Prem Watsa is CEO of Fairfax Financial Holdings, a Toronto-based insurance corporation in the likeness of Berkshire Hathaway (BRK.A)(BRK.B) — he uses the float to invest while growing the book value of the company and making acquisitions. Also like Buffett, he pens insightful, widely-read annual letters in which he discusses his company, the economy and investing in general. In this year’s annual letter he said where he saw the stock market heading in the next decade. He also mentioned six of his stocks: IRE, LVLT, RIMM, WFC, USB, JNJ. Watsa invests according to Ben Graham value principles and has earned a 9.6% average return over the last 26 years. His ten-year cumulative average is 154.6% versus 16.4% for the S&P 500.
While Watsa worries about a 1930s-style GDP stagnation in the U.S. as it “digests the excesses of the past 20 years,” he is bullish on common stock for the long term. He is fully hedged as he expects major risks in the next three years, but will gradually remove the hedges as the risks get discounted in common stock prices.
Bank of Ireland (IRE)
Bank of Ireland is a foreign investment so Watsa does not have to list his holding history to the SEC. He led a capital infusion into the bank in August along with other investors Wilbur Ross, Capital Research, Fidelity and Kennedy Wilson. The total invested was €1.12 billion and together they own 34.96% of the company. The Irish government owns 15.13%. Fairfax owns about 2.8 billion ordinary shares at a cost of 10 euro cents per share.
Bank of Ireland is one of the “Big Four” Irish banks was founded in 1783. It required a 5.2 billion euro bailout in March 2011 due to the Irish banking crisis which pushed the nation’s biggest banks to the brink of collapse.
Watsa noted in his shareholder letter that IRE stock was valued at 8.3 euro cents per share on Dec. 31, 2011, and in early 2012 it traded up to 15 euro cents per share. Today it trades for 13 euro cents.
Watsa shared a great deal about Bank of Ireland in his interview with GuruFocus. “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,” he said.
He discussed the investment in further detail in his shareholder letter: “With the help of our friends at Canadian Western Bank, one of the best banks in Canada, we thoroughly reviewed the opportunity and then quickly formed an investment group with Wilbur Ross, Mark Denning from Capital Research and Will Danoff at Fidelity, which purchased $1.6 billion of Bank of Ireland shares on a rights issue (Fairfax’s share was $387 million). This issue reduced the Irish government’s stake in Bank of Ireland from 36% to 15%.
In spite of having hundreds of years of history and the strongest credit culture in the country, Bank of Ireland barely survived the real estate crisis in Ireland, where both house prices and commercial real estate prices dropped by approximately 50% from their highs. It is the only major Irish bank to survive that crisis – the rest of the Irish banking industry is now government owned. The rights issue plus other capital generated by Bank of Ireland has resulted in the Bank having capital to withstand an even further drop in Irish commercial real estate prices and Irish house prices. Bank of Ireland is very strongly capitalized, led by an excellent banker, Ritchie Boucher, and its shares were available at a significant discount to book value. We look forward to being long term shareholders of Bank of Ireland and hope to make more investments in that country as it continues under strong leadership diligently remedying its economic problems. Ireland by the way is a leading location of choice for foreign direct investment because of its talent, tax regime and technology capabilities together with its unique pro-business environment. Our nSpire Re subsidiary has been in Dublin since 1990 and was a great help in making our decision to invest in Bank of Ireland.”
Level 3 Communications (LVLT)
Watsa initiated a position in Level 3 Communications in the fourth quarter of 2007 when he bought 1,476,400 shares at an average price of $52 per share. He continued adding shares as the price went down. His lowest purchase price was $16 per share in the third quarter of 2010. After buying and several more times, he owns 12,931,142 shares at the end of the fourth quarter 2011 and the stock price opened at $24.12 on Wednesday.
Level 3 is an international communications and information services company that operates one of the largest internet backbones in the world. Watsa has made it his third-largest holding, forming 12% of his portfolio.
The company’s revenue has declined at an average annual rate per share of 15.8% over the last ten years, though it reached a record $4.3 billion in 2011. Free cash flow has been positive only once since 2002; in 2009 it generated $45 million.
The company also has more than $9.3 billion in long-term liabilities and debt on its balance sheet, and $928 million in cash.
Watsa did not discuss Level 3 in his shareholder letter except to say that it contributed to his portfolio’s poor 2011 performance. But, he said, he believes “these stock price declines are predominantly fluctuations and will be reversed over time.”
Research In Motion (RIMM)
Research In Motion is Watsa’s fourth-largest holding, forming 10.1% of his portfolio. He accumulated millions of shares beginning in the third quarter of 2010 at an average price of $50 per share. Most recently he acquired another 1 million shares in the fourth quarter of 2011 at an average price of $19. He holds a total of 12,798,300 shares as of year-end 2011.
Research In Motion was once a hot tech company after introducing the game-changing Blackberry smart phone. Today after a lack of innovation, intense competition and problems within the company, it is a heavily shorted stock whose price that has declined 71% over the last five years.
In his GuruFocus interview, Watsa cited the co-CEOs of RIMM as one of the reasons he liked the company. Those CEOs, however, left the company and have been replaced by the former CFO. Watsa also joined the board in January.
RIMM was another stock he mentioned in his shareholder letter as one that pulled down his return. He said of the company, “I’m trying to help!”
Wells Fargo is one of Watsa’s top three long-term equity holdings. He owns 20 million shares for which he paid $19.36 per share. He invested $388 million, and at Dec. 31, 2011, the holding had a market value of $552 million.
U.S. Bancorp. is also one of his three top equity holdings. He owns 15.9 million shares at a purchase cost of $16.27 per share. His $259 million investment had a market value of $428 million at year-end 2011.
In his shareholder letter, he called his top holdings, “three of the finest companies in the world,” and said they “continue to be very optimistic on the long-term prospects for these companies.”
Wells Fargo’s earnings reached a record $16.2 billion in 2011, while revenue slid for the third straight year to $78.6 billion. On March 13, Wells, the largest U.S. home lender, passed the Federal Reserve’s stress test and increased its quarterly dividend by 83 percent. It increased from 12 cents per share to 22 cents.
U.S. Bancorp produced record revenue of $21.4 billion in 2011 in its third straight year of increases. Net income reached $4.8 billion after three straight years of growth. The bank also increased its dividend by 56% and will buy back up to 100 million shares after passing the Fed’s stress test. The new dividend is 19.5 cents from 12.5 cents previously.
Watsa said at Fairfax’s 2010 annual shareholder’s meeting that Wells Fargo and U.S. Bancorp are “two banks that we think are very conservative in their approach to risk. We like banks that are very conservative,” according to Bloomberg.
Johnson & Johnson (JNJ)
Johnson & Johnson is Watsa’s other top-three equity holding. He owns 7.4 million shares at a purchase price of $61.37 per share. His original investment of $454 million was worth $485 million at year-end 2011.
Johnson & Johnson manufactures and sells a broad range of products in the health care field. Johnson & Johns has a market cap of $177.72 billion; its shares were traded at around $65.08 with a P/E ratio of 13 and P/S ratio of 2.7. The dividend yield of Johnson & Johns stocks is 3.5%. Johnson & Johns had an annual average earnings growth of 5.4% over the past 10 years. GuruFocus rated Johnson & Johnson the business predictability rank of 4-star.
The company generates massive cash flow which has ranged from $11.2 billion to $14.5 billion since 2006. It also reached record revenue of $65 billion in 2011 and earnings of $9.7 billion. Growth was driven by recently launched pharmaceutical products and new product approvals across all its businesses. It expects growth of approximately 3.5% to 5.5% and earnings per share of $5.05 to $5.15 per share for full-year 2012.