The Fairholme Fund seeks long-term growth of its shareholders’ capital by investing in equity securities of public companies and by holding a focused portfolio. The Fund’s preferred investment strategy is to silently partner with exceptional owner-managers who have demonstrated success, honesty, and integrity. The Fund buys when it finds such companies generating or holding significant cash when compared to market values. Purchases are made without regard to categorization. The Fund also intends to invest in special situations, including, but not limited to, Chapter 11 reorganizations.
The Manager uses fundamental analysis to identify certain attractive characteristics of companies. Such characteristics may include, but are not limited to: high free cash flow yields in relation to market values and risk-free rates; sensible capital allocation policies; strong competitive positions; solid balance sheets; stress-tested owner/managers; participation in stressed industries having reasonable prospects for recovery; potential for long-term growth; significant tangible assets in relation to enterprise values; high returns on invested equity and capital; and the production of essential services and products. The Manager defines free cash flow as the cash a company would generate annually from operations after all cash outlays necessary to maintain the business in its current condition.
Period: Q1 2013
Portfolio date: 28 Feb 2013
No. of stocks: 8
Portfolio value: $5,693,768,000
|Stock||% of portfolio||Shares||Recent activity||Reported Price*|
|hist||AIG - American Int'l. Group||53.59||80,280,825||$38.01|
|hist||BAC - Bank of America Corp.||16.10||81,607,015||$11.23|
|hist||SHLD - Sears Holdings Corp.||11.23||14,212,673||$45.00|
|hist||JOE - St. Joe Co.||8.79||23,136,502||$21.63|
|hist||LUK - Leucadia National Corp.||5.78||12,229,050||$26.90|
|hist||MBI - MBIA Inc.||3.48||20,501,100||$9.67|
|hist||SEARF - Sears Canada Inc.||0.98||6,087,327||$9.17|
|hist||OSH - Orchard Supply Hardware Stores||0.05||592,993||$4.66|
* Reported Price is the price of the security on the portfolio date. This value is significant in that it indicates the portfolio manager's confidence in the stock at that price and suggests at least some level of undervaluation and/or margin of safety.
Sector % analysis
Articles & Commentaries
Bruce Berkowitz, managing member of Fairholme Capital Management LLC, discusses mutual-fund rules, investment strategy and his decision to close existing funds to new investors as of the end of this month
Financial disasters start with great investment ideas taken to illogical extremes. For example, what has been more beneficial to family wealth than home ownership? Yet, we recently witnessed a near collapse caused by residential real estate.
Great investment ideas start with disasters. Liquidity disappears. Assets are marked to mayhem. Intangibles are written off. Companies with fixable problems become unusually cheap and again profitable. Yet, they remain hated for past sins and sell for less than assets minus liabilities, reported as book value. They have little, if any, investment risk.
This is when we focus on buying. This is also when we look dead wrong and have periods of underperformance. This is also how The Fairholme Fund has outperformed the S&P 500 Index in ten of the past twelve years.
In 1988, Warren Buffett wrote “...our marketable equities tell us by their operating results – not by their daily, or even yearly, price quotations – whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it.” Twenty years later, the 2008 collapse of financial markets was caused by companies ill-prepared for a national decline in home prices, the freezing of credit, and knock-on effects. Today, they stand at polar opposites.
Our best idea remains AIG common (35% of the Fund) with a reported book value of $57 per share. There are few occasions when systemically important franchises sell for half of book value and are profitable. This is one of those times. AIG warrants held by the Fund (another 3% of the Fund) provide the right to 21+ million shares at $45, or maybe more shares at lower strike prices for the next 34 quarters if dividends above $0.675 per trailing 12-month period are paid.
Bank of America is the Fund’s next largest financial holding (9% of the Fund) affected by the great housing price collapse. The company’s reported book value is over $20 per share. We believe that America’s bank is returning to its retail roots (think of Wells Fargo) with a $1 trillion deposit franchise and that bank profits will skyrocket as legacy real estate loans burn-off.
Sears Holdings (11% of the Fund) is one of the largest corporate real estate organizations in the world, with a portfolio of retail locations that is second to none. Generally Accepted Accounting Principles (“GAAP”) mandate valuing their real estate at the lower of cost or market. GAAP would force the Dutch settlers to value Manhattan today at the 1626 purchase price of $23.70. The company’s reported book value of $43 understates real values.
Warrants received by the Fund from General Growth Properties (7% of the Fund) during its reorganization provide the Fund the right to “cash-in” the difference between GGP’s market price and the current strike price of $9.52 on now 45 million shares. For the next 22 quarters, distributions by GGP will further reduce this strike price and increase the number of shares.
Case Study 1 - Bank Of America
Case Study 2 - AIG
ruce Berkowitz, founder of Fairholme Capital Management LLC, talks about investment strategy, the performance of Bank of America Corp. and Fairholme's stake in St. Joe Co. Berkowitz, who presided over losses last year at his Fairholme Fund as holdings in Bank of America plunged, said financial firms that endured the credit crisis in 2008 and 2009 will prosper
Q&A session with Fairholme's Bruce Berkowitz.
What a horrible year for performance! Market prices plunged in many of our Funds’ core holdings in spite of strengthening book values with huge reserving for legacy issues.
In more-normal times, we expect portfolio companies to generate 10% returns on book values, which would lead to much higher common stock returns with discounts to those book values. However, current events always reverberate much louder than the financial histories of past cycles; positive results and actions are now needed to swing market sentiment and prices toward more balanced views and values. AIG’s $1B common stock buy-back, Buffett’s transaction with Bank of America, CIT’s rapid debt refinancing, and MBIA CEO Jay Brown’s repeated stock purchases all point to improving fundamentals – the process has started.
AIG common stock and warrants are by far the largest issuer holding of The Fairholme Fund and the company is worthy of a Dickens novel. Started in Shanghai by U.S. citizen C.V. Starr in 1919, built into a shining example of how America can compete and win around the world by an imperial M.R. Greenberg, torn apart by a ruthless AG Spitzer, and now rising from the ashes of a great tragedy. The company’s book value of $45 per share is heading to $55 in the near future and yearly earnings power of $4 per share will further propel shareholder value. Yet, AIG’s market price plummeted to less than half of book value due to what we can only surmise as a belief that the United States Treasury will sell its 77% ownership stake below the Department’s $29 cost. Why this is negative for long-term investors we do not know.
Sears remains a large position in all of our funds, notwithstanding announcements in late December of falling sales and margins, rising expenses, and write-downs. Investors fled with this New Year’s greeting before Chairman Lampert purchased over $150 million of common for his personal account. For many reasons, including management, we continue to believe the assets of this iconic brand to be a multiple of values implied by its current stock market price and continue to see the beginning of a new Berkshire Hathaway.
ank of America was our worst laggard – even with results showing $20 per share of book value, $5 per share of reserves for bad debt and legal issues, and yearly pre-provision, pre-tax cash flows growing to $4 per share. Shareholders can find our analysis at fairholmefunds.com. If only BofA could buy back its stock at current prices that are near one-third of book value.
In great years, we asked shareholders not to be swayed by short-term performance. The same is true in a bad year. One circling of the Sun is too short a time to differentiate between good and lucky. Thus, we remain optimistic given our performance since inception and a belief that while history does not exactly repeat, it does rhyme. Unemployment is coming down and elections are near. Our favorite economist, Warren Buffett, is bullish on America. Year-end reports show continuing, positive trends. Our companies are strong and cheap. Shareholders have kept their courage and conviction under stress. Fairholme has kept its word to focus on value-based, long-term investments. We will stay the course.
The presentation illustrates Fairholme's investment thesis and strategy by way of a case study on Bank of America today, with historical data suggesting interesting parallels and precedent in the banking industry. We hope you find it informative and perhaps helpful in understanding why out-of-favor financial companies may present some extremely attractive value investment opportunities.
Consuelo talks to Fairholme Fund’s Bruce Berkowitz about his large and controversial investments in beaten down financial stocks :
We have two exceptional investors who we can follow today with Bruce Berkowitz and Warren Buffett and the financial sector. Specifically Bank of America, but also Goldman Sachs (GS), and Wells Fargo (WFC).
To add further intrigue to their shared interest is that the last time Buffett and Berkowitz were getting greedy with the same bank stock the result was an overwhelming success...
With respect to B of A, it's worth bearing in mind that Buffett didn't buy common equity. He bought preferred shares and was given tons of warrants as sweetener. Would he have bought common equity if B of A's management had rejected his proposal? Probably not.
Fairholme’s founder, Bruce Berkowitz, is hosting a call on Wednesday afternoon with the chief executive of Bank of America, Brian Moynihan.
“The purpose of the call is to better understand how Bank of America is navigating the economic environment and positioning its balance sheet for the long-term benefit of customers, creditors, and shareholders,” Fairholme said in a release. “Skeptics are invited to participate on the call.”
The Fairholme Fund’s outperformance over the past decade was based on seeking undervalued securities of companies perceived to be in extremis. Our inclination remains to run from the popular and embrace the hated where prices tend to reflect such mistrust. Often, we are ahead of the crowd, too early, and appear wrong for a time. However, performance awards over the years show that we eventually get it right by seeing beyond temporary conditions and by avoiding diversification that leads to mediocrity. Our history is to buy in bulk during blowout sales with the knowledge that market price volatility only measures short-term perception of long-term risk.
When prices fall off the proverbial cliff investors run fearing that the market is omnipotent. But, such plummets do not always mean death and destruction. This was the case in the early 1990’s, when studied banks and financial guarantors stabilized around five times normal earnings before their rise to all-time highs.
Today, we believe to be at a similar tipping point for financials with enormous cash flows and diminishing restructuring expenses for the illogical extremes of 2006/2007. Their pre-provision, pre-tax earnings power is compelling. A not unreasonable 1% return on Citi’s assets or 10% return on equity would yield $6 per share. A 1% ROA or 10% ROE for BofA would yield over $2 per share.
AIG common stock is similarly cheap, due mostly to market pressures caused by the U.S. Treasury’s desire to sell its 77% ownership. When a recovering icon trades at half of our understanding of intrinsic value for a reason that has nothing to do with its prospects, we swing big.
Tremendous opportunities also exist in all parts of MBIA’s capital structure based on CEO Jay Brown’s past turnaround successes, the resumption of new business, run-off earnings, and expected litigation proceeds.
Common to all the aforementioned survivors of the Great Recession are misunderstood net operating losses that will shelter hundreds of billions of future profits from taxes over the years to come.
Holdings in predominant life insurers AIA and China Pacific Insurance Company are the result of 30 years studying successful underwriters and the insurance needs of the middle class. Mark Tucker at AIA and Chairman Gao at CPIC maintain strong balance sheets, know their risks, insist on profitable underwriting, and have a tsunami of demand at their backs in Asia.
St. Joe deserves mention given its attention by the press. While our active role at JOE is a first for Fairholme and unusual for mutual funds, our past clearly shows that we ignore what the crowd believes proper and decide for ourselves what is in the best interest of shareholders. We simply view JOE as an investment manager with permanent capital and understand how such companies are capable of above-average returns and how they can complement our other portfolio holdings. The same is true of Sears.
U.S. consumer credit ratings are the highest in 4 years, consumer loan delinquencies are down significantly from the peak, and family debt payments as a percent of income are the lowest since 1994. Confidence is growing, albeit in fits and starts, and real estate activities appear to be on the rise. Halfway around the world are tides of capitalism maybe not seen in the U.S. since after World War II. All in all, the trends are positive for our companies and their customers.
Charlie Fernandez and I continue to believe that the U.S. business cycle has not been repealed and that, in the words of Yogi Berra, “it’s déjà vu all over again.”
Bruce Berkowitz, founder of Fairholme Capital Management LLC and chairman of St. Joe Co., discusses the U.S. Treasury’s stake in American International Group Inc. and his investment strategy. He also talks about the outlook for financial stocks and the U.S. economy:
"To outperform the market, by definition, you have to concentrate somewhere," he said. "A focused approach will guarantee a nonaverage performance. Whether you're right or wrong will determine whether you overperform or underperform. It's a question of whether you know what you're doing."
In many ways, Berkowitz (who along with Fernandez and other insiders has some $300 million invested in Fairholme) is a traditional value investor who plows through piles of paperwork and reams of financial data to find unappreciated companies. Like Buffett, he follows the principles of Benjamin Graham, the legendary value investor who focused on a company’s assets and ability to generate cash. But his strategy stands apart, marked by extremely concentrated holdings and a willingness to go where others fear to tread, and then to wait, often doubling down as stocks fall in the short term...
Bruce Berkowitz, manager of the $17.5 billion Fairholme Fund—which owns about $1.2 billion worth of AIG stock—said Monday he thinks the government will sell shares in AIG to the investing public at about $27 to $29, a price that would be less than what he paid for the bulk of his position...
Bruce Berkowitz, of Fairholme Capital Management, says it's time to shift focus on the assets of financials: