Overview of the Fund’s Performance
Good morning, we have a lot of friends and shareholders o the line, and we want to answer every questions. Here are my thoughts on the Fairholme Fund’s recent performance. Horrible, that’s the summary, in hindsight and maybe to be expected over the short term. We’ve always stated in our report that the short term should not be overemphasized. It’s the long term that counts. This is not the first time we’ve underperformed, it won’t be the last time, and I don’t think it’s reality to outperform every month quarter or year. So it’s a lousy four months. We’ve been losing, way underperforming. It may stay lousy for more time.
In hindsight we [garble] for health insurers from defense to financials too early. We’re into financials with the belief that they’re essential to the well-being of the economy, that they, in the aggregate, are huge chunks of the U.S. financial system. This is a similar argument that we had with health care, when many people thought the health care industry was dead. We argued at the time that our companies were the health care system. In the same way we argue today that our financial companies are the U.S. financial system.
Financials remain today though hated and blamed for our country’s economic troubles. They do deserve part of the blame, but we all had a share in the process we’re going through. The bottom line is, in a perverse way, we need to fail short term in order to outperform in the long term. We need to buy lower and buy lower and buy lower, even when the crowd yells, “You’re wrong!” This is how we’ve achieved our performance over the past decades, and this is how we will achieve our performance over the next couple of decades. Today’s environment is very reminiscent of the 1990s when the market was up and Wells Fargo was going bust and the banking system was crushed and we bought and we bought and we bought and the process lasted quite a bit of time, and then we went on to make five to seven times our money. I think we’ll do quite well in the future now, in the next period. I don’t know if we’ll make five to seven times our money. I doubt it. But we are setting up for a good run.
Today, the trends are quite positive. Balance sheets are strong and getting stronger. Banks have burned through over half of their difficult loans from 2007-2008, while writing great loans in 2009 and 2010. Today our banks are profitable and safe, but still there’s great uncertainty about legislation, lawsuits, regulations and future profitability. Wall Street hates uncertainty. Uncertainty creates a cheap price. Over 2011 this uncertainty will greatly diminish, this noise will reduce. Graham and Dodd quote Horace on the first page of “Security Analysis:” “Many shall be restored that are now fallen, and many shall fall that are now in honor.”
…
It was always an expectation that one day money would flow out from relative performance. It’s just nonsensical for us to think that we’re just going to outperform all the time. So going into 2008 we also understand that money can leave the fund for reasons that have nothing to do with the fund. So in a way it’s interesting. We have more than enough cash. We still have significant amounts of cash. We planned for this. Any redemptions just give us more of what we like and want to own more of.
Financials: AIG (AIG, Financial) & St. Joe’s (JOE, Financial)
Today AIG is valued about 2% of its market price 10 years ago. The government wants to sell 1.6 billion, shares with their cost basis around $29 per share. I ask you, guess when the public offering will take place, given the government is not in the business of making profits. My guess is $27-$29. You could ask, why do we hold? Well, I was wrong. I found it very hard to believe that the government would sell its stake below its book value. Right now, AIG is selling at two thirds of book value. Last year AIG’s remaining operations earned $12 billion before share. And the company will not take taxes for a few years. Graham and Dodd said many will be restored.
Many questioned us about St. Joe. There’s been a tremendous amount of press. Some correct, some incorrect, but there has been too much press. Fairholme isn’t worried. Why spend so much time on a relatively small position? Why spread yourself out too thin? Well, Joe did not have to stay small. And Joe today is taking less and less time. But what you have to understand and the reason that we are in Joe is that Joe is part of a master plan. It’s Florida’s largest, billions have been spent on Joe’s land, billions more will be spent by local, state and federal governments. Joe at its heart is an asset manager. New management at Joe will stop the expense lead, build the balance sheet and afford shareholders the patience for Florida’s master plan to continue. It’s that simple, but it’s not too simple.
So, let me give you a quick summary. We moved too fast, perhaps too soon into financials, we suffered some premature accumulation, our company continued to be priced for continuing stress, and the price we paid reflects those stresses, and the prices we paid were quite cheap in our opinion compared to how these companies should perform in a more normal environment. Some people think we spread too thin. We are smack dab in the middle of our circle of confidence in financial services.
St. Joe’s is basically the history of real estate. I think of the United States and the history of demographics and the history of what happens when you plunk an international airport down in your back yard. But again, most of the heavy lifting is over, and time is patience on St. Joe.
…
Well the intrinsic value is significantly higher, in my opinion, than where we bought AIG and where AIG is trading today. The charts [?] in 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 percent return on equity, I see no reason why they can’t meet their goals in the next few years. There’s tremendous value in AIG, and it’s time, people spent a huge amount of time focused on the right-hand side of the balance sheet, it’s now time for people to look at the left-hand side. And understand, have a better understanding of the earnings power of the remaining companies and a better understanding of the assets and liabilities. For example, there’s a $23 billion deferred-tax after-valuation allowance, it’s not on the books. As the company begins to earn a more consistent profitability string, you will see that tax-deferred asset come onto the books.
So as I mentioned in my opening comments, I can see the company earning about $6 per share, pretax, and on a normal basis, and they will not pay taxes on that for quite a few years, and as that process evolves, you will start to see them grow, and earn more pretax. So that is the basic thesis. They’ve been under a microscope for three long years, there’s a huge overhang of stocks. And there I was wrong. I thought the government would sell the stock at a higher price, but they’re willing to sell it at a lower price. And once that overhang is finished there’ll be a great amount of uncertainty put aside, removed. And then there will be other uncertainties, but there’s time to think about to spend more time focused on the asset side of the balance sheet.
When will the government sell?
This year. I would think a big chunk will be sold relatively soon, before hurricanes season, and then I would expect that there will be good demand for anything that may remain after the hurricane season. And I would hope that it’s all finished by year end.
Sears Holdings Inc. (SHLD, Financial)
I’ve described Sears in the past as a long-term win-win. Nobody believes that Eddie Lampert and team can pull it off on the retail side. It reminds me of Apple (AAPL, Financial), when everyone thought that Apple was about to fail, and Microsoft (MSFT, Financial) had to inject capital into Apple to keep them around as a competitor. If they do succeed as a retailer, then that would be very positive for the stock. If they do not and the stock price stays low or goes lower, I believe the company will continue to buy back shares and eventually Fairholme, ESL, and a few other shareholders will own the entire company and the assets that remain will work out quite well. So whether Sears is a melting ice cube or becomes, heaven forbid, a growth story, I think we’ll do just fine.
You gotta give the guy a break and the company a break. We’re coming out of the great recession, maybe the greatest recession since the Depression. Sears is very much tied to the housing market. So we’ve hung in there and we’re going to continue to hang in there. I just don’t see how we get hurt with Sears, and maybe we make an awful lot of money. Time will tell. So far I’ve been wrong.
No there’s nothing new in my thesis at all. Just time.
International Investments
In terms of expanding beyond Asia, I don’t know. If an opportunity comes up. There’s no such strategy. On visits to Asia it is very, I mean the analogy in the United States in the 1950s where a giant middle class was developing. And I remember growing up with that middle class dream and the dream of my parents that I would have a better life than they had. Life insurance was very important, that life insurance policy was very important in terms of cash value. You could go to work and have a smile on your face that no matter what your children were going to be ok, your spouse was going to be ok.
This was again during a period where the middle class was greatly expanding in the United States and you have that situation today in China and other parts of Asia only on an exponential basis. It’s a product I understand, I’ve lived with my whole life. The rules are different in Asia as to promises that can be made in terms of max, mins, amounts, regulation.
It’s quite tough so we are very excited about Asia and China Pacific (CHPXF, Financial) and we hope that we can find more such high quality companies and management. It’s very hard to explain, you have to be there you have to see it, you have to talk with the management, you have to listen to the regulators, it can almost turn your world upside down. As to what you would expect here seems to be there and there, it’s fascinating. So we’re very slowly carefully expanding our circle. Where it leads, I have no idea today. The dollar doesn’t know how it’s made so if we can grow confidence and get experience.
Future of Real Estate
[The housing market will rebound] when people have confidence. When uncertainty is cleared up. We’ve been through this before. We’ll go through it again. The 1970s were a devastating time. And whether our financial institutions have the wherewithal to wait for that confidence. They do. Their balance sheets have never looked better. They’re making money, we’re working through the real estate issues, continue to work through it. There’s probably another 18 months of working through residential real estate. That will be the last uncertainty to go.
We will get there, and we’ll move on. It’s time for all the plays in the financial system to settle up and move on. A lot of uncertainty, law suits, A suing B, B suing A, uncertainty about regulations. We need the uncertainty to finish, to be greatly diminished. We need the government to do its part. We need our companies to sort of settle up with each other on any disputes. We need to keep working through the troubled real estate as we’re doing. And we will build confidence and then, we’re off to the races. When? I don’t know. But it will happen.
The full audio is available here. You must register to access it.
Good morning, we have a lot of friends and shareholders o the line, and we want to answer every questions. Here are my thoughts on the Fairholme Fund’s recent performance. Horrible, that’s the summary, in hindsight and maybe to be expected over the short term. We’ve always stated in our report that the short term should not be overemphasized. It’s the long term that counts. This is not the first time we’ve underperformed, it won’t be the last time, and I don’t think it’s reality to outperform every month quarter or year. So it’s a lousy four months. We’ve been losing, way underperforming. It may stay lousy for more time.
In hindsight we [garble] for health insurers from defense to financials too early. We’re into financials with the belief that they’re essential to the well-being of the economy, that they, in the aggregate, are huge chunks of the U.S. financial system. This is a similar argument that we had with health care, when many people thought the health care industry was dead. We argued at the time that our companies were the health care system. In the same way we argue today that our financial companies are the U.S. financial system.
Financials remain today though hated and blamed for our country’s economic troubles. They do deserve part of the blame, but we all had a share in the process we’re going through. The bottom line is, in a perverse way, we need to fail short term in order to outperform in the long term. We need to buy lower and buy lower and buy lower, even when the crowd yells, “You’re wrong!” This is how we’ve achieved our performance over the past decades, and this is how we will achieve our performance over the next couple of decades. Today’s environment is very reminiscent of the 1990s when the market was up and Wells Fargo was going bust and the banking system was crushed and we bought and we bought and we bought and the process lasted quite a bit of time, and then we went on to make five to seven times our money. I think we’ll do quite well in the future now, in the next period. I don’t know if we’ll make five to seven times our money. I doubt it. But we are setting up for a good run.
Today, the trends are quite positive. Balance sheets are strong and getting stronger. Banks have burned through over half of their difficult loans from 2007-2008, while writing great loans in 2009 and 2010. Today our banks are profitable and safe, but still there’s great uncertainty about legislation, lawsuits, regulations and future profitability. Wall Street hates uncertainty. Uncertainty creates a cheap price. Over 2011 this uncertainty will greatly diminish, this noise will reduce. Graham and Dodd quote Horace on the first page of “Security Analysis:” “Many shall be restored that are now fallen, and many shall fall that are now in honor.”
…
It was always an expectation that one day money would flow out from relative performance. It’s just nonsensical for us to think that we’re just going to outperform all the time. So going into 2008 we also understand that money can leave the fund for reasons that have nothing to do with the fund. So in a way it’s interesting. We have more than enough cash. We still have significant amounts of cash. We planned for this. Any redemptions just give us more of what we like and want to own more of.
Financials: AIG (AIG, Financial) & St. Joe’s (JOE, Financial)
Today AIG is valued about 2% of its market price 10 years ago. The government wants to sell 1.6 billion, shares with their cost basis around $29 per share. I ask you, guess when the public offering will take place, given the government is not in the business of making profits. My guess is $27-$29. You could ask, why do we hold? Well, I was wrong. I found it very hard to believe that the government would sell its stake below its book value. Right now, AIG is selling at two thirds of book value. Last year AIG’s remaining operations earned $12 billion before share. And the company will not take taxes for a few years. Graham and Dodd said many will be restored.
Many questioned us about St. Joe. There’s been a tremendous amount of press. Some correct, some incorrect, but there has been too much press. Fairholme isn’t worried. Why spend so much time on a relatively small position? Why spread yourself out too thin? Well, Joe did not have to stay small. And Joe today is taking less and less time. But what you have to understand and the reason that we are in Joe is that Joe is part of a master plan. It’s Florida’s largest, billions have been spent on Joe’s land, billions more will be spent by local, state and federal governments. Joe at its heart is an asset manager. New management at Joe will stop the expense lead, build the balance sheet and afford shareholders the patience for Florida’s master plan to continue. It’s that simple, but it’s not too simple.
So, let me give you a quick summary. We moved too fast, perhaps too soon into financials, we suffered some premature accumulation, our company continued to be priced for continuing stress, and the price we paid reflects those stresses, and the prices we paid were quite cheap in our opinion compared to how these companies should perform in a more normal environment. Some people think we spread too thin. We are smack dab in the middle of our circle of confidence in financial services.
St. Joe’s is basically the history of real estate. I think of the United States and the history of demographics and the history of what happens when you plunk an international airport down in your back yard. But again, most of the heavy lifting is over, and time is patience on St. Joe.
…
Well the intrinsic value is significantly higher, in my opinion, than where we bought AIG and where AIG is trading today. The charts [?] in 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 percent return on equity, I see no reason why they can’t meet their goals in the next few years. There’s tremendous value in AIG, and it’s time, people spent a huge amount of time focused on the right-hand side of the balance sheet, it’s now time for people to look at the left-hand side. And understand, have a better understanding of the earnings power of the remaining companies and a better understanding of the assets and liabilities. For example, there’s a $23 billion deferred-tax after-valuation allowance, it’s not on the books. As the company begins to earn a more consistent profitability string, you will see that tax-deferred asset come onto the books.
So as I mentioned in my opening comments, I can see the company earning about $6 per share, pretax, and on a normal basis, and they will not pay taxes on that for quite a few years, and as that process evolves, you will start to see them grow, and earn more pretax. So that is the basic thesis. They’ve been under a microscope for three long years, there’s a huge overhang of stocks. And there I was wrong. I thought the government would sell the stock at a higher price, but they’re willing to sell it at a lower price. And once that overhang is finished there’ll be a great amount of uncertainty put aside, removed. And then there will be other uncertainties, but there’s time to think about to spend more time focused on the asset side of the balance sheet.
When will the government sell?
This year. I would think a big chunk will be sold relatively soon, before hurricanes season, and then I would expect that there will be good demand for anything that may remain after the hurricane season. And I would hope that it’s all finished by year end.
Sears Holdings Inc. (SHLD, Financial)
I’ve described Sears in the past as a long-term win-win. Nobody believes that Eddie Lampert and team can pull it off on the retail side. It reminds me of Apple (AAPL, Financial), when everyone thought that Apple was about to fail, and Microsoft (MSFT, Financial) had to inject capital into Apple to keep them around as a competitor. If they do succeed as a retailer, then that would be very positive for the stock. If they do not and the stock price stays low or goes lower, I believe the company will continue to buy back shares and eventually Fairholme, ESL, and a few other shareholders will own the entire company and the assets that remain will work out quite well. So whether Sears is a melting ice cube or becomes, heaven forbid, a growth story, I think we’ll do just fine.
You gotta give the guy a break and the company a break. We’re coming out of the great recession, maybe the greatest recession since the Depression. Sears is very much tied to the housing market. So we’ve hung in there and we’re going to continue to hang in there. I just don’t see how we get hurt with Sears, and maybe we make an awful lot of money. Time will tell. So far I’ve been wrong.
No there’s nothing new in my thesis at all. Just time.
International Investments
In terms of expanding beyond Asia, I don’t know. If an opportunity comes up. There’s no such strategy. On visits to Asia it is very, I mean the analogy in the United States in the 1950s where a giant middle class was developing. And I remember growing up with that middle class dream and the dream of my parents that I would have a better life than they had. Life insurance was very important, that life insurance policy was very important in terms of cash value. You could go to work and have a smile on your face that no matter what your children were going to be ok, your spouse was going to be ok.
This was again during a period where the middle class was greatly expanding in the United States and you have that situation today in China and other parts of Asia only on an exponential basis. It’s a product I understand, I’ve lived with my whole life. The rules are different in Asia as to promises that can be made in terms of max, mins, amounts, regulation.
It’s quite tough so we are very excited about Asia and China Pacific (CHPXF, Financial) and we hope that we can find more such high quality companies and management. It’s very hard to explain, you have to be there you have to see it, you have to talk with the management, you have to listen to the regulators, it can almost turn your world upside down. As to what you would expect here seems to be there and there, it’s fascinating. So we’re very slowly carefully expanding our circle. Where it leads, I have no idea today. The dollar doesn’t know how it’s made so if we can grow confidence and get experience.
Future of Real Estate
[The housing market will rebound] when people have confidence. When uncertainty is cleared up. We’ve been through this before. We’ll go through it again. The 1970s were a devastating time. And whether our financial institutions have the wherewithal to wait for that confidence. They do. Their balance sheets have never looked better. They’re making money, we’re working through the real estate issues, continue to work through it. There’s probably another 18 months of working through residential real estate. That will be the last uncertainty to go.
We will get there, and we’ll move on. It’s time for all the plays in the financial system to settle up and move on. A lot of uncertainty, law suits, A suing B, B suing A, uncertainty about regulations. We need the uncertainty to finish, to be greatly diminished. We need the government to do its part. We need our companies to sort of settle up with each other on any disputes. We need to keep working through the troubled real estate as we’re doing. And we will build confidence and then, we’re off to the races. When? I don’t know. But it will happen.
The full audio is available here. You must register to access it.
