Watsa: Bank of Ireland was always the most conservative bank in Ireland, run by a fellow who just became CEO in 2009, Richie Boucher, who we like a lot. In Ireland, house prices dropped 40-50%, and commercial real estate building prices came down significantly (office buildings). So it's very difficult to survive that, and even a conservative bank like Bank of Ireland got hit. But coming out of this, it's the only bank that's a private bank (government has 15% of the shares, rest 85% is in the private markets, which we own a little less than 10%).
What impressed us was that Ireland seems to have taken its medicine, reduced the deficit, increased taxes, cut government spending significantly, so without making too much noise, the Irish have done what they had to do. The government of Ireland, with the ECB, set up some very tough rules: You have to have enough capital to take a 60% hit in house prices coming down from the high and commercial real estate prices coming down 70% from the top, and your capital position should be sufficiently strong take those hits. And that's what they did, they did the rights issue and raised a lot of money to make sure they had the capital to withstand those hits.
In our due diligence, we talked to them, we went through the individual portfolios; it's a well-regarded bank, with centuries of experience, and has a history of being conservative, but in a country where real estate prices fell off the bottom, no bank with their leverage and lots of mortgages could survive that. But we feel really good about it, and it's a long term investment.
GuruFocus: Do you think it has a durable competitive advantage?
Watsa: Definitely. It's a full-service bank, privately controlled and listed in the stock market, and not having the government in control of day-to-day operations is a positive. There was a chance, if the rights issue was not done by private interests, that the government would be 70-75%, so the fact that the government is at 15%, and very supportive I might add, is a plus.
In August, Fairfax led the capital infusion to Bank of Ireland. Other investors include Wilbur Ross, Capital Research, Fidelity and Kennedy Wilson. The details of the deals can be found in the press releases here. These investors invested 1.12 billion euro into Bank of Ireland. Following the investment, this group of investors owns 34.96% of the total issued ordinary stocks of Bank of Ireland. Ireland’s government owns 15.13%. Fairfax owns about 2.8 billion of Bank of Ireland’s ordinary shares. The cost of Fairfax’s shares is at 10 cents (euro) a share.
Bank of Ireland’s ADR is traded on the NYSE under the symbol IRE. Each ADR represents 4 ordinary shares. Since the deal, Bank of Ireland ADR had undergone a 10:1 reverse split. Therefore, Fairfax and Wilbur Ross’s cost per ADR is about 4 Euro a share. Today IRE is traded at around US$4.4.
When GuruFocus asked Prem Watsa about the valuation of Bank of Ireland, he said:
The real book value right now is running a little below .30 euro, maybe .27-.28, and then in the next few years it might be static, maybe it will go down a little, but it will be dependent on the economy's performance, and it will be dependent on the Bank of Ireland in terms of what it does, in terms of earnings. If you look at Bank of Ireland's track record in the past, it's done very well, and now it's well capitalized, it has a terrific CEO, it has a good management team, so over time, it should do very well for its shareholders. They are focused on doing well for their shareholders.
The number 0.3 euro Prem Watsa mentioned was for ordinary shares, before the 10:1 reverse split of the ADR. This would translate into about 12 euro per ADR. Therefore Bank of Ireland ADR is traded at about 25% of its book value, far below the valuation that Bank of America (BAC) or AIG (AIG) is traded. We all know that Bruce Berkowitz thinks both of them are extremely cheap.
What does this mean to other value investors like us? It means that we can buy these shares at about 70% of the prices paid by Prem Watsa and Wilbur Ross, or about 25% of the book value.
There are quite positive developments at Bank of Ireland, and in Ireland as a whole. According to Barron’s:
Just one year later, (Ireland) gross domestic product is on track to grow 1.1%, after falling 10% in real terms and 18% in nominal terms between 2007 and 2010. Economists see another 1.1% gain next year, although export growth is fueling the expansion while the domestic economy remains weak. Stripping out exports and inventories, GDP will slip 3.1% this year, according to Eurostat, the European Union's statistics office. Still, that's a notable improvement over the declines of recent years.
Ireland’s 10-year bond yield has also dropped from more than 14% to around 9% today. (For comparison, the yield on Greece’s 10-year bond is more than 270%.) Investors are seeing hope. The shares of Bank of Ireland were up 10.6% yesterday after the bank said it's "making progress" on paying down its massive debt by selling 590 million euro of North American and European loans to Sumitomo Mitsui Banking Corp.
Both Prem Watsa and Wilbur Ross are long-term investors. This investment can be considered “cigar butt” investing, where you buy distressed companies at distressed prices. But often times these distressed prices can go even more distressed in the short term. When GuruFocus asked Prem Watsa about his time frame for this investment, he said:
“Maybe five years, maybe longer, so we think of it as long term. We don't buy it for the next year or two, we don't know what will happen in the next year or two, so we're buying it for five years, and maybe even longer.”
As the European crisis continues to unfold, the road to recovery in Ireland will be bumpy or even distressful for investors. But today you can buy Bank of Ireland shares at only 70% of what Prem Watsa paid or about 25% of book value.
As pointed out by Prem Watsa, this investment will take five years or longer to work out. At the ages of 60s and 70s, Prem Watsa and Wilbur Ross apparently have that kind of time frame. Do you?