Old West Investment Management, LLC
January 13, 2014
As I sit down to start writing this annual letter to investors these first days of 2014, I think back to what my expectations were for the stock market one year ago. I would not have predicted that the S&P 500 would be up 32.39% in 2013. Especially since this market benchmark was up 128.71% from the market bottom in 2009 though the end of 2012. I’m pleased to tell you that all of our portfolios continue to have outstanding performance, and we have fully participated in this robust market rally.
Our Large Cap Portfolio was up 31.24% in 2013, and we accomplished this return without investing in any of the highfliers like Google, Amazon, or Facebook. Our Small/Mid Cap Portfolio was up 25.12% and that was in spite of getting defensive in the second half of the year and at times having as much as 10% cash in the portfolio. Our All Cap Portfolio was up 26.46%, as we continue to build a tremendous five year track record. Our Focused Portfolio of our top ten ideas (which currently contains 12 stocks) was up 32.02% this past year. The very good news for our clients is most of our investments have yet to work. I see significant upside in these outstanding companies.
In addition to our long only separate account strategies, our alternative investment strategies for accredited investors continue to provide our clients with solid long term performance.
Although this five year bull market is due for a correction as we enter 2014, we are true bottom up investors. We are focused on the individual companies we are invested in, or companies we are contemplating investing in, and we don’t pretend to know what the market is going to do.
I would like to give you an update on four of our largest holdings, including their prospect for 2014.
Fairfax CEO Prem Watsa is known as “The Warren Buffet of Canada”. This Toronto based insurance conglomerate has a wonderful long term track record. The book value of this stock has compounded at 23% year for 27 years (I see a trend developing!!) Like Buffet, Watsa has made his fortune investing the float of insurance premiums, and he is truly one of the world’s great investors. Watsa has been rather bearish the past few years, and continues to believe that deflation is the
greatest threat to the world’s economies. On days that the stock market is sharply down, Fairfax stock is often up, so it works as a nice hedge. We own Fairfax in all of our portfolios.
LEUCADIA NATIONAL CORPORATION
Joe Steinberg and Ian Cumming met in college 43 years ago. They started Leucadia in 1978 and since then they have compounded shareholders return at 18.2% per year. Leucadia can be described as a mini – Berkshire Hathaway. Leucadia owns a variety of businesses, including investment bank Jefferies, National Beef, Berkadia, Garcadia and Idaho Timber. Leucadia is currently sitting on $2.2 billion in cash and liquid investments plus a $3.6 billion Federal income tax loss carry forward.
Leucadia was formerly the largest shareholder of Jefferies, and this past year they bought the entire company. Steinberg and Cumming are in the 70’s, and they didn’t have a clear succession plan. Former Jefferies executives Rich Handler and Brian Friedman are now the top executives at Leucadia, with Joe Steinberg staying on as Chairman. I believe Handler and Friedman, who are in their 50’s, will smartly and aggressively seek investment opportunities worldwide for Leucadia, and it could be the Berkshire Hathaway of the next ten to twenty years. We own Leucadia in all our portfolios.
CHESAPEAKE ENERGY CORPORATION
Chesapeake is an interesting story. The company was built by renowned oil man Aubrey McClendon, who aggressively grew the company for many years. Towards the end of his stint as CEO he was accused of self dealing and was forced out by a newly independent Board of Directors. Archie Dunham, the former CEO of oil giant Conoco Phillips, was brought in to be board chair once McClendon’s self dealings came to light.
Dunham became chairman of the search committee charged with finding Chesapeake’s new CEO. After a diligent search effort they chose Doug Lawler, a rising star at Anadarko Petroleum. The same day Dunham announced the hiring of Lawler, he made an open market purchase of $9,000,000 of Chesapeake stock. Open market purchases by insiders of this magnitude are not common, and my eyes light up when I see a transaction this impressive.
Archie Dunham is a Marine Corp. veteran who spent his career working side by side with legendary oilman Jim Mulva at Conoco. With Archie now serving as Chairman of Chesapeake and Lawler getting his chance as CEO, I believe the result will be powerful. Former CEO McClendon amassed huge tracts of oil leases during his tenure, and the company had excess land reserves. Lawler immediately began selling these excess reserves and generated $5 billion in proceeds this past year, and reduced company debt by $3 billion.
Traditionally Chesapeake was mostly a natural gas producer. With the natural gas market depressed due to abundant supplies, the company has been aggressively moving towards oil, and is currently
producing much more oil than gas. Also, McClendon built a bloated organization with excess layers of employees at every level. Lawler has laid off hundreds of employees not critical to the organization, not to mention many other unnecessary expenses. We think Chesapeake has a very bright future.
SEARS HOLDINGS CORPORATION
The team at Old West continues to monitor the situation at Sears very closely. Our thesis has always been that Sears will not survive as a big box retailer. We believe the sum of the parts asset value far exceeds today’s stock price. CEO Eddie Lampert, who owns nearly 50% of the shares, continues to close the worst performing stores, but overall same store sales are falling faster than he expected, resulting in significant negative cash flow.
Besides Lampert owing 50% of the shares, Bruce Berkowitz of the Fairholme Fund, one of the great investors in the world owns 20% of the shares. Noted investor Murray Stahl of Horizon owns 3 million shares, and Thomas Tisch of the Tisch family (Loews Corporation) owns 4 million shares and has a board seat. I am very concerned about this investment and I am following the situation very closely. I believe the sum of the parts valuation is easily in excess of $100 per share (today’s price is $36), but unless Lampert can stop the excessive bleeding, the asset value may not be fully realized.
There are several indicators currently signaling the stock market is due for a pullback. Bullish sentiment of investors recently outnumbered bearish sentiment four to one. Retail investors have been pouring money into mutual funds, with $450 billion going in the past year, which is more than the previous four years combined. Why does this optimism among investors worry me? I am a contrarian investor by nature, and I have learned that the greatest opportunities arise when things are bleakest. The more the investing public likes the market the more worried I become. However, the market is basically flat for the past fourteen years, so it very well could keep going. But nervous I am!
In the year 2000, the market multiple was 35 times earnings, almost double today’s market multiple. The S&P 500 is not that much higher today than the peak in 2000, yet corporate earnings are three times higher today. But this five year bull market run is showing signs of slowing, and most likely due for a fairly sharp correction. I take great comfort in knowing that the companies we are invested in are reasonably priced, with owner/operators who are invested right alongside us. The year 2000 market fall was preceded by massive insider selling at nearly all the technology companies. Our promise to you is we will vigilantly watch insider activity to be sure there is no significant selling at our companies.
We have recently moved offices within the same building, and we hope you’ll stop by to see us and our new space the next time you’re in Downtown Los Angeles. Thank you for your continued support, and we at Old West wish you and your family a happy and healthy 2014.
Joseph M. Boskovich Sr.