by Amit Wadhawany)initiated a new position, buying 771,224 shares in Bermuda based reinsurer Montpelier re (MRH - NYSE). Here is a quote from the annual report for 2007 ...."Shares of Montpelier Re were purchased at prices which we believe understate its value as a going concern, as it imputes little to no value to the company’s operational infrastructure,underwriting expertise, or the membership at Lloyd’s."

Asia & Middle East

Longleaf Partners International Fund made no changes but retained a significant weighting to Japanese insurers , NipponKoa Insurance Company (6.7% of fund) (8754 - Tokyo) and Millea Holdings (3.7% of fund) (MLEAY.PK - US pink sheets; 8766 - Tokyo) Japan's largest non-life insurer. Both insurers represent a little over 10% of this Longleaf Fund.

Disclosure: I own shares in MKL,BRKB,FFH,Y,FAIRX

Disclaimer: The opinions expressed by the author in this article are not intended as investment advice & should not be relied upon as investment advice.

Thursday, February 14, 2008

Auction-rate securities fail to attract bidders

This was an interesting story this week. Here are some excerpts from Bloomberg.

"Auctions of bonds sold by cities, hospitals and student loan agencies are failing as confidence in the creditworthiness of insurers backing the securities wanes, and as loss-plagued banks seek to avoid tying up their capital. More than 129 auctions failed yesterday, said Anne Kritzmire, a managing director for closed-end funds at Nuveen Investments in Chicago"

and further on

"Bank of America Corp. estimated in a report that 80 percent of all auctions were unsuccessful yesterday. That may mean as much as $20 billion of bonds failed to find buyers, based on the $15 billion to $25 billion of auction bonds that are scheduled for bidding daily, said Alex Roever, a JPMorgan Chase & Co. fixed income analyst. "

The flip side to this story is that where there is less demand & more supply , buyers of auction rate securities get paid handsomely.

With the turmoil in the municipal bond markets, munis generally could now represent a very attractive fixed income investment opportunity for insurance companies and pension funds.

Municipal bonds are pretty safe. Interestingly the article mentions ... "auctions have failed for frequent and well-known borrowers, such as Port Authority of New York and New Jersey and New York state's Metropolitan Transportation Authority. "

It is not just the fact that financial guarantors are under stress that is causing distress here, as investment banks such as UBS suffer with their own capital writedowns and liquidity issues, they are unable to participate in these auctions & purchase those auction-rate securities that don't sell. Who knows, could be another opportunity for Warren Buffett....capital seems to be highly prized these days.

Warren Buffett recently alluded to the fact that Berkshire Hathaway (BRKA/B) were buying up insured municipal bonds suffering from the "financial guarantor" stigma. Here's what Warren said on the CNBC interview yesterday...

"We've actually bought, or, we see bonds trading that are insured that are selling at lower prices than their uninsured counterparts, just because there's been an unusual supply and demand situation. "

Here's the full article from Bloomberg...


Disclosure: I own shares in Berkshire Hathaway (BRKB)

Tuesday, February 12, 2008

Buffett names his price

Warren Buffett's latest offer to re-insure up to $800 billion of municipal bonds held by the mono-lines should come as no surprise.

Buffett's price is one & a half times the unearned premium on these municipal bonds, nearly double the price originally charged by these monoline insurers (MBIA,Ambac & FGIC). Its a steep price & as of this time, two of the monoline insurers (one is Ambac) have spurned Buffett's proposal.

Buffett's big pricetag does highlight the bargaining power Berkshire Hathaway has at this time and his own view that the mono-line insurers are facing a desperate financial situation.

If all the mono-line insurers reject Buffett's proposal , they are likely to face an even more hard-line from Insurance regulators who may seek to preserve capital for the policyholders by preventing dividends being paid from the insurance subsidiaries to the bond insurer holding companies. As I have said previously, the insurance regulators are intent on stabilising the municipal bond market and while doing this in a commercial way would be ideal, they may be left with no option but to engage in more direct intervention to protect capital and municipal bond markets.

Finally, Buffett & Berkshire are expected to dramatically raise their profile in the municipal bond underwriting area over the coming year. If Buffett doesn't succeed in reinsuring the municipal bonds held by the bond insurers, he will succeed in stealing away new business.

Here's the CNBC interview transcript with Warren Buffett


Ajit Jain's letter (which walks us through Berkshire's reasons for the deal and proposed price) - thanks Berkshire Shareholders at MSN board for this one!


Disclosure: I own shares in Berkshire Hathaway (BRK)

Monday, February 11, 2008

Is it possible Fairfax Financial might have raised their CDS bet?

With AIG's recent report of larger than expected CDS "mark to mark" losses and default spreads on AIG hitting over 200 bps as of today, Odyssey re & Fairfax Financial would have received another boost to the value of their enormous CDS portfolio (AIG is one of their CDS positions held most likely for hedging rather than investment purposes).

I believe it is more probable than not that Fairfax would have taken profits on positions in CDS positions in Countrywide, MBIA & Ambac amongst others over the last few months. That is my expectation given the excellent pricing Fairfax would have received, MBIA & Ambac were recently priced for a 70% chance of bankruptcy. However, this is pure speculation and journalistic opinion on my part. We won't know until they report their results for this quarter.

Economic conditions have degenerated rapidly throughout the world particularly in North America but also Europe, Japan and other regions. Risk continues to be re-priced into corporate bonds and expectations are that default rates will increase considerably from current levels.

Further, in two interviews given since November ,Prem Watsa, CEO of Fairfax, has maintained that we that we are only at the beginning stages of a credit crunch and the US could be facing a Japan like economic situation of deflation.

Finally, the largest equity positions recently added by Fairfax are in healthcare/pharmaceutical stocks which definitely have defensive characteristics in a recession like environment.

The question therefore I want to pose is this , if Prem Watsa feels we are only in the beginning stages of a credit crunch and Fairfax continues to set up its equity and bond portfolio for recession, is it possible that during the 4th Quarter 2007 Fairfax Financial may have raised its CDS bet on some names perhaps already held or others not held at the end of the 3rd Quarter 2007?

Disclosure: I own shares of FFH & AIG

Disclaimer: The opinions expressed by the author in this article are not intended as investment advice and should not be relied upon as investment advice.

Sunday, February 10, 2008

Asia insurance industry awards 2007

ICICI Lombard General Insurance Company (part of a joint venture between India's ICICI Bank & Fairfax Financial Holdings (FFH)) received General Insurance Company of the Year award.

From the article

"However, it was ICICI Lombard’s innovation that really caught the eyes of the judging panel. To reduce the cost of claims processing in rural areas, it launched a first-of-its-kind pilot project issuing biometric smart cards to rural customers availing of health insurance. The card contains a smart chip which authorises transactions based on the customer’s fingerprints. The balance sum insured can be easily ascertained when the card is presented at a hospital.

ICICI Lombard, together with the involvement of the World Bank, has also pioneered weather insurance to cover weather-related risks faced by crops. In fiscal 2007, more than 200,000 farmers and 250,000 acres of land were insured for a range of crops."

Here's the link to the full story


Latin America insurance review

This report includes an excellent review of the insurance market in Brazil which is growing rapidly.

W R Berkley (BER) has in recent years established a business subsidiary in Brazil.

Wednesday, February 6, 2008

Warren Buffett - P&C industry profits will continue decline over next few years

In a recent business wire presentation from Canada, Warren Buffett said he expected 4points of worsening in combined ratios in 2008 vs 2007. Buffett said insurers will face combined headwinds from lower insurance pricing and increasing inflation, raising the amount of loss exposures for property and casualty insurers. Buffett expects several years of lower profitability and worsening combined ratios.

Here is a link to the presentation which includes a great Q & A with Warren Buffett on a great variety of topics...


Tuesday, February 5, 2008

Buffett says won't invest in bond insurers

heres the link


HCC Insurance (HCC) looks like reasonable value

Many insurance stocks have been sold off recently by investors due to fears over the credit crunch and expectations that softer insurance market pricing will further reduce insurers’ profitability.

One insurer which I think represents good value, despite these headwinds, is HCC Insurance. HCC insurance (HCC) is AA rated by S&P and began operations in 1974. It has offices in the US, Europe and the UK.

HCC Insurance is truly a specialty insurer with an excellent franchise . They don’t write general liability or workers compensation insurance. They write numerous products including directors and officers liability, aircraft insurance, marine insurance and life,accident and health products. Many of the insurance products fall outside the standard market so are subject to less price competition. HCC estimate that over 60% of their products fall outside the standard insurance cycle.

Historically, due to its specialty focus and underwriting discipline, HCC has maintained a combined ratio well below the industry average and their loss reserving has been overly conservative with loss redundancies consistently reported with one or two exceptional years. Since 1981, HCC has only made an underwriting loss on only two occasions in 2001 (combined ratio was 101.8%) which included $22 million in losses from the World Trade Centre attacks and 1999(combined ratio was 104.1%).

One way HCC maintains above average profitability is by keeping a solid grip on their underwriting. HCC will buy the Managing General Agents or MGAs that they use. This way they have more control over terms and the pricing of policies.

Around 12 months ago HCC was mired in controversy over the manipulation of options grants which cost the job of former CEO Stephen Way. The ultimate cost of these grants was minimal. A recent legal case resulting from this options was settled for $3 million , which was fairly immaterial. The loss of Stephen Way was far more damaging as he spearheaded HCC since founding the company in 1974 and has been instrumental in HCC’s success. Nevertheless, many of the key operating officers who have been part of HCC’s growth over many years including Frank Bramanti ,current CEO, and John Molbeck, current Chief Operating Officer, remain with HCC. Further, HCC has an experienced management team in each of its operating subsidiaries. Their de-centralised management structure is a key strength for HCC.

HCC under current management has been hitting on all cylinders over 2007. Net earnings are up 13% to $295 mil for the nine months ended 30 September 2007 from $261 million in nine months ended 30 September 2006. The GAAP combined ratio for 2007 and 2006 has been an excellent 83%. On a trailing twelve month basis their earnings are around $370 million.

Frank Bramanti has maintained disciplined & patient approach on the issue of making acquisitions , insisting they will wait for the right opportunities to come up as the insurance cycle continues to soften, and they will not over-pay. In the meantime, HCC continue to pay down their debt and build their cash reserves. Recently they acquired Mulitnational Underwriters (MNU) further adding to their health insurance arm and which will add $40 million in premiums to their business. They aso recently rceived approval for a new Lloyds syndicate platform to help expand their global insurance products.

HCC has a very conservative balance sheet, their fixed income investment portfolio had an average AAA rating. They have debt to capital of just 11.6%. Their fixed income investments are managed by New England Asset Management , a subsidiary of Berkshire Hathaway. They have just $20 million, less than 1% of shareholder equity, in subprime and Alt A bonds which are rated AAA and have not been subject to downgrade. They own no CDOs or CLOs.

HCC valuation looks reasonable and in my view is now being priced both for a recession and a soft insurance market (not to say the share price can’t go lower …all the better!). HCC Insurance has a market cap of around $3.1 billion or $27 per share, around 1.28x my estimate of closing book value of $21 for 2007. This is the one of the lowest price to book value ratios that HCC has traded at in the last decade. Its earnings for this year will be around $3.30 per share ,so the PE ratio is a modest 8x and pays a 1.6% dividend. A lot of downside risks have been priced into this company. Despite options related sales by two directors, insiders have been buying shares over the last 6 months. Of note, John Molbeck ,COO, bought $418K in stock on open market in August at around $27-$28 per share and during January Edward Ellis, Chief Financial Officer, exercised over $1 million in options at $18 per share and has not sold any shares after that exercise.

Finally,HCC Insurance could also become an acquisition target for a large insurance company such as AIG or foreign insurer such as Allianz, given the unique franchise HCC holds in the specialty insurance market. I would expect HCC would command a price to book value of 2x book or $42 per share if sold on a private market basis.

Disclosure: I own shares in HCC Insurance(HCC)

Disclaimer: The opinions expressed by the author’s own views and are not intended as investment advice and should not be relied upon as investment advice.

Monday, February 4, 2008

Insider buying exceeds insider selling in January

from Bloomberg "Total purchases were 1.44 times more than sales, the first time in 13 years that insiders became net buyers, the data show. The S&P 500, the benchmark for American equities, hasn't fallen in the 12 months after insiders bought more than they sold, according to Washington Service data that go back 20 years."

here's the link


Saturday, February 2, 2008

A bond insurer bailout is likely to put policyholders interests ahead of shareholders

During Markel Corporation’s recent conference call, Tom Gayner , Chief Investment Officer, explained why Markel had sold off their positions in the mono-line insurer/financial guarantors, Ambac and MBIA.

“In the financial guarantee companies (our portfolio position) is zero. There is too broad a case of dispersions and risk and reward and things that can happen that are way beyond just what you can analyze with numbers. I mean there's political issues involved that are well beyond our circle of competence. That is a battle we're going to sidestep.”(Tom Gayner 4Q 2008 Markel Corporation conference call)

Gayner’s comment on the “political issues” would likely refer to Insurance regulators interest in protecting muni-bond policyholders and ensuring the smooth running of the capital markets for municipal bonds. These political considerations are likely to come before the interests of financial guarantor shareholders.

The man charged with saving the day is Eric Dinallo, NY Insurance Commissioner. Dinallo has already moved to raise insurance capacity in the municipal bond market by inviting Berkshire Hathaway to insure municipal bonds for New York.

Dinallo has also discussed capital raising initiatives with major banks. According to a FT article Jan 28 2008, Dinallo convened with the major banks and told them that $15 billion would be needed to fix the bond insurers and protect their ratings. Various measures discussed included extending credit lines and capital raising initiatives to strengthen their balance sheets.

Dinallo’s current focus is on organizing a bailout of Ambac. As well as capital raising initiatives, a reinsurance plan has also been discussed, according to a recent Bloomberg report. Under this arrangement banks and brokerages, would offer to reinsure losses Ambac suffers on bonds and securities over an agreed upon limit in return for a fee. Any such reinsurance arrangement would involve a number of considerations such as ensuring financial institutions are not reinsuring their own exposures, calculating what the reinsurance loss provisions will be for each bank or brokerage and deteriming how much Ambac will have to pay for any reinsurance.

Bill Ackman, ardent critic of MBIA and Ambac , who is shorting the stock of both companies, believes regulators must act now if they want to protect policy holders. Ackman explained why he is still short MBIA and Ambac in a recent WSJ article

"The reason why we're still short the holding companies of MBIA and Ambac is because we believe the regulators and the banks are working to help policyholders, and not holding-company shareholders," (“Bond Insurer foe soldiers on” Feb 2 2008)

Ackman also mentions in this WSJ article that Banks, who have billions in off-balance sheet investments in CDOs and subprime mortgage securities that are insured by Ambac and MBIA, would see an arbitrage opportunity in helping the ailing bond insurers keep their triple A ratings. According to some estimates up to $70 billion of subprime investments would be written down by investment banks and others if the bond insurers failed. Paying the $15 billion price tag as suggested by Dinallo would be a small price to pay to protect the value of these securities.

Ackman is supportive of a plan to protect muni-bond holders but says” if the bailout is a mechanism for banks to continue to hide losses off balance sheet, then we think it's very bad for the capital markets." (“Bond Insurer foe soldiers on” Feb 2 2008)

What form the eventual bailout of Ambac or potential capital infusions for MBIA will take remains an open question , however this is a precarious time for financial guarantor shareholders. Political considerations such as protecting policy holders as well as ensuring the solvency of insurers are likely to dominate the thinking of Insurance regulators who are intent on stabilising the municipal bond markets.

Disclosure: I own shares in Markel Corp(MKL) and Berkshire Hathaway (BRKB) but no other positions in any securities discussed.

Friday, February 1, 2008

Fairholme Fund shareholder letter 2007

Bruce Berkowitz and the team at Fairholme Funds have a great track record and have achieved a 17% plus annual compounded return since starting out in 1999. Their shareholder letters are always insightful.

Insurance holding company Berkshire Hathaway (BRKA/B) remains their top position with around 20% of their portfolio. They continued to add to this position during the period ending November 30 2007. Their rationale on why the credit crunch will benefit Berkshire ...

"With a war chest of roughly $40 billion of cash and $100 billion of other liquid investments, Berkshire is a logical senior lender or last-resort acquirer for the financially wounded."(Fairholme annual report 2007)

They also added to their investment in Sears Holdings (SHLD) . Commenting on public and media criticism of Sear's Chairman, Eddie Lampert ....

"Many despair that Sears seems unable to regain past retail glory, despite a conservative balance sheet and many valuable assets. In searching for instant gratification, most are missing key points. As with Warren Buffett in the late 1990s, many believe Eddie Lampert’s investment skills have faded — but it is just as unlikely that this leopard has lost his spots." (Fairholme annual report 2007)

Finally, the Fairholme management have always kept a 20% plus cash balance , they discuss the philosophy and benefits of doing this...

"The unexpected happens more frequently and with more severity than most expect.Accordingly, cash remains a sizeable chunk of the portfolio. As demonstrated this year, cash helped the Fund to weather portfolio headwinds and allowed the Fund to buy without the need to sell already inexpensive securities on the cheap. Shareholders should not fear a temporary decline in the Fund’s NAV, as lower prices for sound investments usually indicate better bargains and higher future returns — particularly with cash hoarded for such chances." (Fairholme annual report 2007)

Here is the link to the Fairholme shareholder letter and annual report. Enjoy...


Disclosure: I own shares in the Fairholme Fund (FAIRX)

Sunday, January 27, 2008

Whitney Tilson likes Fairfax Financial and Berkshire Hathaway

here's the link


Interestingly Whitney Tilson says he believes the stockmarket represents the best value he has seen since late 2002 and early 2003.

Monday, January 21, 2008

What a legendary investor did during a stockmarket crash

With European markets falling over 6% during Monday’s trade(marking a 20%+ drop since last June) and Wall Street set to fall sharply on Tuesday, its easy to feel a sense of panic right now. Are we in for 1987 all over again?

Let me tell you what Shelby Cullom Davis did on that infamous day “Black Monday” in 1987. Davis , one of the greatest investors of all time, achieved 20% plus compounded share returns over multiple decades and put himself on the Forbes rich list.

On Black Monday, Shelby Davis picked up the phone & placed millions in buy orders to his broker’s trading desk. His office manager thought he had gone mad and tried to hang up Davis’s phone. But Davis grabbed the receiver back and kept on dialing(The Davis Dynasty – Rothchild)*

After the market had closed, Davis had lost $125 million* on paper. But as far as Davis was concerned, he hadn’t lost anything. He had bought many stocks at big discounts to what he knew was their real value. Why did other investors sell to Davis? Because they panicked. Over time Davis was proven right as Wall Street rallied following its Black Monday correction.

There’s a well known saying that when panics occur in the stockmarket, wealth flows from weak hands to strong hands.

So whatever happens on Tuesday or beyond, remember what Shelby Cullom Davis did. The worst thing you can do during a panic is to sell. And if you have the nerve and conviction, its probably smarter to buy stocks on discount.

*(The Davis Dynasty by John Rothchild is an excellent book I highly recommend).

Disclaimer: The above comments represent the authors own opinions and are not intended as investment advice and should not be relied upon as investment advice.

Saturday, January 19, 2008

Title insurers could be on the menu

"[Stock market investing] is the one sphere of life and activity where victory, security and success is always to the minority and never to the majority. When you find anyone agreeing with you, change your mind. When I can persuade the Board of my Insurance Company (National Mutual) to buy a share, that, I am learning from experience,is the right moment for selling it."
John Maynard Keynes quote (Sep 1937) p154 The Keynes Mutiny Justin Walsh

With the depressed housing market, housing related stocks are very unpopular at the moment. The housing industry in the US will remain in recession for at least 2008 and probably 2009 and the general economic outlook is negative. Unsurprisingly, housing related stocks such as homebuilders, mortgage insurers, banks etc have been on Wall Street's sell lists. Title insurers have also been swept up in the large wave of selling of housing related stocks.

When will these stocks bottom? Who knows. But the storm will eventually pass , it always has in the past. Nevertheless, it will claim its victims, companies with weak balance sheets or banks and lenders who have written poor loans will suffer the consequences.

Title insurance is a very old business and is indispensible in all real estate transactions. When you buy a property you want protection from anyone else laying claim the property, you want a clean title. Title insurance provides this protection. In fact it is required by law.

Title insurance is a very profitable business because defects or problems with title are generally very low. Its required every time a property is sold or refinanced, residential or commercial.

Over the foreseeable future, title insurers will face headwinds from lower transaction volume and value, as vendors become reluctant sellers, but this is normal in the title insurance business during a down period.

I recently read an excellent presentation from the value investing conference by Zeke Ashton of Centaur Capital on two title insurers, Fidelity National Financial(FNF) and LandAmerica Financial(LFG). The stock prices of both these companies are currently trading close to 52 week lows. What is interesting also is that insurer Markel Corporation(MKL), know for its value investing prowess, recently disclosed a new position in LandAmerica and is seeking permission to push its ownership to over 10%. Markel also owns stock in Fidelity National Financial.

So could title insurers now be on the menu for patient long term investors?

Here is the presentation link (remember also that reading intelligent analysis is no substitute for your own research. A good place to start but not to end)


Disclaimer: The above opinions represent the authors own views and are not intended as investment advice and should not be relied upon as investment advice.

Disclosure: I own shares in Markel Corporation(MKL) but no other securities discussed.

Tuesday, January 15, 2008

Post-Christmas sales

Everyone loves a post-christmas discount sale, investors should feel no different about the recent correction in equity markets. The fact is, its better to buy companies when they are cheap & negativity abounds than when everthing is positive.

Buy at the sound of canons, sell at the sound of trumpets. So goes the saying.

Now is a great time to start making a list of stocks with your preferred buy target price that you have always liked but may have been too expensive to consider in recent years. My only suggestion is to stick with companies with strong balance sheets & great managers that can weather tough credit and consumer conditions.

If you own mutual funds , now may be a good time to consider making contributions. Its always smarter to average down than try & pick a stockmarket bottom so consider staggering those contributions over each month.

Hopefully I will have a few interesting stock ideas to post in the next few weeks so stay tuned.

Disclosure: The above comments represent the opinions of the author and are not intended as investment advice and should not be relied upon as investment advice.

Friday, January 11, 2008

Why Fairfax Financial(FFH)remains one of my largest positions

Property and casualty insurers will face tough headwinds over the course of 2008. On the underwriting side, over-capacity is driving rates down and lowering premiums and we are likely to see worsening combined ratios. On the investing side, some insurers face losses on CDOs and riskier corporate bonds while insurers with large equities positions will see lower returns from capital gains as economic growth slows.

It all sounds a bit grim. There are opportunities out there for investors in insurance stocks, but now is the time to be extremely selective.

Canadian based insurer Fairfax Financial is one company I own and remains one of my top holdings. Here are my reasons

Fairfax will benefit from a large housing downturn and I think we still have ways to go. Fairfax owns a large credit default swap position ( with a notional value of over$18 billion at 30th September 2007) on 30 names exposed to a collapse in the housing market such as mortgage insurers, financial guarantors and mortgage lenders. Fairfax has enjoyed substantial unrealized gains on this CDS portfolio to date, in excess of $1 billion as of the 3Q 2007 conference call, and this CDS portfolio will likely have continued to appreciate in recent months.

Substantially all of Fairfax’s fixed income portfolio is in government bonds, they have no CDOs or other toxic securities . As treasury yields(and interest rates) fall, Fairfax will enjoy unrealized gains on the bonds they own, a 1% fall in interest rates will lead to a 10% increase in the value of their bond portfolio(2006 Annual report). This will boost shareholder equity and book value per share.

Fairfax has hedged 80% of its equity portfolio against a decline in the S&P. This is insurance for Fairfax, protecting its capital position against any unforeseen shock we might see to equities as the economic fundamentals and business conditions deteriorate.

Fairfax’s Asian operations will continue to grow rapidly with the economic expansion throughout the Far East. US is facing a recession but the prospects in Asia continue to look favourable. Fairfax’s net premiums written on its Asian subsidiaries are up 20% year over year.

Fairfax’s investment portfolio is worth more than its carrying cost. Their 26% interest in ICICI Lombard, India’s largest general insurer, is carried on the books at $60 million well below its fair value estimated at $147 million in Fairfax’s balance sheet disclosures. Commentators such as Whitney Tilson have placed even high fair value estimates. Also Fairfax owns private equity investment in Chou Associates Fund that would be in the books at cost.

Softer insurance pricing for reinsurance and general insurance will affect Fairfax’s US and Canadian operations. However, even as the top line shrinks, Fairfax enjoys an improved reserving position from that which existed a few years ago which means Fairfax can continue to improve its bottom line through a stronger combined ratio. In the first nine months to 30th September 2007, even though net premiums were down slightly, Fairfax’s had a big improvement in underwriting profit of $198million versus $62 million for the year earlier.

Prem Watsa, Fairfax's Chairman and CEO, is a fantastic value investor with a great track record. Investors in Fairfax should rejoice over declining equity values, as Prem Watsa will have the opportunity, the smarts and financial wherewithal to take full advantage.

Finally, with an estimated book value of around $220 as at December 2007. At around $280 per share Fairfax trades for a reasonable 1.3x book value. That’s cheap considering Fairfax has compounded book value at a 24%+ clip over 20 years . Looked at another way, Fairfax has around $1000 per share in cash and invested assets, if they can do conservative 5% after tax return that’s $50 a share on a $280 share price.

In part due to poor equity market conditions, Fairfax’s shares are also likely discounted as a result of Fairfax’s troubles over the last few years. However, on the latter point, I remain confident, based on their improving reported financials, that Fairfax have now put these reserving issues behind them.

Disclosure: I own Fairfax Financial (FFH) shares

Disclaimer: The opinions expressed in this article represent those of the author and are not intended as investment advice and should not be relied upon as investment advice.

Thursday, January 10, 2008

A tough 2008 lies ahead for insurers

2008 will be a year in which over-capacity in the insurance industry takes its toll on insurers, in the form of weaker pricing and lower premiums. Maintaining record profitability will in turn become a tougher proposition.

Here is a link to an excellent article discussing what we can expect...


Greenberg drops plans to exert control over AIG


Joe Petrelli from Demotech responds re. Universal Insurance article

Joe Petrelli from Demotech Inc has provided his response to my article 8th January 2008 on Universal Insurance. Please click on Comments at the end of the article.

Tuesday, January 8, 2008

Small cap insurer Universal Insurance(UVE) plays a high stakes game in Florida

Universal Insurance’s website (at universalproperty.com) gives the appearance that this Florida insurer possesses sound financial strength. A red elephant stands proudly next to the company’s logo and the financial stability rating of “A Exceptional” appears further down the home page.

However, dig a little deeper and you may conclude that Universal’s financial condition is not as rosy as it appears.

Universal’s questionable rating

Firstly, the “A” rating does not come from a nationally recognized rating service such as S& P or Moodys but from a lesser known rating service used by smaller insurers known as Demotech.

Demotech’s definition of this rating follows:-
A - Exceptional financial stability
Regardless of the severity of a general economic downturn or a deterioration in the insurance cycle, insurers earning a Financial Stability Rating® of "A" possess exceptional financial stability related to withstanding a general economic downturn or deterioration of an underwriting cycle.

I believe this rating is misleading and in this article I will detail my reasons for this.

Insurers can minimize their underwriting risk by writing policies in different States, giving them geographic diversity, and by writing multiple product lines they lower their product risk exposure.

Universal Insurance carries greater risk because it is a one state and one product company. Operating in Florida through its subsidiary Universal Property and Casualty Insurance Company(UPCIC) it principally writes homeowners insurance which represents 85% of its premiums and a further 15% of premiums come from dwelling insurance.

Being based in Florida means UPCIC is exposed to substantial catastrophe risk from hurricanes. Further, because it is 100% exposed to property, its losses from hurricane damage will have a greater affect on its financial position than on other more diversified insurers operating in Florida.

Universal expands business rapidly by taking big risks

In the wake of the dislocation in the Florida insurance market after the strong hurricane season in 2005 that resulted in larger insurers reducing their policy coverage in Florida, UPCIC took the opportunity to grow its policy count and expand its premiums rapidly and as of June 2007 had captured a 3% share of the homeowners insurance market in Florida , with around 341,000 policies.

This rapid business growth is reflected in Universal’s financial results. Based on the September 2007 quarter, year over year comparison, Universal’s earnings growth is 237% and revenue growth 136%. Meanwhile it had an impressive return on equity of 131% and combined ratio in the 70s. Universal’s premiums written have grown from $41 mil in 2004 to $371 mil in 2006 and are $263 mil for the first half of 2007.

Shareholders equity has expanded almost three-fold from $22 million at December 2006 to $63 million at September 2007.

Yet all this has been achieved by Universal taking on enormous risk, a strategy of win big or lose massively.

At the Small cap equity conference in August 2007, Bradley Meier ,CEO of Universal ,detailed Universal's exposure to a major hurricane or catastrophe. He said that based on their models, Universal would take a $45 million dollar hit on the first storm, $9 million on the second event and $9 million on a third event. Translated, if the hurricane events of 2004 or 2005 repeated themselves in 2007, Universal would have been exposed to $63 million in losses before tax, over $40 million after tax. That would have taken a 67% chunk out of shareholders equity of just $63 million.

Universal relies on models due to its short operating history

Furthermore, these forecasts given by Meier are based on models and assume reinsurance coverage. Universal’s models are based on industry data rather than individual data, because Universal is a relatively new insurer. If problems emerge that Universal’s models are not correct or a reinsurer is not prepared to foot the bill, Universal would have very little shareholder’s equity to play with. There is simply little or no margin of error.

A substantial hit to shareholders equity would threaten Universal’s risk based capital position under the Florida insurance Code and could force Universal into a substantial dilutive share offering to protect its capital position. It may in turn be required to reduce its premium levels to reflect its revised capital position.

Fortunately for Universal insurance , both 2006 and 2007 were benign years for hurricanes. However, there are no guarantees for 2008. Universal has indicated it is preparing to apply to other States to expand its geographic reach, one would suggest this should be a priority.

A further look at Universal’s reserve for unpaid losses and LAE estimates may give investors some more cause for concern. As at 31st December 2006, LAE estimates given by Universal’s actuaries were between $37 million to $60 million. Universal booked its actual reserves at $49 million. As well as the fact it is relying on industry data (due to its short claims history) , Universal’s reserves don’t provide much scope for error. If Universal had used the higher actuarial estimate of $60 million, this would have reduced its shareholder equity by 50% from $22 million to $11 million as at December 30, 2006.

Universal’s share price doesn’t account for risks

Universal’s share price takes no account of the high levels of catastrophe risk faced by its operations. It sports a market cap of around $280 million or 4.4x its book value of $63 million. This is well above its peer average of 1.7x.
Insiders have cashed in on the high share price selling 3.1 million shares over the last 6 months according to yahoo finance. There have been no insider buys during this time.

Concluding remarks

Universal has succeeded in growing rapidly in Florida however it has only achieved this by effectively “betting the house”. This Company does not deserve an A rating and its high share price masks the high level of catastrophe exposure its business faces.

Disclosure: no position in any securities discussed

Friday, January 4, 2008

Australian insurer QBE buys North Pointe

Looks like QBE have paid a decent premium of 1.6x North Pointe's book value. Given other foreign acquisitions of US insurers such as Midland, this could be an ongoing trend on the M&A front.


Thursday, January 3, 2008

Media hype

As investors we’re surrounded by media “noise”. Financial tabloids, television broadcasters and internet news services publish their daily opinions on their latest favourites and villains. Most of the time these opinions reflect a popular held belief that is the prevailing sentiment at the time whether it is factual or not. Share price movements in particular stocks can further reinforce these biases. Its easy to feel this pressure as an investor. When you see a stock you own being vilified in the press and trading down each day, its easy to start second guessing your own judgement and believing that you should join everyone else and dump the stock. After all it feels better and safer to do what everyone else is doing.

Lets explore three companies whose leaders and stocks have been subjected to a media storm, they include two insurance focused investment companies whose prospects and shares prices are now back on a favoured footing and one holding company with a retailing focus which is still down but certainly not out. In each case, the CEO or Chairman and Company has been the target of attacks by the press.

Prem Watsa and Fairfax Financial(FFH)

Smart people don’t suddenly become stupid, the story of Prem Watsa and Canadian insurer Fairfax Financial is a case in point. From 1986 to 2000, Fairfax Financial and Prem Watsa achieved phenomenal business results growing book value per share by 37% and Fairfax's share price by 33% (measuring from 1985 to 2006, compound book value grew a more moderate but still excellent 24% ) . Much of that success was attributable to Prem Watsa and his team achieving strong investment results using the float from the insurance businesses.

But by 2001, Fairfax Financial’s golden run was in trouble after making a series of takeovers , including TIG & Crum and Forster. Fairfax was forced to massively raise its reserves for these new subsidiaries and this substantially reduced its book value and placed pressure on its ratings and caused successive years of writedowns and losses. Things looked bleak , Fairfax Financial’s Canadian listed shares(FFH.TO) went from $600 in 1999 down to $85 in 2003 and were $175 as recently as January 2006.

Fairfax a one time darling of the financial community became a villain in the press . Fairfax’s record prior to 1999 was forgotten amid the media hail storm, in a Value Investor Insight article Jim Chanos a short seller of Fairfax described Fairfax as massively under-reserved and even implied it was a bankruptcy candidate or a “zero” . However, Prem’s closest friends and supporters all great investors themselves backed their man, they included Steve and Tony Markel at Markel Corporation, Mason Hawkins at Southeastern Management and John Templeton at Templeton Funds.

So the battle lines were drawn, a small collection of some of the smartest investors of our time backing Prem Watsa and Fairfax versus numerous short-sellers and many financial publications. Given the central argument of the media and short sellers that Fairfax was massively under-reserved to the tune of billions of dollars that would potentially destroy all of shareholder capital, their argument was simply that management were either careless in setting reserves or were not being forthcoming about their exposure (translated - not of good character). But what was interesting is that the Markels and Templeton, people who knew Prem on a personal level, had worked with him and who were experienced with the insurance business and were in a better position than anyone else (media and short sellers included) to judge Prem Watsa’s character continued to back Prem and Fairfax. If you are a betting man, it pays to back the people in the know!

In 2006 and 2007 the tables began to turn. The reserve writedowns started to end, Fairfax’s Canadian, US and Asian insurance subsidiaries began firing and huge bet by Hablim Watsa Investment Council (owned by Fairfax Financial) against the bubble in the US housing market and inadequate yield spreads in the corporate bond market began to pay off in a very big way. Fairfax sued a group of short sellers who they said were spreading malicious rumours about Prem Watsa and the Company in the press in order to manipulate their share price. And over the last 12months Fairfax’s shares have bounced to new highs, up 48% from $187 to $277 today (4 Jan-07 to 4 Jan-08)

All of a sudden Prem Watsa and Fairfax were back. From favourite to villain to favourite again.

Warren Buffett and Berkshire Hathaway (BRKA & BRKB)

Everyone knows the legendary story of Warren Buffett and Berkshire Hathaway. Yet Buffett has received his fair share of media attacks. What really struck me as downright ridiculous was a series of media articles in 2005 by Peter Eavis for TheStreet.com. After it was reported that General Re was caught doing finite reinsurance deals with AIG, Peter Eavis in a March 2005 article bluntly titled “Show Buffett the door” said that “There has been no indication so far that Buffett was personally involved in the deal… But it would be absolutely no surprise if Buffett had played a part in this transaction or others like it.” And then Peter Eavis gave his view on why Warren Buffett should depart from Berkshire “Even if Buffett never ends up getting specifically tied to any particular deal that comes under the regulators' scrutiny, it is time for the Oracle of Omaha to go. His handling of the 1998 General Re acquisition is reason enough.”

Anyone who has listed to Warren Buffett or read his annual reports or any “informed” press on Berkshire Hathaway would know how irresponsible and unfair these comments were.

In 1999 commentators suggested that Berkshire was out of touch and missing the internet stock bonanza. Well in hindsight they certainly didn’t miss much. Then in more recent times the media concern became that Berkshire was sitting on too much cash because Buffett wasn’t spending it quickly enough. In a Forbes piece, released in October 2004 titled “Berkshire weighed down by cash” it was reported “…the biggest uncertainty for Berkshire Hathaway (according to Morgan Stanley) remains allocating its cash balance”. Berkshire Hathaway made some acquisitions but did avoid much of the private equity frenzy and buyouts over the 2004-2006 period.

Well fast forward to 2007. Berkshire Hathaway is now riding high . Its conservative balance sheet and big cash reserves are now being viewed favourably, its share price has jumped and its excellent business performance has stood out amid the storm that has engulfed numerous financial concerns over the last year due to the subprime loan crisis and credit market freeze. Many private equity funds are seeking to undo deals made at the peak of cheap credit in 2006 and early 2007 meanwhile Berkshire is taking advantage of all the distress and has become the acquirer , adding Marmon holdings to its collection of outstanding businesses just recently.

Warren just like Prem was always smart and honest, even if he was portrayed in a different light in some areas of the news media.

Eddie Lampert and Sears Holdings (SHLD)

Eddie Lampert and Sears Holdings are the latest company to feel the wrath of the mainstream press.

A few years ago, after Eddie Lampert made a vulture like move on Kmart in bankruptcy and later merged it together with Sears , he became the poster guy for the hedge fund community. Eddie Lampert was described as the next Warren Buffett and there have been press reports comparing Sears Holdings to an early day Berkshire Hathaway.

But this year , Sears performance has been ugly and Lampert’s star has faded. Sears has suffered from the housing downturn and like its competitors has seen a big drop in profitability. Sears shares in 2007 hit over $190 a share , but are now down nearly 45% and trading at $105.

In a recent CNBC broadcast, Lampert was nominated as one of the worst 3 CEOs of 2007. After being called a modern day Warren Buffett , he’s suddenly become one of the worst CEOs , besides the fact he is actually Chairman and not CEO but lets not get technical.

First lets look at the facts and start with Lampert’s hedge fund, ESL investments. Eddie Lampert achieved 30% a year for his investors from 1988 to 2006. An accident, I don’t think so! Richard Rainwater, a former business colleague of Eddie’s, has described Eddie Lampert as “…the greatest investor of his generation,"(Fortune Feb 6 2006). Unlike the financial tabloids, that is the kind of recommendation that I take note of as an investor. Like Eddie, Richard Rainwater has a great track record and performance and ,having known Eddie on a personal level, he is in a sound position to judge Eddie’s character as well as his business acumen.

When Eddie Lampert started buying up Kmart’s senior bonds at 40 cents in the dollar, it was no accident that he saw enormous potential unlocked value in Kmart’s real estate. He was betting big time and could not afford to be wrong. As it turned out he was right. During liquidation all of Kmart’s real estate had been valued at just $800 million, yet soon after taking control Lampert sold a small portion of Kmart’s real estate for $900 million to Sears and Home Depot.

Lampert later merged Kmart with Sears knowing that there was enormous value in Sear’s real estate along with its retail operation and other assets. Currently Sears shares are suffering under the weight of criticism in the press and the housing downturn. Certainly things look bleak. But taking a longer term view, Sears Holdings looks cheap. Its market cap is $14 billion and sells for less than the value of its real estate,estimated at between $15-$20 billion. Throw in its brands, $2 billion in Sears Canada stock and other assets , and its net asset value works out between $24-$26 billion and that’s not including an option play on its retail operations that may or may not be turned around.

Eddie Lampert sees value in the shares at current price also. He has spent billions in cash buying back shares, and in the September 2007 quarter spent around $1 billion.

Investors backing Eddie Lampert have to be brave. And there are smart investors backing Eddie Lampert like Bruce Berkowitz and Michael Price. Certainly Sears Holdings could be a 2 to 3 year work out. The press will continue to argue Eddie Lampert is out of touch, doesn’t know how to run a retailer. But I believe Eddie Lampert’s record speaks for itself. Sure smart investors make mistakes and Sears retail turnaround may be too hard a task even for Eddie, but given that the shares of Sears trade for less than the value of its real estate and you’re getting one of the smartest investors around without paying a “hedge fund like” surcharge, its hard to see much downside on Sears Holdings.

Just a final note, Eddie’s decision to be patient in selling real estate and unlocking value has upset many investors in Sears. But I have two points to make on this. Eddie has not been selling real estate to upgrade Sears stores and in so doing I believe he’s protecting his downside or his “out” option if the retail turnaround does not work, I think that’s smart. My second comment is that Eddie knows the real estate potential better than anyone, his current strategy is to maximize its use for its retailing concerns, if this doesn’t work out I’m sure he knows the potential for this real estate to be used or developed for other uses. Either way I trust Eddie Lampert’s judgement more than the popular press.

Wrapping it up

Media negativity surrounding Sears and Lampert at the moment is a good example of media journalists pushing a popular but ill-informed opinion like they have with Fairfax Financial and Berkshire Hathaway. My own view is that Lampert is smart and that hasn't changed. I am not betting that Sear's retail business will succeed but simply that Sears will not trade substantially less than its net asset value indefinitely.

Disclaimer: The opinions expressed represent the authors own point of view and should not be regarded as investment advice or relied upon as such.

Disclosure: I own shares in Fairfax Financial (FFH), Berkshire Hathaway (BRK_B) and Sears Holdings (SHLD)

Note: This blog post was updated and re-edited 4th January 2008.

Wednesday, January 2, 2008

Prem Watsa presentation

This speech by Prem Watsa , superinvestor & CEO of Fairfax Financial, was recorded earlier this year. His comments on structured finance and debt risk spreads are particularly interesting in light of the credit crisis that has developed through the second half of 2007. Here is the link...