ap1234

Peridot, any thoughts on Seritage’s Q4 results as a read through for SHLD real estate? I know it’s a small sample size but so far it looks like the economics for the landlord are pretty healthy and the incoming rents are much higher than expected ($30/sqf!). You were concerned that Berkowitz was missing the fact that the landlord would have to spend a bunch of money in order to achieve higher rents and the ROI to the landlord would be high single digits. According to Seritage, they are expecting 12-13% unlevered returns on the projects that are underway (see below). From the Seritage Q4 release: -Average base rents for signed but not yet opened leases (“SNO leases”) increased to $20.73 PSF, reflecting average base rents of $30.03 PSF for 154,000 square feet of new leases signed during the fourth quarter; average base rents for in-place third-party leases and Sears Holdings Corporation (“Sears Holdings”) were $11.78 PSF and $4.30 PSF, respectively -“In addition, we have successfully launched five new projects originated on the Seritage platform. Each of these projects involve the repurposing of single tenant buildings into multi-tenant shopping centers at materially higher rents. We expect to achieve 12-13% unlevered returns on these new projects based on the incremental rental income we generate on our invested capital. Additionally, our leasing pipeline remains robust and continues to grow. As of March 1, 2016, we had executed leases representing approximately 370,000 square feet since our inception. This space was signed at average rents of approximately $31.50 PSF, as compared to the $6.15 PSF paid by Sears Holdings on a same space basis. As we recapture and repurpose our portfolio of well-located real estate, we believe we can continue to deliver on our compelling built-in growth opportunity and drive long term shareholder value.”

Does anyone know what percentage Valeant is of the PSH NAV (either at Dec. 31st or more recently)?

Thanks for your insights Peridot! I really enjoy hearing your perspective on this. You seem to have done a lot of work on SHLD and are level headed in your analysis. As much I enjoy the endless debates about whether Bruce or Eddie is the “next Buffett” or have lost their mind, it’s refreshing to occasionally focus on the fundamentals! I agree with several of your points. For example: 1. SHLD’s real estate isn’t as valuable as a landlord like Simon. Looking at metrics like EV/sqf is deceiving as it ignores the difference in rents. 2. There is a very real cost to repositioning if either Sears subdivides the space or walks away from the box. You can’t look at the incremental rent from a new tenant without adjusting for the costs associated with the repositioning. Having followed Bruce for a long time (I have admired him ever since I read the 1992 OID interview on WFC), I would be very surprised if he didn’t understand these points above. While he can come across as superficial in his interviews/letters, I think that's more a reflection of trying to cater to a mass audience then suggesting anything about his due diligence. And he has a lot of experience investing in the shopping mall space including buying GGP debt/equity during the crisis. That said, there is no point having a theoretical debate about whether he has done his homework or not. Let’s stick to the facts. The part that I’m not sure I agree with you on is as follows: 1. You argue that the SRG sale price was “fair” because it had an independent appraisal. I’m not sure hiring an independent appraiser makes the price either fair or a good comp. There are many ways to highlight that the properties were undervalued on a fundamental basis (rental lift on repositioning + the large development backlog). I don’t think it makes sense to value the properties assuming Sears is the tenant in perpetuity (as this isn't likely the case). And I've heard from both large and small landlords who are happy to spend money to remove Sears and reposition the box (even if you think the ROI sounds low). From a landlord's perspective, there are also secondary benefits to spending money and getting rid of Sears (it increases mall traffic and can result in a lower cap rate for the entire property). You can also look at how “investors” reacted to Seritage REIT. While normally I wouldn't pay attention to the stock market reaction to a company, I think it's interesting to see how Seritage has traded since going public. In a difficult market for most companies (including REITs), it’s interesting that the stock has never traded even close to the subscription price of $29.58 (today’s stock price is 35% higher). This was not a spinoff - Bruce and Eddie had to put up fresh capital to own Seritage. If it was fully valued, it’s hard to see why Bruce/Eddie would put incremental new money in addition to their significant SHLD investments. Finally, Warren Buffett bought it in his PA (and presumably his average cost is above the $29.58 subscription price). Buffett has a pretty large universe of stocks to look at (especially in his PA) and I don’t think he has such a great affinity to the Sears brand that he wanted to pay a fair price for Seritage. 2. The initial Seritage sale price partly reflects the fact that Seritage doesn’t own 100% of the economics of the real estate (i.e. they would have had to pay more if they wanted to own 100% of the land free and clear). For example, for most of the properties, Seritage has to pay a termination fee to Sears if they want to recapture the remaining 50% of the box. When you look at the value of SHLD's remaining real estate they still retain 100% of the economics. 3. You mentioned that the leases are worth substantially less than the owned stores. I think you suggested that at most the leases are worth 50% of the value of the owned stores. I'd be curious to know whether you have seen any historical data that highlights this? Based upon disclosed transactions, I've seen many leases that seemed to sell at similar valuations to what a property would be worth if the retailer owned it. For example, Sears (and other retailers) have sold lots of leases in Canada and the US at extremely high valuations ($/sqf) which seems to suggest that it’s the quality of the property and not the fact that it’s owned/leased that determines value. 4. You mention that the Bruce’s implied valuation suggests the 900+ Kmarts have to be worth $12.5 billion or $98/sqf. I wonder if doing high level math (as opposed to doing property by property appraisals) like this can skew the numbers. A very small % of the properties represents the vast majority of the value. And there are a ton of properties that are likely worth sub $10/sqf. But that misses the point. The much more important figure is what the top 10-20% of the real estate is worth. So if you do high level math and potentially understate the value of the highest valued properties, it might make the lower valued properties look more expensive than they actually are. Anyways, I would love to hear your thoughts on this. You seem to be very knowledgeable about Sears and always interested to see your perspective.

Am I the only one who misses all the activity in the SHLD thread?? On a serious note, it was interesting to see Berkowitz’s comments in his annual latter. He has talked about his $150 NAV appraisal in the past. However, this is the first time I have seen him break out the value of the real estate. He thinks it’s worth $15.8 billion. He also laid out a breakdown of the properties by grade (A, B, C and D). Peridotcapital, I know you have expressed concerns in the past about aggressive real estate valuations (i.e. Baker Street’s analysis). What do you think about Berkowitz’s real estate valuation? I think Baker Street’s analysis pegged the real estate at $7-10 billion. Berkowitz’s $16 billion value is after the $3 billion sale (i.e. the real estate would have been even more valuable when Baker Street did their analysis). I think the bear arguments about the brands/retailing operations being worthless as well as the large cash burn are well laid out. Does anyone have any thoughts on Bruce's real estate appraisal/what he is missing? At $16 billion, you can take an awful lot of haircuts and get a margin of safety.

Count me in as well!

Thanks for an interesting idea oplia! I haven't followed the situation. Does anyone have a sense for why there is such a large spread between the current stock price and the tender offer? It seems like an unusually large discount even if the tender is prorated.

Dazel, I attended a presentation with Prem and Paul. The question was asked about the composition of their hedges and whether they have been beneficiaries of their bearish views on China. It sounds like their short book consists of individual short positions on some natural resource stocks (BHP, Rio, etc.) as well as highly valued "tech" stocks (Tesla, etc.). They said their gains from the natural resource shorts were relatively small (it didn't sound overly material). The reason they didn't make a larger bet on the China short was that they couldn't find a cheap way to get exposure to the idea. In contrast, they built a large deflation position because they felt the cost was relatively modest in relation to potential payoff if their thesis played out. As an aside, I got the impression that the deflation swaps have likely reversed some losses from last quarter and they are quite optimistic about the value of these positions over the next few years. In terms of the Russell hedges, they are in place not for a 5-10% market correction but because they are worried about a 30-40% correction. They are unlikely to reduce the hedges until we see a meaningful drop in equity prices. They use the Russell hedge for two primary reasons: 1. Protect their balance sheet. If you aren't careful you will need money at the wrong time. 2. They worry about a market correction at the same time the insurance cycle hardens and they want to have the capital to double their premiums when their competitors are shrinking. Hard markets don't last long and you need to be in a position to write more business when capital is leaving the industry. Full disclosure: Long Fairfax. Ap1234

Williams406, The list of royalties you mentioned from the Global Mining Observer sounds quite interesting. I'd love to read it. Would you be able to post a .pdf of the article or would we be able to find a free version online? Thanks!

If you guys do something downtown (or at the very least on the Yonge or Bloor subway line) I'll try and attend.

Dazel, As always, thank you for your contributions to the board! I always enjoy our posts. Similar to you, I am long FFH. I like the fact that the company acts as a unique diversifier/uncorrelated bet within my portfolio. Today’s valuation is not particularly expensive and there is a lot of embedded optionality given their defensive positioning. That said, you made a few interesting comments about Fairfax making a killing on their bond portfolio/equity hedges right now and suggested we could potentially see a 10% up day in the stock at some point. Can you provide some more color on why you think Fairfax is currently making a killing in this environment? Based upon their disclosed positions, I don’t see Fairfax’s BV growing meaningfully since Q2. I’d be interested to know whether I am missing anything? My thoughts are below: 1. Equities: Prem has said in the past that during a market downturn, Fairfax’s equity portfolio will hold up better than the market (i.e. they will make a profit on their equity hedges). Based upon their disclosed equity holdings (US holdings in 13F + Bank of Ireland + Greek equities), it doesn’t appear that Fairfax is outperforming the market on the way down (i.e. their disclosed equity positions have dropped more than the Russell 2000 in Q3). Without knowing the exact nature of the individual equity hedges, it's hard to know how it is has performed over the past few months. 2. China: Fairfax has been publicly warning about the risks in China for many years. They have discussed at length the property bubble, the super cycle in commodities, etc. However, their equity hedges aren’t directly correlated to their views on China. Based upon previous conversations with management (unless anything has changed over the past few months), my understanding is that they didn’t use equity hedges to directly profit from a Chinese slowdown. Instead, their view was that if China slows down there will be contagion around the world and the most expensive stock markets (ex. Russell 2000) will be impacted. They have some smaller individual equity hedges that are more direct bets on a China slowdown but these are reasonably small in relation to their overall hedges and the size of their investment portfolio. 3. Fixed income: The majority of their bond portfolio is in US muni bonds. Less than 20% is in US Treasuries. Based upon QTD moves in US Treasuries + the performance of the muni bond index (as a rough proxy), I don’t see a significant gain. They also have some corporate bonds as well as acquired fixed income portfolio from Brit but it still doesn’t make a huge dent based upon my back of the envelope math (i.e. not significant in relation to the company's BV). While I would love to wake up and see Fairfax up 10% in a day, nothing as of yet leads me to believe it will happen. Of course if the market collapses from here (a very real possibility) and Fairfax covers the hedges and puts their cash to work, the company’s BV/share will grow materially. Some investors may begin to pay up for this optionality in advance but QTD returns on their investment portfolio don’t suggest to me that they have grown BV materially. If I am missing anything, I'd love to hear your analysis.

Thanks for highlighting the idea snowball! You mentioned that they aren't simply a distributor. Can you elaborate on what the "value add" that Biosyent provides? Also, how would you compare/contrast the business model/value proposition of Biosyent vs. the old Paladin Labs model? I'd be interested to get a better understanding of the similarities/differences. Thanks for sharing your insights.

Ni-co, can you please elaborate on what you mean by the "calls are essentially for free today." I would be very interested to hear your thoughts on this. I own SHLD common and think that the market may have misunderstood/overreacted to the Seritage REIT rights offering. I have never used options before but am considering using options to add to my SHLD position. Which particular options are you looking at and how do you think about the relative valuation between the options that are "free today" and the common stock at current levels? Any color on the implied valuation of the options versus the common stock would be very helpful.

There was a discussion a while back comparing BAC to WFC and whether there are structural reasons why BofA can't earn an adequate ROA. Bernstein published a note recently and isolated BAC's expense ratio versus other large US banks. The conclusion is that the majority of BAC's higher expense ratio is a function of business mix: "BAC is lagging on efficiency… BAC is generally perceived to be a laggard on expenses, and on a headline basis, this perception plays out in our adjusted numbers, with the company's efficiency ratio at ~66% even embedding the benefit from all of the progress it expects on LAS costs over the next two years. BAC also comes in worse than universal peers on expense/assets, while its revenue/assets is basically in-line despite a higher concentration of loans on its balance sheet. …but perhaps not as much as you think. We think there are a few factors that explain much of BAC's higher efficiency ratio compared to peers – the company's business mix is weighted much more heavily to wealth management which screens poorly on efficiency, and it seems plausible that BAC's revenue yields are even more cyclically depressed than peers given its higher rate sensitivity, though this also could partially reflect the competitive positioning of the underlying businesses relative to peers. Adjusting for business mix, we size up BAC against JPM and find that ~60% of the difference in efficiency in 1Q15 could be explained by business mix – i.e. if it had JPM's revenue mix, we estimate BAC would have had an adjusted efficiency more like ~62% in 1Q15, compared to ~66% on our adjusted numbers and ~59% for JPM. Going forward we think BAC could have some incremental expense leverage outside of LAS and legal, though this is likely to remain a "show me" story until the company demonstrates it has room to improve on core expenses net of investments in its business, in our view."

Netnet, I should have been clearer in my previous post. I referenced the discussion from the 2013 President’s Letter as it provides important clues on how to think about the drivers of CSU’s intrinsic value. I was trying to caution Gio that 20% FCF/share growth over the next 10 years is not a simple feat. That said, I wouldn’t necessarily rely on Mark’s value of the business either. He is an incredible investor with a phenomenal track record. But he has historically undervalued his own business. At various points in CSU's history, you could have asked him about the value of his own business and he would have suggested there wasn’t sufficient margin of safety to invest.

Gio, I’ve been a shareholder for a while. It is a wonderful business. Mark Leonard is a very saavy capital allocator and he has a talented team of (relatively young) managers who run the different divisions. The decentralized business model and incentive structure are brilliant. If you’re going to try and value the business, a good starting point is looking at adjusted net income (GAAP reported earnings are skewed by the non-cash amortization charges). You can look at the company’s historical record in their President’s Letters. To value the business, I don’t think it’s as simple as saying that adjusted EPS grew at 40%/year so just slash it in half and grow it by 20%/year for the next decade. That is no easy feat! If you’re going to grow FCF/share at 20%/year, you should probably work backwards to see what is being implied in those growth rates. For example, let’s assume that CSU has organic growth of 5%/annum over the next decade (this is not a simple task). That still leaves 15%/year of acquisition growth (assuming no margin expansion). Clearly, as you scale up the top line, you need to do significantly more deals (or fewer VERY large deals) to maintain the same growth rate. You will need to make reasonable assumptions about the average deal size, # of deals, acquisition multiples, how much debt will be employed, terminal operating margin, etc. Go out to Year 10 and look at the revenues in your model and ask yourself how many deals were implied to get there and whether that was a reasonable run rate. As you start walking through this exercise, I suspect you will find that 20%/share CAGR for the next decade (while very possible) is certainly not an easy task. I think it's also a worthwhile reading the President's Letter in 2013. On pg. 4-5 of the letter, Mark discusses some of the different drivers of CSU's intrinsic value and provides some sensitivity analysis. I hope this helps as a starting point in your valuation exercise.