giofranchi

twacowfca, I have just read both Libs’ post and Ian L’s reply. What figure would you use for BV? $1.298 million or $1.455 million? I have never understood exactly why people fixate so stubbornly on TBV, when it is clear that many businesses are worth much more than BV… Anyway, I also share Ian L’s doubt that LRE could hardly achieve a 20% return on their investment in Cathedral right away… So, I would like to hear your opinion! :) Thank you, giofranchi

Hi Plato1976, Of course you are right! The 11.6% I talked about is what we usually refer to as 'owner's earnings' yield. But it surely won't be completely distributed to shareholders. Look, what could be expected, if LRE keeps performing like it has done historically, is the following: LRE posts ROEs around 19-20%, reinvests what is needed to compound BV at 4-5%, and distributes the rest. If this comes to pass, and I reinvest shrewdly the dividends I receive, I will compound capital at a very satisfactory rate for many years to come. And in the end I will have received from LRE alone more cash than from my other investments combined! At least, this is how I view it! :) giofranchi

Yes, of course… That is the nature of business (and of most human endeavors!). Nothing is certain… Are BRK’s manufacturing, service and retailing operations 100% safe? No! Likewise, LRE might underperform for some time. Sure! That’s why my question remains valid and I ask it again: does anybody know a better way to generate cash in the marketplace? If no, I guess we must be content of doing our best in an uncertain world… :) giofranchi

twacowfca, I know Mr. Watsa keeps repeating that he far prefers “a lumpy 15% to a steady 12%”. But sometimes (not very often, don’t worry!! ;D) I also try to follow my own reasoning. I think you must have both: FFH for a lumpy 15% and LRE for safe and predictable 12%. The reason I think a safe and predictable 12% is important is that earnings power gives you optionality. If you enjoy a reliable stream of cash, you can take strategic decisions that otherwise would not be possible. There is clear advantage to know when you will enjoy new cash and how much of it. Don’t you agree? And any advantage is surely worth something, right? Think, for instance, at BRK: at year end 2012 manufacturing, service and retailing operations had a tangible BV worth $22.64 billion, with Goodwill and other intangibles that were worth $26.017 billion. BRK equity (in those businesses) was worth $48.657 billion. Net earnings were $3.699 billion, or 16.3% tangible BV, but only 7.6% what BRK had paid for them. So, how does this compare to a 19.5% ROE and an 11.6% earnings yield offered today by LRE to its owners? If Mr. Buffett has decided to invest almost $50 billion that way, to make sure BRK will always enjoy safe and predictable sources of cash, there might be a lesson to learn here, don’t you agree? So, yes, if we see a 3-4% CAGR in BVPS going forward I would certainly be pleased, but I also hope Mr. Brindle won’t dramatically change LRE dividend policy! :) giofranchi

I think that VRX business model answers both the valuation and the patent cliff questions. VRX has still relatively small revenues, but a very substantial Cash EPS of $6.2. And this is because it has almost no R&D costs. So, it is Cash EPS that justifies market cap. Furthermore, if growth continues, in just 4 years VRX will have closed the revenue gap with TEVA... The same is true for the patent cliff: VRX is very diversified, and no product is a meaningful percentage of sales. Furthermore, VRX strategy is to buy companies with already approved and established products. Therefore, the process of replacing products that lose patent protection is much faster and certain than for other pharma companies. All in all, I am very pleased to buy VRX anytime it trades between 10x and 13x Cash EPS. After the recent run up in its stock price, I am not adding. Actually, I sold some, to buy more LRE. giofranchi

Hi original mungerville, Of course you are right!! The fact is simply my goal with LRE is to build earnings power for my firm. So, I hadn't thought carefully enough about my math of reinvesting the dividends in LRE. The dividends my firm receives from LRE are not furtherly taxed, until I decide to distribute them among my partners. So, I get to reinvest an 11.6% yield. How could you give up on such a thing? Especially when your goal is both to achieve good investment results and to build earnings power? I want them both for my firm! Let's put it this way: if there is another opportunity in the market (I cannot buy whole businesses yet), which is better than LRE to increase my firm earnings power, I will gladly sell LRE and buy that other business! So, I am all ears! :) PS I am in love with women... Businesses certainly not!! ;) giofranchi

"Signs of the Top" by John Mauldin giofranchi 20130817_TFTF.pdf

Very interesting read: http://www.distressed-debt-investing.com/2013/08/off-topic-on-starting-company.html giofranchi

Hi ASTA! Of course, twacowfca is the one to thank! The work he has done building this awesome thread about Lancashire is just wonderful and gives the clear idea of how much he really has followed the company through its first years until today. How much he knows and understands its business. As I have already said, I just follow in his steps! What I find amazing about business and investing is that you don’t have to be Nole Djokovic, to achieve extraordinary results… You just have to learn how to recognize the Djokovices of this world and follow in their steps! ;) Cheers! giofranchi

Hi Plato1976, I suggest to reread Warren Buffett 2008 AL, where he explains how and why insurance had been their best performing business that year... You don't get out of bed and try to do business without insurance, even in a depression! Lancashire increased BVPS 7.5% in 2008, when the market tanked more than 30%... That's my idea of outperformance! And Lancashire is the insurance company which enjoys the largest percentage of its earnings derived from underwriting operations (as you can see from its leatest presentation for investors). Hope this helps! giofranchi

Good weekly paper by Mr. David Hay and Mr. Walter Deemer. giofranchi EVA+8.16.2013+NA.pdf

original mungerville, another way to look at Lancashire’s valuation: If it keeps posting ROEs of nearly 20%, and you reinvest the dividends, and in 10 years it is still trading at 1.64 x BV, you will enjoy a CAGR of nearly 20%. If you are more concerned about “valuation risk” than “business risk”, ask yourself: why a contraction in multiple should be justified? The S&P500 is selling for 2.54 x BV with an average ROE of 13%; Lancashire instead is selling for 1.64 x BV with an average ROE of 20%! Without a serious deterioration in their business performance, I don’t see why a contraction in multiple should come to pass. And 10 years from now Mr. Brindle at 60 will still be relatively young and at the top of his game! :) giofranchi

Hi original mungerville, of course twacowfca is the one to ask about LRE, I only follow in his footsteps… And he knows and understands LRE much better than I do. I will try anyway to tell you my thesis. First of all, and most importantly, I think about LRE as the third operating business of mine. Like the first two (engineering services and for-profit higher education), its greatest appeal to me is that LRE produces cash. In the last paper by Charles Gave (another Charles I listen to very attentively :) ), that I have just posted in the macro musings thread, he has written: And that is precisely why I think that to possess sources of new capital, capital that is YOURS and not borrowed, is something extremely important, yet most often undervalued. And whenever I am able to add one such source, I will always do it. If there is trouble with the market, I will surely be grateful for a business that keeps generating cash, and gives that cash to me to scoop up great bargains! Now, to the valuation question: 755 Gbp equal to 7.55 x 1.56 = $11.8, which is 1.64 x BVPS. An historical ROE of 19% gives you a current yield of 19 / 1.64 = 11.6%. Most of which will be paid out in dividends (cash generating machine), but, when the opportunity is really worthwhile, it will also be used for growth (see, for instance, the recent acquisition of Cathedral). And, reinvesting the dividends, BVPS has only to grow at a CAGR of little more than 3%, to achieve a 15% compounded annual return. Of course, taxes on dividends will be a drag on performance, but here again LRE enjoys an extremely favorable tax regime! :) If Mr. Brindle & Co. keep performing, I don’t think it is too optimistic to expect a 15% compounded annual return (LRE is still relatively small, and the specialty insurance market around the world is huge). But even if I were to settle for less, I would do it: imo, to possess means that keep generating cash is just too important for investment long-term success. Also, I will gladly keep on averaging down as the market allows me to do, lowering my average cost and increasing my yield. This is my view about LRE, and I hope it helps… Now, ask twacowfca! ;) giofranchi

"A Young Man's Game" by Charles Gave I must be somehow an 'old man'... :) giofranchi Daily+8.16.13.pdf

"France As A Lynchpin" by Louis Gave giofranchi Daily+8.13.13.pdf

Hi Ron, and yes: still here on this beautiful island! I have a villa with a small park, that I think is one of the most relaxing places I know of! If you ever plan a trip to Italy, don’t fail to let me know, because I want you to be my guest! :) But you would be surprised how incredibly bad a ‘gigolo’ I really am! Also, to talk to beautiful babes about Lancashire doesn’t help much…!! ;D ;D ;D All the best, Gio

I have bought more LRE at 755 pence today. Now LRE is 20% of my firm's portfolio. What the market is seeing just as a dilution to shareholders, I see as proof that Mr. Brindle will find ways to grow BV for many years to come. I think Mr. Brindle is proving wrong the thesis Lancashire only is a dividend play. Instead, he is saying: Lancashire is both a dividend and a growth story. Of course, I like it very much. :) giofranchi

Good weekly paper by Mr. David Hay. giofranchi EVA+8.9.2013+NA.pdf

"Greek Tragedies Always End The Same" by Charles Gave giofranchi Daily+8.8.13.pdf

Yes! You are right... I meant at the end of Q2 2013. Also the numbers I used in my last post make reference to the 10q-q2-2013 file. giofranchi

Well, that for me is the easy part! Given its relatively small size, I think Mr. Biglari has still many opportunities to go on increasing capital at a 20% CAGR for many years to come. And anything which compounds capital near 20% yearly for many years is worth much more than 1.4 x BV. I don’t want to talk about Mr. Biglari’s ethics here! That subject has already been touched too many times! giofranchi Thank you wellmont, for the explanation about how oversubscription works! :) I would like to explain a little bit better why I think a 20% increase in BVPS is achievable by BH for many years into the future. BH has $400 million in equity + $40 million of its own shares held by the Lion Fund. So let’s see what would be required to increase those $400 million in equity by 20%, the $40 million invested in BH shares will follow suit. 20% of $400 million is an increase of $80 million. Now, from restaurant operations alone BH enjoys an earning power in between $35 million and $40 million, that’s to say 9% to 10% of equity. Therefore, investment should make up for the remaining $40 to $45 million. Investments are worth $386 million, and a gain of $40 to $45 million would mean a return in between 10.5% and 11.5%. This kind of required return from investments could be further decreased, if Mr. Biglari is successful in getting control of a soundly managed and conservatively reserved insurance company, adding its float as a source of cheap and safe leverage. That’s why I like the announced raising of capital! Moreover, operating earnings from restaurants are still growing: they grew 9% in 2012, and franchise royalties and fees still count for only a tiny fraction of revenues. They could go on growing very fast for a long time! So, I don’t see the contribution of operating earnings to BV growth become irrelevant anytime soon. Actually, the way Mr. Biglari invests in the stock market leads me to believe that operating earnings will become ever more meaningful: in fact, once he has invested in a business through the stock market, Mr. Biglari very often strives to acquire the whole company. And, when successful, he will increase earning power substantially. So, yes! BH is an holding company, but also with meaningful earning power. Imo, a great platform for doing business! Of course the ethics issue remains… But the fact is what I have just written is clear and easily understood… ethics and behavioral traits, on the other hand, are extremely difficult to fathom… at least for me! giofranchi

Well, that for me is the easy part! Given its relatively small size, I think Mr. Biglari has still many opportunities to go on increasing capital at a 20% CAGR for many years to come. And anything which compounds capital near 20% yearly for many years is worth much more than 1.4 x BV. I don’t want to talk about Mr. Biglari’s ethics here! That subject has already been touched too many times! giofranchi

unless you oversubscribe and get some shares. wellmont, how exactly do you oversubscribe? Do you have to purchase rights on the market? Thank you, giofranchi

Equity right now is $440 million, because I think you should add the BH’s pro-rata ownership of its common stock through the Lion Fund, 99,800 shares. So, with a market cap of $615 million, BH is trading for 615 / 440 = 1.4 x BV. New BV will be $440 million + the cash received = $440 + $76 = $516. With 1,720,540 share outstanding BVPS will be $300. At the same multiple of 1.4, I expect a share price of $300 x 1.4 = $420. If my reasoning is wrong, please correct me! Of course, given the rate of growth in BH’s investments and given how shrewdly Mr. Biglari could deploy the newly raised $76 million, I think BH deserves a much higher multiple than 1.4, and I think the market will realize it, when Mr. Biglari announces his new target. If you want, it can be viewed this way: Mr. Biglari’s new acquisition could become the catalyst this stock is waiting for a long time. giofranchi

That's only going to be beneficial in the "oversubscription privilege", so it's ultimately a bet on other shareholders not exercising their option. Any idea what level participation this type of deal usually attracts? No, I am not sure... But, the way I see it, 1) BH already is cheap, 2) Mr. Biglari wouldn't do such a thing, if he hadn't the opportunity to use the new capital in an equity and earnings per share accreative way. If 1) and 2) are true, you basically get the rights to buy deeply undervalued shares for free. And, if you are lucky, you can buy more due to undersubsciption. You must be a shareholder by August 27 to receive the rights. giofranchi