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Highlights from Prem Watsa Shareholder Letter
Posted by: GuruFocus (IP Logged)
Date: March 19, 2013 09:34AM

If you have been reading the shareholder letter of Warren Buffett, that is great. You don’t want to miss the letter of Prem Watsa, either. You can learn just as much. Mr. Watsa is always very cautious. This is understandable because he runs an insurance business. Risk control and management is the most important part of insurance business. These are the highlights from the shareholder letter of Prem Watsa, Chairman of Fairfax Holdings (TSX:FFH):

1. Book value per share increased by 6.5%. Book value per share ended the year at $378 per share, and common shareholders’ equity ended the year at $7.7 billion.

2. “In the 27 years since we began in 1985, our compound annual growth in book value per share has been 23%, while our common stock price has compounded at 19% annually.”

3. OdysseyRe has produced an average accident year combined ratio in the last ten years (since 2003) of 92.8%.

4. Getting into other businesses.

a. Bought 77% of Thomas Cook India, a travel and currency exchange company in India

b. Prime Restaurants in Canada. Purchased at 10 times of free cash flow.

5. 100% hedged. The hedge cost $1 billion in 2012. Still 100% hedged.

6. Investment return was 4.5% because 100% hedged. If not hedged, the return would be 8.7%.

7. On Blackberry (BBRY):

Markets fluctuate – and very often in extreme directions. Remember the tech boom, when companies with no sales were valued at tens of billions of dollars? In 2000, Northern Telecom accounted for 36.5% of the Toronto Stock Exchange index and was worth almost Cdn$400 billion; by 2009, it was bankrupt! Well, last year the oppo- site happened to Research in Motion (now known as BlackBerry). At its low of approximately $6 1 ⁄ 2 per share, it sold at 1 ⁄ 3 of book value per share and a little above cash per share (it has no debt). The stock price had declined 95% from its high! The company produces the BlackBerry which for years was synonymous with the smart phone. The BlackBerry brand name is perhaps one of the more recognizable brand names in the world and the company has 79 million subscribers worldwide. Revenues went from essentially zero to $20 billion in about 15 years – and then it hit an air pocket! The company got complacent, perhaps overconfident, and did not respond quickly enough to Apple and Android. Mike Lazaridis, the founder and a technological genius – and a good friend – asked me to join the Board, which I did after meeting Thorsten Heins, whom Mike recommended as the next CEO of the firm. Thorsten's 27 years of experience in all types of leadership jobs in small and large divisions at Siemens, combined with his five years at BlackBerry, were exactly what was needed. Thorsten hired a very capable management team and then focused on producing a high quality BB10 – the next generation of BlackBerries. The brand name, a security system second to none, a distribution network across 650 telecom carriers worldwide, a 79 million subscriber base, enterprise customers accounting for 90% of the Fortune 500, almost exclusive usage by governments in Canada, the U.S. and the U.K., a huge original patent portfolio, an outstanding new operating system developed by QNX and $2.9 billion in cash with no debt, are all formidable strengths as BlackBerry makes its comeback! The stock price recently moved as high as $18 per share, a far cry from the $140 per share it sold at a few years ago. And please note, 1.8 billion cell phones are sold worldwide annually, and of the 6 billion cell phones in the world, only 1 billion are smart phones. Lots of opportunity for Canada's greatest technology com- pany! What is striking, even for a person like me who has seen many bull and bear markets, is that at $6 1 ⁄ 2 per share, all the Wall Street and Bay Street analysts were uniformly negative – just as they were uniformly positive only a few years ago at prices north of $100 per share. John Templeton's advice to us: "Buy at the point of maximum pessimism", still rings in our ears!! We own approximately 10% of the company at an average cost of $17 per share and we are excited about its prospects under Thorsten's leadership and Mike's technical genius.

8. Continued to be 100% hedged. Why? We continue to fully hedge our common stock portfolios because of the reasons first discussed in our 2010 and 2011 Annual Reports. Those reasons have not changed! Total debt (private and government) as a percentage of GDP in the U.S., Europe and the U.K. are at very high levels, thus limiting the options available to governments. Deleveraging in the private sector has only just begun. In spite of the significant deficit spending in the U.S. and Europe, high levels of unemployment prevail in both areas and economic growth continues to be very tepid. In fact, Europe and the U.K. appear to be heading for another recession. The markets are ignoring this as they believe the Fed and the European Central Bank will bail us out – again! Forgotten is the fact that the present Chairman of the Fed, in July 2008, yes July 2008, said that Fannie Mae and Freddie Mac were "adequately capitalized" and "are in no danger of failing". 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 eco- nomic fundamentals rising to meet the financial markets or the markets coming down to meet the fundamentals. We think that the latter is likely and that the Fed has simply postponed the inevitable by its QE1, QE2 and QE3 actions.

9. Chinese real estate bubble: In our 2010 and 2011 Annual Reports, we discussed the Chinese bubble in real estate. This past Sunday (March 3, 2013), the CBS show "60 Minutes" did a segment on the Chinese residential real estate bubble. They showed vast empty cities with "new towers with no residents, desolate condos and vacant subdivisions uninhabited for miles and miles, and miles and miles of empty apartments." They called it the biggest housing bubble in history. We agree! The ultimate collapse of this bubble will have major consequences for the world economy.

10. Commodity prices have yet to collapse: While commodity prices have yet to collapse (i.e., complete the down cycle), almost all the major mining com- pany CEOs have retired, including at Vale, Rio Tinto, BHP Billiton and Anglo-American, reflecting the sin of making acquisitions at the top of the market. Rio Tinto's purchase of Alcan is a great case in point. Purchased for $38 billion in 2007 at the height of the commodity boom, Rio Tinto has already written off $20 billion or half of the purchase price!

11. Toronto condo prices will fall: As we said last year, if commodity prices come down after their parabolic increase, Canada will not be spared. Also, Canadian house prices have gone up significantly, driven by lax policies at CMHC (Canada's equivalent to Fannie Mae and Freddie Mac). Canadians have accessed their increasing real estate wealth through lines of credit easily available from the Canadian banks. This has begun to reverse and we are watching cautiously from the side- lines. The condo boom in Toronto (you cannot miss it when you drive into the city) continues to slow down and we believe that prices will fall, as they have in past condo booms.

Read the complete shareholder letter.

Guru Discussed: Prem Watsa: Current Portfolio, Stock Picks
Stocks Discussed: TSX:FFH, BBRY,
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