Bruce Berkowtiz, founder of the Fairholme Fund, has an outstanding investment record but a poor performance last year that placed him in the bottom 99 percent of funds and incited a wave of client redemptions. This year is showing the beginnings of validation of his long-term investment theses and a comeback as his fund has returned to the top percentile. Four of his five top holdings are up significantly year to date. They are: American International Group (AIG), CIT Group (CIT), Bank of America (BAC) and Sears Holdings (SHLD). The one that is down is his fourth-largest, MBIA Inc. (MBI).
Berkowitz assembled a highly concentrated portfolio after the near collapse of the U.S. financial system. His top five holdings compose more than 60 percent of it. It is filled with some of the most unpopular and beleaguered names of the crisis. American International Group (AIG) is the largest holding, with a 34.9 percent weighting.
AIG is the multinational insurance corporation that faced a liquidity crisis in 2008 and required an $85 billion bailout from the U.S. Federal Reserve Bank to prevent bankruptcy. AIG reported a loss of $61.7 billion in the fourth quarter of 2008 — the largest loss in corporate history to that point.
Berkowitz bought 15,038,100 shares of AIG in the first quarter of 2010 at an average price of $29. The company had reported its first quarterly profit since the third quarter of 2007 in the second quarter of 2009 and had another positive quarter in the third quarter, but Berkowitz did not buy. The company then swung to a fourth quarter loss. In the first quarter of 2010 there was a large dip in the share price and the company posted net income of $1.5 billion though he still suffered from what he called “premature accumulation.”
In the first quarter, the company was also working on selling assets to repay its obligations to the Federal Reserve Bank of New York and improve its capital structure. Berkowitz continued to add shares throughout the year.
Then, in 2011, Berkowitz made his largest and perhaps costliest move [?] with AIG when he bought 58,966,502 shares in the second quarter of 2011 at the average price of $30.50 per share. By the end of the year, the price was near $23. Since the start of 2012, however, it is up 21.3 percent to $28.
Berkowitz outlined his thesis on AIG in his conference call with investors in May 2011: “The intrinsic value is significantly higher, in my opinion, than where we bought AIG and where AIG is trading today. Chartis, Sun America are intact, they made reasonably good money last year, fabulous money compared to the price where the stock is today. I see no reason why AIG can't make a 10% return on equity.
I see no reason why they can't meet their goals for the next few years. There's tremendous value in AIG … people spent a huge amount of time focused on the right hand side of the balance sheet. It's now time for people to take a look at the left hand side and have a better understanding of the earnings power of the remaining companies and a better understanding of the assets and liabilities.
For example, the $23 billion deferred tax asset valuation allowance is not on the books. As the company begins to earn a more consistent profitability stream you will see that tax deferred asset come onto the books. As I mentioned in my opening comments, I can see the company earning about $6 per share, pre-tax and, on a normal basis, they will not pay taxes on that for quite a few years. As that process evolves you'll start to see that grow and earn more pre-tax.”
CIT Group (CIT) and Bank of America (BAC) are Berkowitz’s second and third-largest holdings. He has been gradually selling small amounts of CIT. He launched his Bank of America position at the same time he bought AIG, the first quarter of 2010, with 39,309,900 shares at an average price of $16 per share. He continued adding until the third quarter of 2011. His holding peaked at 105,012,795 shares. But the stock price fell to $4.92 per share— another costly error and drag on performance that year.
The year has been good so far for Bank of America. Its stock is up almost 44 percent to close at $7.99 on Monday. It reported net income of $2.0 billion for the fourth quarter of 2011, compared to a net loss of $1.2 billion in the year-ago period. It also originated 20 more small business loans and had 13 percent higher commercial and industrial loan balances from the previous year.
Berkowitz spoke about Bank of America most recently on Bloomberg in February 2012. He again compared it to Wells Fargo (WFC)’s situation in 1990. Warren Buffett, chairman and CEO of Berkshire Hathaway (BRK.A)(BRK.B) increased his ownership in the company to just under the legally permissible 10% that year.
“Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks,” Buffett said in his shareholder letter. “The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.”
It took several decades for Wells Fargo shares to appreciate substantially.
“I particularly haven’t figured out why one revolution around the sun is the appropriate measurement period, or why one month is, I don’t know. It’s long term. It’s a long race. We’re in it for many, many years,” Berkowitz said in the Bloomberg interview.
Sears Holdings (SHLD), Berkowitz’s fifth-largest holding, has had a dramatic year. After declining about 55 percent in 2011, it has risen 144.5% year to date.
Sears is a long-term holding for Berkowitz, who has owned it since prior to 2007. His average price for all of his purchases was $94, and the stock closed at almost $78 Monday, for an average loss of 17 percent.
The company is chaired by fellow investor Edward Lampert, founder, chairman and CEO of ESL Investments. The company reported a net loss of $3.1 billion in 2012, compared to net income of $133 million in 2011. Revenue also slid to $42.3 billion from $43.3 billion as domestic comparable store sales declined 3 percent.
Berkowitz mentioned the stock in his February 2012 interview with shareholders. When questioned about the company’s intrinsic value, he responded: “That seems to be the $64 question, and it’s hard for most to get a hold of it because of the different components. Everyone knows there’s real estate, that they’re a brand, and there’s an online component. A lot of people don’t realize that there’s a service business with 12 million visits to homes every year, a warranty business on the products. Of course there’s Sears Canada – mostly owned by Sears now.
But the real interesting issue which people have to get their hands around is the long leases that Sears and Kmart have. You have to ask yourself the question, when does the long lease equal in value what ownership is. So when you take into account the very long leases and just the nature of what it is to be an anchor in a mall, how you become an anchor and the terms and conditions of becoming an anchor in a mall, there’s tremendous value. Quite a lot of work to get there, but when you add up all the values, including the long leases and the importance of anchors in malls, plus the brands, whether it’s Lands’ End online or the Sears websites that are doing reasonably well, you come up with a pretty big number. The number is multiples of what we think the current stock price is, but we’ll let everybody on the outside figure out what the exact range is.”
As the year unfolds it will continue to show whether these positive signs mean his investment theses are playing out as he expected.