Cautious 'Canadian Warren Buffett' Prem Watsa’s Portfolio Positioning for Second Half
Fairfax Financial released its second-quarter financial report on Aug. 1, but it contained the same statements of caution Watsa has been repeating for several quarters now.
"We are maintaining our defensive equity hedges due to our concern about the financial markets and the economic outlook,” Watsa said in the company’s second quarter release.
Watsa went in-depth about his concern in his annual letter dated March 8. He compared the current uncertainties to 2007 and 2008, when bank CEOs knew something was amiss but continued as usual, and later needed rescue from the government. “We prefer to wait for the music to stop and not depend on the kindness of strangers to be in business,” he said
Among his top concerns about the economy are:
· Total private and government debt as a percentage of GDP are at very high levels.
· Deleveraging in the private sector is at early stages.
· Unemployment continues the U.S. and Europe.
· Economic growth continues at low rate.
· The Chinese bubble in real estate.
Soaring markets are ignoring the above factors and trusting in bailouts again should disruption occur, Watsa believes.
Watsa supported his view with quotes from two financial experts.
“In spite of QE1, QE2 and recently QE3, the economic fundamentals remain weak while stock markets and bond markets are back to near record levels, leading Gary Shilling, one of the best economists we know, to call this ‘the grand disconnect.’ This ‘disconnect’ or gap will be closed by either economic fundamentals rising to meet the financial markets or the markets coming down to meet the fundamentals,” he said. “We think that the latter is likely and that the Fed has simply postponed the inevitable by its QE1, QE2 and QE3.”
He also took from Ben Graham. “From the distant past comes the warning of our mentor, Ben Graham, whom I have quoted before: ‘Only 1 in 100 survived the 1929 – 32 debacle if one was not bearish in 1925.’ We continue to be early – and bearish!”
Watsa has indeed been early, as this is the third year he has been issuing market warnings, repeating similar concerns in his 2010 and 2011 annual reports. The scale of his hedging program almost erased common stock gains for 2012.
As of June 30, 2012, Watsa had increased his exposure to common stocks in his portfolio investments to $4.7 billion from $4.4 billion at Dec. 31, 2012. He reduced his exposure to bonds to $9.42 billion from $10.8 billion. The investor also enlarged his cash position to $3.18 billion from $2.73 billion.
Over half of Watsa’s stock portfolio is allocated in the top three positions: BlackBerry Ltd. (BBRY), Johnson & Johnson (JNJ) and Resolute Forest Products Inc. (RFP). He increased the size of only one of the three in the second quarter – Resolute Forest Products (formerly AbitibiBowater).
Watsa purchased Resolute in the second quarter of 2012, during which the price dropped to 52-week lows. He added to the stake in subsequent quarters, most recently increasing it by 16.87%, or 4.18 million shares, in the second quarter of 2013.
Fairfax’s ownership of Resolute increased from 26% to 30.3% during the second quarter, due to receiving shares from the bankruptcy of several predecessor companies of Resolute, as well as open-market purchases.
Resolute is a paper and wood products company, and significant generator of newsprint. It is the smallest of its peers, with a market cap of $1.27 billion. Shares have declined 38% from their December 2010 IPO price.
Along with becoming the largest shareholder, Watsa’s Fairfax is taking a more active role at the company. In May, Fairfax Financial Holdings vice president Bradley P. Martin – who has a background in mergers and acquisitions – was elected its new non-executive chairman of the board.
At $13.40 per share on Friday, Resolute is trading at far under its book value per share of $32.46, with a P/B of 0.4. Below is its revenue and earnings history:
Significant events took place recently at Watsa’s top holding, BlackBerry Ltd. Watsa, who owns 10.06% of the company, stepped down from the company’s board on Aug. 12. The news came as BlackBerry officially announced it was considering a sale, after years of losing money and market share and the failure of its new Z10 smartphone to generate much excitement. Watsa resigned to avoid conflicts of interest that could potentially arise during the sell process.
"I continue to be a strong supporter of the Company, the Board and Management as they move forward during this process, and Fairfax Financial has no current intention of selling its shares,” Watsa said.
Watsa’s loss on his BlackBerry investment currently sits at an estimated 35%. In his reasoning for buying the company, Watsa named the company’s founders, Mike Lazaridis and Jim Balsillie, as major selling points. Then, shortly after Watsa had amassed roughly half his stake, the two men left the company, to be succeeded by Thorsten Heins in January 2012.
Watsa cited similar faith in Dell (DELL) founder Michael Dell as a reason for his investment in that company. He has since cut his position in Dell by approximately two-thirds from its peak, and has roughly a 2% loss on the investment.
Watsa’s success with banks, coal and other companies indicates that perhaps technology – a notoriously intractable industry – is outside his circle of competence. Speculation has been circulating that he may engineer a leveraged buyout of the company, but he would need a buy price of above his average price of $17 per share to break even. Shares currently stand at $10.84, after jumping 13% in the past month. It remains to be seen whether he will profit or lose on the investment.
Well known for his proclivity for what many would deem lost causes, Watsa invested in beleaguered Greece last year. In August 2012, he purchased 14.78% of the shares of Eurobank Properties, a Greek commercial real estate company, at €4.75 per share. Shares at that point were just coming off of their historical low reached in June.
A Fairfax vice president, Wade Burton, joined Eurobank Properties’ board the next month. “It is obvious that the realization of this transaction is occurred during a crucial period for the Greek economy and shows the investor’s optimism for its future,” the company said in a statement.
Watsa increased his stake in the company to 42% as part of a share capital increase in June.
Eurobank Properties Real Estate Investment Co. share price history:
Eurobank Properties (ATH:EUPRO) has a €406.98 million market cap. Shares at €6.8 on Friday give Watsa a current profit of approximately 43% on the investment.
The increase in ownership from Watsa followed the company’s first quarter results released May 30. Eurobank reported steady net profit €9.1 million compared to €9.98 million a year previously. The company said “escalating macroeconomic problems in the market and consequently in real estate” caused the decrease. The company retained €160 million in cash and short-term deposits at that point, compared to €161 million the previous year.
Watsa also expressed interest in the recapitalization of another Greek institution, National Bank of Greece (NBG) back in March. Two days later, the bank clarified its original announcement, saying that Fairfax Holdings was interested in participating by up to €1.5 billion in the recapitalization.
“The said expression of interest remained at an early stage, given the fact that it required certain changes in the existing legal framework for recapitalization of systemic banks which, in any case, lie beyond the competence of NBG,” the bank said in the statement.
National Bank of Greece share price history:
Neither Fairfax nor National Bank of Greece has commented on the potential infusion publicly since then. However, in the bank’s first-half financial report released on Aug. 29, it confirmed that it had completed the recapitalization through a share capital increase of almost €10 billion. Of that, €1.079 billion “was contributed by private investors,” though it did not mention Fairfax specifically. The remainder of the funds came from the Hellenic Financial Stability Fund, which will own 85.6% of the bank’s ordinary shares thereafter.
Watsa’s call on another ailing financial institution has proven to be spot-on. In the summer of 2011, Watsa made a $1.6 billion investment Bank of Ireland (IRE). In the last year, the stock has gained more than 137%.
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