Who’s Prem Watsa? You might remember him from previous blog posts as yesterday’s, or that time I talked about doing merger arbitrage when his company – Fairfax Financial (TSX:FFH) – bid $9 U.S. per share of Blackberry. That takeover obviously didn’t go through, which is reason number 3,201 you shouldn’t listen to a word I say. Reason 1 is that I’m just too handsome.
(Aside: I recommended the merger arbitrage when the stock was at $8.03 (USD). It fell, but did reach $10.78 at one point three months later. Hell, even if you would have sold at $10 it still would have turned out okay. So I got it wrong, but it still would have been okay.)
Watsa has been referred to as Canada’s Warren Buffett, rising from humble beginnings to becoming a billionaire investor extraordinaire, buying an insurance company during his rise and using the insurance float to fund his investments. Sound familiar? I guess you gotta copy what works.
Recently, Watsa made a bunch of money betting against the big banks back in 2007. He also fully hedged his equity portfolio, protecting Fairfax when the rest of the market swirled down the toilet. Then he bought a big chunk of Bank of Ireland for 8 Euro cents per share in July 2011. The current price is more than 30 cents. Go ahead and kiss his feet.
What’s Watsa up to lately? Like Warren Buffett, he writes a shareholder letter each year. And like Buffett’s, it’s good. He uses a few too many exclamation points for my taste, but it’s filled with valuable stuff if you’re a value investor. I spent some time over the weekend reading the 2014 edition, and Watsa has made some interesting bets.
Here are some of the juicy bits.
Last year, I quoted a major U.S. bank CEO who famously said, ‘‘As long as the music is playing, you have to get up and dance.’’ You can see how difficult it is not to dance! And what a party it was in 2013! The S&P went up 30% while the Russell 2000 was up 37%. As discussed earlier, the high tech stocks were soaring – particularly those with no earnings and very little revenue. Tesla Motors, for example, sold 22,477 cars in 2013 but commands a market cap of $31 billion, while Fiat, which we like, sold 4.4 million cars but has a market cap of only $14 billion. Amazon has a market cap of $167 billion but has not earned more than $1.2 billion in any one year since it went public in 1999. Facebook has recently made a $19 billion offer for WhatsApp – a company with approximately 50 employees and $20 million in revenue. This is the poster child for the excesses that prevail in the tech world!
See what I mean with the exclamation points? RELAX PREM. JUST DO ALL CAPS LIKE ME AND MAGARY.
He’s got a great point here. At what point do tech acquisitions start to get silly? I laughed my ass off when Facebook paid $1B for Instagram, and then a year later they drop 19 TIMES that on WhatsApp? This is what happens when you give tech companies a lot of cash. And Tesla? I already wrote about how stupid I think Tesla investors are.
Watsa, meanwhile, buys a 13.8% stake in Reitmans, a company that actually makes money, has prudent management, and is a classic value play. This is why parts of his letter get quoted on FU, while I crack Zuckerberg jokes on the Twitter.
Signs of speculative excesses are everywhere – even though the U.S. economy is still very tepid. The world might muddle through as it did in 2013, but the grand disconnect between stocks and bonds, and the real economy, continues. You will remember, we consider the 2008 – 2009 contraction to be a one in 50 or a one in 100 year event – similar to the 1930s in the U.S. and Japan since 1990. Because of massive fiscal and monetary stimulus in the U.S., the economic consequences have yet to play out. We continue to worry about the unintended consequences, and continue to hedge our common stock portfolio for the reasons discussed in our last few Annual Reports.
Fairfax’s insurance business posted a $720M operating profit in 2013, but the investment portfolio posted a $1.2B loss. The reason was the massive hedges Watsa put into place, betting against the market as a whole. The S&P 500 was up 30% last year. Obviously these hedges did not pan out well. Watsa continues to hold his ground, even after getting his ass handed to him.
In the last few years we have discussed the huge real estate bubble in China. In case you continue to be a skeptic, here are a few observations from Anne Stevenson Yang, an American who has been in China for over 20 years and is the founder of JCapital Research in Beijing:
- China added 5.9 billion square metres of commercial buildings between 2008 and 2012 – the equivalent of more than 50 Manhattans – in just five years!
- In 2012, China completed about 2 billion square metres of residential floor space – approximately 20 million units. For perspective, the U.S. at its peak built 2 million homes in a year.
- At the end of 2013, China had about 6.6 billion square metres of new residential space under construction, around 60 million units.
- Yinchuan, a city of 1.2 million people including the suburbs, has 30 million square metres of available apartments – roughly 300,000 units that could house 900,000 people. This is in addition to the delivered but unoccupied units. The city of Guiyang, capital of Guizhou Province, has roughly 5.5 million extra units for a city of 5 million.
- In almost every city Anne has visited, pretty much the whole existing housing stock has been replicated and is empty.
- Home ownership rates in China are estimated to be over 100% versus 65% in the U.S. Many cities report ownership over 200%. Tangshan, near Beijing, is one.
- This real estate boom could only be financed through unrestrained credit growth. Since 2009, the Chinese banks have grown by the equivalent of the entire U.S. banking system or 15% of world GDP.
- The real estate bubble has resulted in companies extensively borrowing and investing in real estate or lending on real estate in the shadow banking system. This is exactly what happened in Japan in the late 1980s.
- And one observation of our own: Since 2009, the easing by the Federal Reserve combined with the explosive growth in China, backed by higher interest rates, has resulted in huge inflows (‘‘hot money’’) into China. The near unanimous view that the renminbi would strengthen has resulted in a massive carry trade where speculators have borrowed at low rates across the world and invested in China, almost always backed by real estate. The shadow banking system in China – i.e., assets not on the books of the major Chinese banks – is estimated by Bank of America Merrill Lynch to be approximately $4.7 trillion or 51% of Chinese GDP. Oddly enough, prior to the credit crisis, the U.S. had $4.5 trillion in asset-backed securities outstanding or approximately 31% of U.S. GDP. You know what happened then. When the flows reverse in China, watch out!
LOL CHINA. Prem Watsa is right, this isn’t going to end well. But, as always the issue with shorting is timing. Watsa’s shorts performed badly in 2013. My bets against the Canadian banks didn’t fare any better. If you think Canada has a massive housing bubble, China’s is far worse.
The other issue with China is the government’s large role in the economy. I’m no expert on bubbles popping, but I’d say China is better insulated because the government has such tight controls. These types of credit bubbles never end well, but maybe China can delay the cops at the door for an hour before they break up the party.
That’s all I’ll give you, since this is getting past most of your attention spans. I’d recommend reading Watsa’s whole letter, it’s all good stuff. And while you’re at it, watch the BBC documentary How China Fooled The World, which you can find on the Youtube, or just click around and find it on yesterday’s post. It’s interesting stuff.