Interview with Bruce Berkowitz, released today by Fairholme Funds. First the fund holdings, which have two things in common; most were down in 11, and most are financials.
TOP HOLDINGS BY ISSUER * * * as of 11/30/2011
%of Total Net Assets
American International Group, Inc. 26.2%
AIA Group Ltd. 11.4%
Sears Holdings Corp. 10.7%
Berkshire Hathaway, Inc. 9.3%
CIT Group Inc. 6.9%
Bank of America Corp. 5.5%
General Growth Properties, Inc. 4.2%
The St. Joe Co. 4.0%
China Pacific Insurance (Group) Co., Ltd. 3.8%
Leucadia National Corp. 3.6%
Now for the interview with Bruce
EDITED FOR CLARITY AND ACCURACY
Fred: Bruce, it’s great that we can do this today, because we’ve had a really
tremendous response to asking our shareholders for questions. So we’ve taken
all the questions and put them in the order of how often they were asked, and if
it’s okay with you, I’ll just get right into it.
Bruce: Great, if you’ve got questions, hopefully, we’ll have answers.
Fred: Okay. The most asked question was about Sears. People want to know what is the intrinsic value of Sears?
Bruce: That seems to be the $64 question, and it’s hard for most to get a hold of it because of the different components. Everyone knows there’s real estate, that they’re a brand, and there’s an online component. A lot of people don’t realize that there’s a service business with 12 million visits to homes every year, a warranty business on the products. Of course there’s Sears Canada – mostly owned by Sears now. But the real interesting issue which people have to get their hands around is the long leases that Sears and Kmart have. You have to ask yourself the question, when does the long lease equal in value what
ownership is. So when you take into account the very long leases and just the nature of what it is to be an anchor in a mall, how you become an anchor and the terms and conditions of becoming an anchor in a mall, there’s tremendous value. Quite alot of work to get there, but when you add up all the values, including the long leases and the importance of anchors in malls, plus the brands, whether it’s Lands’ End online or the Sears websites that are doing reasonably well, you come up with a pretty big number. The number is multiples of what we think the current stock price is, but we’ll let everybody on the outside figure out what the exact range is.
Fred: Given all those asset values, people also wanted to know whether you view this
like a Berkshire Hathaway type of company?
Bruce: A lot of similarities. Warren Buffett, hedge fund manager, starts to invest
heavily in a textile mill, Berkshire Hathaway. Over time, decides to call it a
day as a fund manager, stays focused on Berkshire Hathaway. Tries to turn
around the company, the entire company for the benefit of the employees.
Eventually comes to the conclusion it can’t happen, fixes what he can. Sells
what he can’t fix and moves on with insurance and becomes a conglomerate
holding company, and the Berkshire that we know today.
If you take a look at Eddie Lampert in Sears from Kmart, so then the merger
with Sears, then trying to fix the entire system. Recently announcing that it all
can’t be fixed, so that which can’t be fixed will be sold. He’s going to
rationalize it, and you can take a look at the cash flows. Whether it’s his
partnerships, the company’s recent purchase of more Sears, there’s a pretty
good analogy between the two. So can Sears become Eddie Lampert’s
Berkshire Hathaway? Well, so far it looks that way. We’ll see.
Fred: Believe it or not, the second most asked question was about last year.
Everybody knows that 2011 was a really tough year, and they want to know in
retrospect, would you have done anything differently if you knew what you
Bruce: In retrospect and in hindsight, yes, I’d do a lot differently. I’d go all to cash and I would have really slowed down the selling of the healthcare companies and the buying of the financials. With hindsight, of course I would do that. You know, we bought the healthcare companies when everyone thought they were going bankrupt because of Obamacare, and we knew that wouldn’t be the case and we did reasonably well. But we sold too soon, because the financials became cheaper and because of the market’s belief that President Obama was going to destroy the financial system. But the financials that we bought were cheap and they became much cheaper. Of course we buy cheap, and we bought more of those stocks cheaper. So yes, with hindsight, of course we’d do a lot. We’d be perfect. But given the events and given the fact that the business trends of every company that we purchased, that’s all the financials that we purchased during that period have all turned positive since the time at which they’d been purchased. So it’s going the way we expect it to go. It all looks great. The rest of the investment world has to start to be convinced that these are valuable franchises that are going to make money once they clear up the sort of one-time fixable problems they had from sort of the irrational exuberance of home ownership.
Fred: Sort of the follow-up to that, which they didn’t ask, but I’ll ask you is, are you happy with the whole portfolio the way it is now? Is this the portfolio that you want to take forward for the next couple of years?
Bruce: This is it. This is the kind of portfolio composition, business type that I had in the early ’90s where I had my greatest performance, companies like Wells Fargo and others. It’s what I know best. It’s the industry that we’re in. I mean, these companies, especially the financial services companies, are just dead center in what I believe to be my circle of competence. I’ve seen this act
before. I’ve seen the play before. I’ve seen the cycle of financials. That’s the
one thing good about old age, you’ve seen it before and you know how it plays
out. History may not be exact, but it does rhyme. I’m excited. I never thought
I’d have another opportunity to really take advantage of the financial cycle.
And we’re going to do it, and hopefully this will be the year it shows.
Fred: AIG is our largest holding in the Fairholme Fund, and people wanted to know what the investment thesis is specifically on AIG. The backup question to that was why would you want to own a company that the government owns 77% of?
Bruce: We’ll go with the latter question first. Why the government ownership is such a concern to long-term investors I don’t know. To me it would be a positive. If you’re truly a long-term investor, and you like to buy cheap and cheapen your value base, then the worst that could happen is you get to buy more at a cheaper price. That’s the situation that we’re in, and that’s the reason why we bought more at a cheaper price, because of this fear. Going back, AIG, starting in this business, was the champion of the insurance business. A global
enterprise, showing America how you can compete on a worldwide basis. Then you had it trading at five, six times book value, and then you have this tragedy that happens to the company, one step after another. It was Eliot Spitzer and then the recession and then the loss of management and the credit default swap issues. Then the taking of tremendous chunks of value from the company in order to repay the banks. And then the government taking its pound of flesh. A tragedy. line today is two core franchises are intact, Chartis and SunAmerica. The company has a tangible book value of $45 a share, going probably to $55 with the realization of tax-deferred assets, a few other areas. Earnings power of four dollars a share. So we’re buying a company that was started in 1919 by C.V. Starr, at half of book value, that still has a significant franchise. And that’s where we are. It’s not more difficult than that, and it’s a very common model that we’re using for many of our companies. A company, a fixable problem. Fixable problem is covering up all that’s good at the company. When the problem is fixed in total, and you see the normal cash flows of the business in a more normal environment, then it will be obvious to everyone the earnings power and the balance sheet strength of the company, and many of our other companies.
Fred: In the financials, in the banks and in the finance companies, going back to 2008 when you hadn’t invested in them, you actually said you couldn’t know what
they owe, or what they owned, and it was difficult to know who owned them.
But things have changed. Could you specify how that’s happened?
Bruce: Well 2008 was really the beginning. It became