Francis Chou Semi Annual Letter: Long BBRY, Intralot, Eurobank

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Francis Chou (who needs no introduction to our regular readers) is out with his semi annual report to investors – Among the notable facts contained in the letter –  the Canadian value investor still owns shares of blackberry, check out the full letter below.

H/T Cornerof Berkshire


JUNE 30, 2014

Dear Shareholder,

During the first six months of 2014, the Chou Opportunity Fund (the “Fund”) was up 2.37%, while the S&P 500 Total Return Index (the “S&P 500”) generated a return of 7.14% during the same period. The Fund’s past performance is not necessarily an indication of how the Fund will perform in the future.

Portfolio Commentary

Our investments in the TARP warrants of Wells Fargo were up during the first six months of 2014. They increased in value from $15.83 as of December 31, 2013 to $21.44 as of June 30, 2014. TARP warrants have several characteristics that make them appealing long-term investments. Specifically, they are long dated, with most expiring around 2018-2019. This time frame of four-plus years allows banks to grow their intrinsic value to a high enough level to have an appreciable impact on the strike price of the stock warrant. In addition, we believe the strike price will be adjusted downward for any quarterly dividend that exceeds a set price. This is rarely seen in a stock warrant. An example: for Bank of America, class ‘A’ warrants, the strike price is adjusted downward for any quarterly dividend paid exceeding one cent per share.

We also hold TARP warrants of Bank of America and JPMorgan Chase, and as a group, we still consider them undervalued on a long term basis because the stocks underlying the TARP warrants are still cheap.

Our common stock investment in MBIA Inc. did not perform well because of concerns over its exposure to Puerto Rico’s economic and financial situations, decreasing in value to $11.04 as of June 30, 2014 from $11.94 as of December 31, 2013. Although MBIA is cheap based on book value, it makes it harder to evaluate its intrinsic value when the main operating business has been mothballed for a while. Time is not on the side of investors in that type of business.

We sold 50,000 shares of Resolute Forest Products at $20 when we felt that the Fund’s holding in this stock as a percentage of total assets was too concentrated.

Sears Holdings spun out Lands’ End in April. We believe that the value of Lands’ End is worth more than $10 per share of Sears Holdings’ stock. Sears Holdings is a misunderstood story. There are many moving parts but we believe Sears Holdings’ intrinsic value lies in its real estate assets. It also has other valuable assets such as Kenmore, Craftsman and Diehard. Being a traditional department store has become a tough business during the last decade but, according to management, Sears is transitioning its historic focus on running a brick and mortar department store into a business that provides and delivers value by serving its members in the manner most convenient for them: whether in store, at home or through digital devices. The value of its real estate allows Eddie Lampert, the controlling shareholder and CEO, the time and money to effect the changes. If the transformation does not work out as expected, we believe the real estate values are high enough that we would not lose money in our investment at current prices after netting out all liabilities.

Negative contributors to the Fund were securities of Asta Funding, and Sears Hometown and Outlet Stores Inc.



JUNE 30, 2014

Investors should be advised that due to our portfolio’s high exposure to Resolute Forest Products and Sears Holdings, the net asset value of the Fund can be volatile. However, we are not bothered by this volatility because our focus has always been, and continues to be, on how inexpensive we believe the stocks are relative to their intrinsic value. Based on June 30, 2014 prices, in our view, these two stocks are trading at significant discounts to their intrinsic value.

In general, we believe that stocks and non-investment grade bonds are fairly valued. We do not time the market but when bargains are scarce, we are happy to hold cash equivalents as an alternative.

Credit default swaps (CDS)

One way of assessing investors’ appetite for risk is to check the prices of Credit Default Swaps (CDS). In CDS, one party sells credit protection and the other party buys credit protection. Put another way, one party is selling insurance and the counterparty is buying insurance against the default of the third party’s debt.



The price of the CDS can be a strong indication as to how investors are viewing risk. It is not a perfect measurement, has its limitations but is still one of the best indicators of how investors are viewing risk. If





JUNE 30, 2014

one looks at the chart, the CDS of One Year Treasuries is trending to lows not seen since just before the Great Recession hit in 2008. The prices indicate that investors are throwing caution to the wind. Risk appears to not be adequately priced into any securities, whether they are treasury bills or corporate bonds. Whenever the majority of investors are purchasing securities at prices that implicitly assume that everything is perfect with the world, an economic dislocation or other shock always seems to appear out of the blue. And when that happens, investors learn, once again, that they ignore risk at their peril.


In terms of investment ideas in derivatives, we believe that CDS are starting to sell at prices that are becoming compelling. At recent prices, they offer one of the cheapest forms of insurance against market disruptions. We are continuing to monitor CDS prices and may potentially invest in CDS in the future. We are looking at who deals in such investments and we want to examine carefully what counterparty risk we may be exposed to. The mechanics of investing in CDS have changed somewhat from six years ago.


As you can see from the chart, to make money in CDS, you don’t need a default of the third party’s debt. If there is any dislocation in the economy, the CDS price will rise from these low levels. The negative aspect is that, like insurance, the premium paid for the protection erodes over time and may expire worthless.



Yours truly,






Francis Chou


Portfolio Manager and CEO


Chou America Management Inc.


Factors Influencing the First Six Months Results

Positive contributors to the Fund’s performance during the period ended June 30, 2014 included equity securities of Berkshire Hathaway Inc., Resolute Forest Products Inc., Wells Fargo & Company warrants and International Automotive Components.


Securities of Nokia Corporation ADR, Citigroup Inc. and were negative contributors to the Fund’s performance during the same period.


Our covered call options of Inc. expired in March of 2014.


PTGi Holdings Inc. changed its name to HC2 Holdings Incorporated and we received common shares of Lands’ End Inc. as a spinoff from Sears Holdings.

The Fund sold all of its equity holdings of Actavis PLC, and we reduced our holdings in HC2 Holdings Inc.


Bargains are Hard to Find

We believe that the market is currently fairly valued. The P/E ratios and price-to-book values are still high and dividend yields are low relative to historic valuations, but the number of companies that are underpriced is at an all-time low. We sincerely doubt the overall returns from equities in general over the next five to 10 years will be compelling. On the contrary, we believe the returns may be far more modest than those hoped for by investors. In light of this scenario, and with its obvious lack of bargains, we would not hesitate to sell our investments and be 100% or 50% cash — or whatever the number may be.


Source: Bloomberg


When we looked at some of the 10- year sovereign debt involving several countries we were surprised to see how low they are at currently. The interest rate suggests that these countries must be in great economic shape, with low unemployment rates, low debt to GDP ratios etc. On the contrary, most of these countries are in dire economic shape. For example, Spain has an unemployment rate of about 25%, yet its interest rate is approximately 2.45%.


The low interest rate is due to unprecedented printing of money worldwide. In the United States, it is popularly known as “Quantitative Easing” (QE). Many think that this creation of an almost limitless supply of money is benign, as long as the economy does not show any visible sign of high inflation in the short term. In fact it is generally accepted that low inflation (in the 3% range) is good for the economy.


However, printing money has serious repercussions. It creates asset bubbles and sets the stage for a financial crisis as it has done in the past. For example, spectacular real estate bubbles happened in Japan in the 1980s, and more recently in Ireland, Spain, the United Kingdom and the United States in the 2000s, and when the bubble burst as it should have, it led to severe recessions and financial crisis.


The unprecedented creation of money whether you call it QE or something else, has resulted in huge indebtedness regardless of whether it is measured in absolute terms or relative to economic productivity such as the GDP. It has created a range of distortions such as mispricing of assets, misuse of productive resources and, for investors, misallocations of capital.


Currently the pressures in the real economy are generally deflationary, but sooner or later, this reckless money printing by central banks may lead to another financial crisis

Semi Annual 2014 draft Final (1) (1)

063014 Chou Funds Semi Annual Report FINAL

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