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Prem Watsa’s Fourth Quarter: Adds RIMM, C, ORI, JNJ; Sells CNU, FPFC; Reduces DELL

Holly LaFon

Holly LaFon

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Prem Watsa is renowned for his long track record of outstanding returns using Buffett-style value investing through his worldwide insurance and reinsurance company, Toronto-based Fairfax Financial Holdings. His five-year cumulative is 176.4%, compared to 12.2% for the S&P 500. Most recently, he made headlines for making a large contrarian bet on Research In Motion (RIMM) and joining its board in his first activist investing foray. In the fourth quarter, he added to this position. He also added to his positions in Citigroup Inc. (C), Old Republic Corp. (ORI) and Johnson & Johnson (JNJ) and dramatically reduced one of his largest holdings, Dell (DELL). As a Ben Graham devotee, Watsa looks past short-term fluctuations in price to the underlying strength of a business. His stance on the economy, as of September and October 2011, was that he believed the U.S. was showing Depression-level interest rates and deficits, but he still liked some stocks and would hedge his exposure, he told CFA Institute Magazine.

Fourth Quarter Adds

Citigroup (C)

Watsa first bought citigroup in the second quarter of 2010 at an average price of $41.50. He continued to add shares in subsequent quarters. Most recently, he added 5,000 in the third quarter of 2011 at an average price of $32.50, and 5,000 in the fourth quarter of 2011 at an average price of $28. At the end of the third quarter, his holding size is 20,000 shares.

Financials comprise the largest sector of Watsa’s portfolio, at 28.6%. The next largest sector is health care, at 21.6%. This is a new occurrence. In the third quarter of 2010, he cut back financials to 10.5% of his portfolio, from 27.3% the previous quarter. He kept his weighting in financials small until the third quarter of 2011, when he nearly tripled his exposure to 24.4% of his portfolio.

Citigroup suffered from a difficult capital markets environment in the fourth quarter, which drove lower market activity. Its holdings assets declined $90 billion in 2011 to $269 billion. As it continues to have the European sovereign debt crisis overhang, it wants to focus on cutting expenses in 2012. Its fourth quarter 2011 revenues dropped to $78.4 billion, compared to $86.6 billion the previous year, and net income increased slightly to $11.3 billion, compared to $10.6 billion the previous year. Revenues from retail banking increased 3% year over year, while revenue from Citi-branded cards fell 5% year over year. Revenue from retail banking for fiscal year 2011 declined 4% year over year, and revenue from Citi-branded cards for fiscal year 2011 declined 10% year over year.

Other business areas improved, however. Citi saw continued growth in its international consumer banking, and had its third consecutive quarter of sequential growth in North America Consumer Banking, and had solid treasury & trade services growth despite the low-rate environment. Some aspects of its balance sheet strengthened as well, including an increase in tangible book value to $49.81, and a Tier 1 Common ratio increase to 11.8%.

Citigroup announced in the first week of February that it would exit its mortgage brokerage business, which contributed less than 10% of the bank’s $67.9 billion mortgages in 2011.

The bank also reached an agreement on February 9 with the United States and the Attorneys General for 49 states and the District of Columbia to settle investigations into residential loan servicing and origination practices. Citi’s will be forced to pay $2.2 billion as their part of the settlement.

Research In Motion (RIMM)

Research In Motion is a wireless communications industry that invented the once-popular BlackBerry mobile device in 1999 and saw its stock fall nearly 78% over the last year. Prem Watsa bought RIM stock the first time in the third quarter of 2010, buying 2,065,000 shares at an average price of $50. He increased his stake by 6,308,300 shares in the second quarter of 2011 at an average price of $44, by 3,425,000 shares in the third quarter of 2011 at an average price of $27, and by 1 million shares in the fourth quarter of 2011 at an average price of $19 per share (less than book value of $19.45 per share). At quarter end he owned a total of 12,798,300 shares.

RIM is facing numerous issues in the market but has strong financials. Revenue at the company has increased every year from $294 million in 2002 to a record $19.9 billion in 2011. Earnings likewise increased each year, reaching a record $3.4 billion in 2011, and free cash flow reached almost $3 billion in 2011, a record by far.

But RIM is facing fierce competition from Apple (AAPL) and companies who make devices using Google (GOOG)’s Android platform, which is eroding its market share. Attempts to promote new products have not helped. The price of RIM’s flagship tablet dropped by more than half its original price in six months after its launch. The company took a $485 million charge against its revenues in the third quarter mainly for unsold PlayBooks (as well as $50 million due to a three-day network outage in mid-October).

The inability to know whether people will remain interested in BlackBerry devices concerned investor Bill Ackman. “We like businesses like the railroad business which aren’t going to go away,” he said in a public meeting in Toronto. “As much as I like my BlackBerry, there is some risk it’s going to go away. And that’s a risk we don’t want to take with a billion and half dollars.”

Watsa still sees plenty of value in the company. Fairfax told GuruFocus he liked that it is “trading at less than book, [has] 75 million subscribers and growing, $700 million free cash flow in last reported three months, $1.5 billion in cash, No. 1 smartphone in many large growing markets, genius founders invested in company and buying more stock, and a seasoned operator in [newly appointed CEO Thorsten] Heins.”

RIM is also trading near historical low valuations, and its P/E was even lower in the third quarter, when Watsa bought:

RIMM pe,ps,pb Interactive Chart



Old Republic Corp. (ORI)

Old Republic Corp, one of the 50 largest publicly held insurance organizations in the nation, engages primarily in commercial lines underwriting and has a client base of leading industrial and financial services companies.

Watsa has held Old Republic shares since prior to 2007. He has not added to his holding since the third quarter of 2008, and since then the stock rarely went higher than his first quarter 2008 purchase price of almost $14. The stock dropped to an average of $9 in the fourth quarter of 2011, and he bought 5,000 more shares, bringing his total holding to 35,000 shares.

For the full year 2011, Old Republic experienced a loss of $218.5 million, compared to $40.6 million in 2010, due to two factors. The company’s general and title insurance segments turned positive for the first time since 2007, which was offset by the record-high operating losses due to dramatically increased claim costs. All of its gain in net income for the final quarter of the year was from substantially increased investment gains.

Johnson & Johnson (JNJ)

Prem Watsa has had Johnson & Johnson (JNJ) in his portfolio since prior to 2007, and it is his largest holding. Most recently, he purchased 763,000 shares in the fourth quarter of 2011 at an average of $64 per share.

Johnson & Johnson was founded in 1886 and today is one of the most comprehensive health care businesses in the world. It also has several impressive achievements that qualifies it as one of the nation’s premier blue-chip stocks: 27 consecutive years of adjusted earnings increases, 49 consecutive years of dividend increases. Johnson & Johnson stock generated 4% total return for investors over the last 10 years, compared to 1.4% for the S&P 500.

Currently, Johnson & Johnson, in partnership with Pfizer (PFE), is working on Bapineuzumab, what it calls the drug industry’s “best chance” to delay Alzheimer’s. They plan to release results of the drug’s Phase III data in the second half of this year.

Warren Buffett, in data released today from GuruFocus Real Time Picks, sold shares of Johnson & Johnson in the fourth quarter.

Sells and Reductions

Watsa sold two stocks in the fourth quarter: Continucare Corp. (CNU) and First Place Financial Corp. (FPFC). He reduced Dell (DELL), one of his largest holdings, but almost 60%.

The investor’s top holdings include several extremely high-quality companies and some with more uncertain futures, meaning 2012 will be an interesting year to watch him.

See Prem Watsa’s portfolio here. Also check out the Undervalued Stocks, Top Growth Companies, and High Yield stocks of Prem Watsa.


Rating: 3.9/5 (8 votes)

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