Guy Spier's Q211 Shareholder Letter

Below are excerpts from Guy Spier’s annual shareholder letter reprinted with permission. First Guy’s spectacular track record:

Guy Spier’s Track Record

Below are selected comments from Guy’s annual letter:

Security Sales
Since my last report to you, where I talked about my sale of our Leucadia position, I have sold a
number of other positions in the fund including International Coal, Cresud, London Mining and
Fortescue Metals Group.

International Coal (ICO) ICO is a US based coal producer with substantial reserves of metallurgical coal – an essential for
steel production, which normally sells at a substantial premium to thermal coal and is used in
power plants. This premium declined substantially during the crisis of 2008, and along with it
the market’s valuation of International Coal. At the time that I saw it, both Prem Watsa of
Fairfax Financial and Wilbur Ross had taken substantial positions, and it became clear that the
market was extrapolating depressed metallurgical coal prices into the distant future, when there was a high likelihood of a recovery in met coal prices. When the met coal prices did
recover in 2010/2011, the marketplace’s evaluation of the value of the company was revised.
Earlier this year, International Coal was sold to Arch coal for a 3X return in 12 months (US$ 1.5
million invested, US$ 4.8 million sale.)

I only wish that all my investments worked out this well, this fast, and this effectively. You can
be sure that I am looking for more, and that I will pounce when I find the next one.
Cresud and London Mining.
These are two investments that were made during some of the darkest days of 2008, when the
world seemed on the edge of a chasm. They were both Ben Graham style net-nets: In the case
of Cresud, it is the owner of substantial amounts of real estate in down town Buenos Aires – via
its stake in IRSA, a Buenos Aires property company. It also owns 675 million hectares of fertile
agricultural land in Argentina and Brazil (280 hectares of producing land). At the time I
purchased it for the fund, the market capitalization was amply covered by either asset, even
valuing the agricultural land at a fraction of what it would be valued in the USA ($1,000 in
Argentina vs. $16,000 or more in the US).

It was a similar case with London Mining: At the time that I invested, it had a market
capitalization of US$ 146 million, and cash balances of $316 million. This was a company trading
at 50% of cash. However, in addition to this pile of cash, London Mining’s CEO, Graeme Hossie
had proven capital allocation skills, and he was marshalling a substantial and diverse
developmental portfolio of iron ore assets. These ranged from Greenland, to Saudi Arabia, to
Ghana. Even though I could not value the iron ore assets easily, I did not have to – as they
provided an extra kicker to the already substantial margin of safety provided by the cash
balances in excess of the market capitalization.

We exited Cresud and London Mining at more than 3X the original investment.
Fortescue Metals Group (FMG AU)

Parts of Brazil and the Pilbara in the Australian North-West are ideal places from which to
supply China with its growing demand for sea-borne iron ore. The Pilbara, because of its
proximity, has a slight advantage. A remarkable Australian entrepreneur Andrew Forrest, with
the help of far – sighted financiers like Leucadia, created in the Pilbara a junior miner of iron ore,
and has grown it so much that many no longer consider it a junior miner.
As with International Coal, Fortescue’s share price also collapsed during the crisis of 2008. Even
though at that point, they had the bulk of the development capital expenditures behind them,
they were cash flow positive, and were able to grow iron ore production from internally
generated cash flow.

I had found and invested in FMG through my regular study of Leucadia’s investment moves.
However, in 2010, and not long after having made the investment, the relationship between the two companies soured: Fortescue was seeking to reinterpret the terms of a loan from Leucadia
in a way that would be highly detrimental to Leucadia, and very favorable to Fortescue. This
matter is now being litigated. Although there is economic benefit to the shareholders of FMG if
they prevail against Leucadia, one of my investment checklist items relates to the willingness of
the management at a company to respect the providers of capital and to treat them fairly. I do
not believe this is the case here. Indeed, the term ‘daylight robbery’ comes to mind.
My experience has shown that the moment there are concerns about potential bad faith, the
best thing to do is to take your money off the table and move on. We took a slight profit on
Fortescue, and left substantial potential upside on the table, but I am excited about recycling it
into other ideas which, unlike Fortescue, have unimpeachable management.
For more background into these investments, I refer you to the slide deck that I prepared for
our partner meetings in New York and Zurich.

Purchases

The recent downturn has, I believe, given investors the best buying opportunity
since 2008/2009, and I have not been idle. Two of the places where I see substantial
opportunity are Japanese smallcaps, and US money center banks.

Japanese smallcaps

One of my more recent purchases in Japan, Daiwa Industries, has the following characteristics:
Consistently profitable with net income after taxes of JPY 3-4 billion per annum.
Fortress balance sheet with cash and investments of JPY 30 billion, a number which is
net of debt, deferred revenues and post – retirement liabilities.
Now for the best part:

Market Capitalization of JPY 20 billion.

I believe that I have been purchasing Daiwa Industries at less than 1/3 of a conservative
calculation of intrinsic value. I have taken a basket approach to Japan, building a diversified
portfolio of companies like Daiwa Industries – all of which have 3X or greater potential. I believe
that it is highly likely that the whole portfolio will double or triple over the next few years.
To add to the appeal of this investment, the Nikkei 225 index is at a 30 year low, and is at ¼ of
its peak value, reached in the late 1980’s.

US financials

It is longer than I care to remember since I studied economics at Oxford. At the time, I
particularly enjoyed studying Monetary Economics, and was an avid reader of the Journal of
Monetary Economics published by the University of Rochester, New York. While it was fun, I
never saw how I could apply all this theoretical knowledge in the real world. Now, 20 something years later, I believe that my studies may finally be paying dividends by giving me insights into
the dynamics of the Federal Reserve’s interaction with the banking system and the broader
economy. This is something that I believe few people truly understand – even when it comes to
financial professionals.

For example, I see so many investors complaining about lack of yield for their cash. From my
perspective, I hardly find this all that surprising. The investor’s cash is competing with that of the
Federal Reserve and the Federal Reserve, unlike private investors, can purchase as much as it
likes with the stroke of a pen. When you see it that way, it hardly makes sense to compete with
them – especially when, via quantitative easing, they have promised to do just that.
Perhaps this was best demonstrated with those investors who were chasing a rising Swiss Franc
and putting themselves in an adversarial position with the Swiss central bank which, like the
Fed, holds the ultimate trump card: The ability to create as much cash to meet demand as they
like. The losses that some Swiss franc investors endured this last week proves that behaving in
this way can be hazardous to your wealth.

However, in spite of all this, credit is still tight when it comes to the general economy. When the
Fed expands its balance sheet, as it has done, it does not put money directly into the hands of
individuals and small businesses, it purchases highly rated securities from the banking system.
This creates a markedly different environment to the one that existed before the financial crisis:
Money center banks and large corporations have easy access to credit, while smaller businesses
and individuals do not.

This combination of easy money for the banks combined with elevated interest costs for
consumers of credit creates high profitability for those banks that will shine once they have
worked through the hangover created by the burst housing bubble.
Thus, for as long as the Fed decides to hold down interest rates, and / or do quantitative easing,
money center banks will have a very cheap source of funding and likely very profitable
operations.

I am positioning Aquamarine Fund accordingly.

This recent panic from my perspective

We went into this recent panic with substantially more cash than the last one, and also with a
better set of investors who are appropriately focused on long term results. Indeed, the autumn
panic, rather than trigger redemptions, actually had the opposite effect, and triggered
subscriptions. I’ve said it before, but I will say it again: Thank you!
This time around I have also been much better prepared mentally, and have been acting boldly
by putting our cash balances to work in the ideas that are offering the best value. From an economic perspective
There is also a world of difference between this recent downturn and the crisis of 2008/2009:
In spite of the gloom and doom in the US unemployment and GDP growth numbers, there are
many indicators that are showing consistent improvement in the economy. Those include US
rail car loadings, beer volumes, credit card billings and the home affordability index to name afew.

Also, the financial system is, I believe, in much better shape. Regarding the 2008/2009 crisis,
Warren Buffett said that if you were not worried, you were not paying attention. This time
around, we are in a different place: The financial system may still be digging itself out of a hole,
but the rescue actions by the US government have now been battle tested. Unpleasant
politically as they may be to invoke, there is no question that similar rescue actions would be
available if necessary. While past and future rescues may prove inflationary (I rate that
probability quite high) it is far from a foregone conclusion.

High unemployment contributes to the sense of malaise and reduces government revenues –
and while part of the explanation consists of actions taken by this administration, another part
is simply how much easier it is to outsource to low cost workers. A few years ago, only large
corporations could do this, but now so can small businesses. The other side to this is that
corporate profitability is strong: Even though the US job engine needs restarting, the corporate
profit engine is up and running.

If I consider the lessons learned from two books: Jared Guns, Germs, and Steel: The Fates of Human Societies: The
Fate of Human Societies (which I recently re-read) and George Friedman’s The Next 100 Years: A Forecast for the 21st 

Century, there is no question in my mind that the United States is still the
most favored location for dynamic economic growth. Those determining factors include:
Access to both the Pacific and Atlantic oceans, vast natural and mineral resources including
some of the most productive agricultural land on the planet, an extremely diverse immigrant
population, a decentralized political system and huge amounts of space for development.
To give a sense of the tremendous, untapped dynamism in the US economy, consider a simple
change to US immigration laws that would allow expedited immigration procedures for two classes of people:
1. Those who have enough cash to purchase a home for $250,000 or more.
2. Those with a college degree from an accredited institution (either US or foreign).
There are few who doubt that this would dramatically accelerate the US economic recovery.
All this makes me extremely optimistic about the future of the US economy.Performance expectations
I believe that I can continue to out-perform the various indexes, although by how much I cannot
say.

My historic rate of outperformance over the last 14 years has been 6% better than the
S&P, which is better than 98% or so of all mutual funds and pooled investment vehicles out
there, so I believe that you are getting a good deal. For as long as the assets are at the current
levels, I would be disappointed if I did not continue to deliver this.