FAIRHOLME CAPITAL MANAGEMENT, L.L.C. Fairholme Capital Management Public Conference Call Bruce Berkowitz Moderator: Daniel Schmerin February 23, PDF

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FAIRHOLME CAPITAL MANAGEMENT, L.L.C. Fairholme Capital Management Public Conference Call Bruce Berkowitz Moderator: Daniel Schmerin February 23, 2016 EDITED FOR CLARITY AND ACCURACY Operator: Good morning.
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FAIRHOLME CAPITAL MANAGEMENT, L.L.C. Fairholme Capital Management Public Conference Call Bruce Berkowitz Moderator: Daniel Schmerin February 23, 2016 EDITED FOR CLARITY AND ACCURACY Operator: Good morning. My name is Brandy and I will be your conference operator today. At this time, I d like to welcome everyone to the Fairholme Capital Management 2016 Public Conference Call. Bruce Berkowitz, the firm s founder and Chief Investment Officer, will be answering questions submitted in advance by callers. Moderating the call today is Daniel Schmerin, Fairholme s Director of Investment Research. All lines may be muted to prevent background noise from compromising sound quality. After the call, a transcript will be made available on our site at: Daniel Schmerin: Good morning, I m Daniel Schmerin, Director of Investment Research at Fairholme Capital Management. I d like to welcome Fairholme shareholders and other listeners to our 2016 Conference Call. I d like to begin by expressing our appreciation to all of those who took the time to submit thoughtful questions for our call today. Without further ado, I d like to introduce Bruce Berkowitz, our Founder and Chief Investment Officer. Bruce Berkowitz: Thanks Dan, and good morning to everyone. It s a pleasure to be hosting this call today. Before we dive into your questions, I would like to make a few opening remarks. First, for those of you who have invested with us for many years, and those who have invested with us more recently, I thank you for the trust and confidence you ve placed in 1 our hands. Fairholme is a family, we are not a large firm. Through thick and thin, we remain intensely focused on one overriding objective: and that is to generate aboveaverage total returns for our investors over time. As you know, we take unconventional approaches to investing. Our clients expect us to beat to a different drum. They expect us to ignore the crowd, and they expect us to focus on our best opportunities, as we said we would since inception of the fund. We continue to do this day in and day out. We continue to follow a time-tested approach that has worked for Fairholme. We are contrarian, not for the sake of being contrarian, but contrarian as a result of our research work to find bargains. Three decades of experience have taught me that this is the safest investment approach and the safest way to meet our investment objectives. Avoiding permanent loss of capital is the number one rule. That s how wealth is created over time. I know that recent times have not been easy for any of us shareholders. And at Fairholme, we experience many of the same emotions as our investors. After all, Fairholme is personal and I have always had my family s entire liquid net worth fully invested in Fairholme products. We set a very high bar for ourselves at Fairholme, particularly with respect to performance. I expect us to surpass that bar. When we fall short, as we did in 2014 and 2015, I can assure you that we assess whether our analysis is flawed or whether the market temporarily disagrees with our perspective. If our analysis remains sound, but few other market participants agree, we rely upon conviction, courage, and fortitude and we tend to buy more at cheaper prices. Running with the crowd is easy, but that s not what we do. Separating from and ultimately leading the pack is harder. Dan, given my years in this business, I d like to provide some context to today s environment. It s very reminiscent of my experience in the late 80s and early 90s. At that time, Wells Fargo was constantly testing new lows, plunging on fears of its California real estate loan exposure. The market was unbelievably fearful, and the company s share price was trading at just two times pre-tax, pre-provision earnings. I 2 strongly disagreed with the market, but that didn t mean it was easy or pain-free. I calculated that Wells Fargo was worth many multiples of its distressed trading price back then. And with conviction and courage, I built up the position until it was by far my largest holding, and boy did I look wrong. In fact, I continued to look wrong for several years after I initiated the investment. However, by the late 90s, Wells Fargo s share price dramatically increased it was a seven bagger. Today, when I compare our current positions to that investment journey, or if I think about more recent successes like General Growth Properties and AIG, I can t help but conclude that our current portfolio has as much, if not more performance potential than any of the past investments. I want to make sure we address the key points for our core positions today, and that we answer the most popular questions submitted. Daniel Schmerin: That provides a good segue into our first question: in the Fairholme Fund s Annual Letter published last month, you indicated that times have changed and that if markets remain less liquid, we will become less concentrated than in the past. Does that mean Fairholme will become a diversified fund? Bruce Berkowitz: Rest assured, it is not in Fairholme s DNA to manage index-like, broadly diversified funds. When I started the Fairholme Fund just over 16 years ago, our investment philosophy was straightforward: focus on best ideas; buy at a cheap price; it s all about what you pay versus what you receive. What you give versus what you get, price versus value, with a focus on best ideas. That remains true today, and all of our core positions fit that profile. Again, we can look quite wrong until we are perceived to be right. That s the hard part. We do look very wrong today based on market prices. As you know, there is no free lunch. Mr. Market will make you work for it. But eventually, I believe, when investor emotions change or deeply buried facts emerge, the price pendulum swings back to a more normal positioning. In the commentary in my Annual Letter to shareholders, I tried to shed some light on why we adjusted positions, and how position sizing is affected by a host of factors. Consider this: in the past 16 years of the Fairholme Fund s life, there have been only three periods when the Fund s performance has landed it in the bottom quartile was followed by four years of absolute and relative outperformance was also followed by two years of absolute and relative outperformance. Our recent performance has put us back in the doghouse, and this is the third such period over the life of the Fund. Some believe that this time is fundamentally different, that the past won t serve as a useful guide, or that the price pendulum may never swing back our way. I m not going to offer any specific predictions, because everyone knows my timing is not perfect, but I can say this to you: history may not exactly repeat itself, but it does tend to rhyme. Daniel Schmerin: We received several questions about the long-term capital gains distribution to Fairholme Fund shareholders in late 2015, and how that impacted the Fund s share price. Bruce Berkowitz: The 2015 distribution represented a very big win on AIG. The distribution of about $13 per share reduced our fund share price by $13 per share. There were two results. For those who take their dividends in cash, it was a bonanza, Christmas came early. For those who reinvest, they earned 30% more shares in the fund the next day. And I am not blind to taxes. I paid my share of those capital gains distributions. In the end, it was just not worth the opportunity cost of attempting to offset gains with losses. I thought our positions were so unique and have so much potential, that to try and sell those with losses, and then regain those positions after a 31 day period would be near impossible. Daniel Schmerin: On the topic of AIG, people were interested to know why you reduced the Fund s exposure during Did your view fundamentally change? Isn t it still cheap? Bruce Berkowitz: As we have written in all of our letters, we bought AIG at substantial discount to tangible book value ( TBV ). We had a simple thesis that AIG still had a franchise value, and that AIG was worth at least TBV. We then started selling in 2014 as our thesis played out and AIG approached our estimate of TBV. That was always our game plan. We have made a considerable amount of money in AIG, and AIG remains the largest position in the Fairholme Fund in the form of long-dated, double-ratchet warrants, which we received during the recapitalization of AIG in It is my belief that these double- 4 ratchet warrants have unique features regarding conversion price and conversion ratio, and they can potentially disproportionately benefit from future corporate actions of AIG including asset sales, capital distributions, and dividend payments. Daniel Schmerin: It is clear you like the AIG warrants over AIG s common stock. What is your view on recent activist efforts? Bruce Berkowitz: I ve followed AIG for decades. The company s configuration is unique. But I believe that underappreciated assets should be sold. I believe that corporate expenses need to be dramatically reduced. Less regulatory restrictions across the entire company would be quite beneficial. AIG can take a lot of actions, and we support all efforts to maximize shareholder value. Daniel Schmerin: During 2015, you reduced Bank of America common stock across portfolios. What changed? Do you fear another crisis brewing like 2008? Bruce Berkowitz: Nothing has changed. Again, similar to AIG, in fact same story as AIG. We sold based on TBV. If anything has changed, today the financials are more akin to regulated utilities. All too big to fail institutions, except for Fannie Mae and Freddie Mac, have fortress-like balance sheets. And it s harder now for banks to effectively generate a decent return on that fortress-like capital. Daniel Schmerin: How would you assess Brian Moynihan s leadership to date? Bruce Berkowitz: Brian has done well with the hand he was dealt. It s not easy to steer such a large organization, but he has been paddling fast. Personally, I think he should spin off Merrill Lynch and U.S. Trust. Those gems are certainly not utilities. Daniel Schmerin: Let s turn to Leucadia. You ve owned it for a long time. What are your thoughts? Bruce Berkowitz: I have tremendous respect for Mr. Steinberg and Mr. Cumming, who created the company. But it s a different company today. It s a different environment. And there are many industries in stress today. Facts change, we change. We still think 5 highly of the people at Leucadia, but in our rank ordering process, we have found other opportunities to take advantage of. Daniel Schmerin: Let s move on to the St. Joe Company. Some market participants have interpreted the recent registration statement filed by St. Joe to mean that your view on the company has soured. What s the truth? Bruce Berkowitz: My view on St. Joe has not soured. The company s regulatory filing was routine. It happened previously in April It has no bearing on our investment outlook. The company last year received entitlements spanning 110,000 acres of nearly contiguous land on Florida s Emerald Coast. The company now has the ability to develop 22 million square feet of retail, commercial, and industrial facilities, along with 170,000 residential units. There is huge potential at St Joe. Daniel Schmerin: So let s drill down on that a little bit and discuss your perspective regarding St. Joe. Particularly, what has been accomplished since you ve been actively involved? Bruce Berkowitz: Dan, I started with four objectives. Stop the bleeding that is, eliminate excessive corporate spending and other fixed expenses at St Joe. Strengthen the balance sheet is number two, to create huge liquidity to be able to weather any environment. The third objective was to focus the company on core projects that can really move the performance needle. Fourth is helping the company create the underlying conditions for maximum optionality and long-term success. I believe these objectives have been accomplished. Over the last few years, St. Joe has sold some of its non-core assets. More recently, the company appointed a new CEO, Jorge Gonzalez. The company is now focusing on creating partnerships with the best, most experienced companies that can help increase the value of St. Joe s land whether it s the entitlements, the deepwater port, the short-line railroad, the new international airport, the hotel, or the golf and resort properties, there s a whole lot at St. Joe. And I have to tell 6 our shareholders, for those who think St. Joe is just forestry land far away from civilization, you need to come down and visit St. Joe and take a look for yourself. Daniel Schmerin: Do you need to remain Chairman of the Board for the company to succeed going forward? Bruce Berkowitz: The short answer is no. The company is now entering a new phase, transitioning from what I consider defense to offense. While I am happy to continue serving, there may well be others who can bring different expertise that will be accretive for St. Joe s next chapter. Daniel Schmerin: Let s turn to Fannie Mae and Freddie Mac. Shareholders expressed a lot of support for our ongoing efforts. I know that you recently corresponded with a soldier bravely serving overseas in the 5 th Marine Expeditionary Brigade. Bruce Berkowitz: Yes, I was thrilled to receive his message and we should all be grateful for his service. A true patriot. Yet, he is one of thousands upon thousands of our shareholders affected by Fannie Mae and Freddie Mac. Daniel Schmerin: Give listeners a brief overview of the state of play with respect to Fannie and Freddie. Bruce Berkowitz: This should be a replay of our experience with AIG. Fannie and Freddie should be treated the same as AIG, and ultimately released of government control. Let us back up a bit. Fannie Mae and Freddie Mac are absolutely essential to America s housing market. Who else makes the 30-year pre-payable fixed-rate mortgage widely available through thick and thin? Who else can provide $7 trillion of liquidity to America s housing market since 2009 helping low and moderate-income Americans buy, rent, or refinance a home? Fannie and Freddie are two companies that help all Americans, whether they know it or not. Fannie and Freddie are definitely two of the most valuable companies in the world. It is still hard to believe that some in Washington want to eliminate them in the hope of 7 finding something better, or at least finding something that caters better to their special interests and crony capitalists. But the Companies are not going away. Fannie Mae is relocating to a new million square foot office complex in downtown Washington, and Freddie Mac just announced that they hired several hundred new employees. If this Presidential Election is any indication, the days of such bureaucratic malfeasance are numbered. I believe the United States Treasury is growing increasingly isolated as a result of its 8- year policy forcing Fannie and Freddie to remain in a state of captivity known as conservatorship. It is a shame and a huge delay of game. I am shocked that Senator Corker allowed the President to take $250 billion dollars without Congressional approval, a stunning figure that continues to grow and an action that may well cause the next financial crisis. Daniel Schmerin: Can you explain the nature of our investments in Fannie and Freddie? Bruce Berkowitz: We own preferred stock of two of the most successful companies in American history. Preferred stock is not common stock. Preferred stock is a contract, a contract that protects our bundle of economic rights. One of the rights it protects is a liquidation preference, a priority claim with regard to the repayment of principal. The contract is between a buyer and seller, and it is backed by the nation s laws. The Treasury also owns preferred stock. We own Preferred stock, the Treasury owns preferred stock, and a preferred stock is a preferred stock. But the Department of the Treasury seems to make up the rules as they go. They take everything with their preferred stock, and we don t even receive a return of principal with our preferred stock. I don t understand why some believe they are above the law, and that they are able to choose who wins and loses. Fairholme and other shareholders aren t seeking anything more than for Treasury to respect the capital structure of each company, to respect the economic bundle of rights associated with our securities and to respect the law setting forth the rules of a conservatorship as decreed by Congress in the passing of the Housing and Economic Recovery Act of 2008 ( HERA ). 8 Daniel Schmerin: A few years have elapsed since you initiated this investment. Do you have more or less conviction in Fannie and Freddie today than when you first bought? Bruce Berkowitz: We have made enormous progress over the last 12 months, largely behind the scenes. With each passing day, we seem to be getting closer to the finish line, so I remain very optimistic. We have the facts on our side. Fannie and Freddie are hugely profitable. We have the law on our side. We have common sense on our side, and we have history on our side. Alexander Hamilton, one of our founding fathers, made a momentous decision after the Revolutionary War to recognize the debt of states as federal debt. Hamilton chose not to differentiate between original holders of bonds and those who later bought the bonds from original holders. Hamilton believed it was imperative for our nation to honor all its obligations. So, while a statue of Hamilton sits outside the Treasury Department today, it doesn t seem as though those inside today appreciate that precedent he set, but this will change. Daniel Schmerin: Perhaps you can you elaborate on some of the progress. There are 22 cases pending across the country challenging the so-called Net Worth Sweep, the federal government s blatantly illegal expropriation of private shareholders interests in these two companies, and it seems like there are more complaints filed with each passing month. Bruce Berkowitz: Dan, anyone who is willing to spend an hour of time understanding the facts ends up shocked and outraged by the government s unlawful actions. There are cases advancing in the District of Columbia, Iowa, Kentucky, Delaware, and Illinois. I expect that there will be judicial decisions on several of these cases this year. Our lawyers have taken discovery on various topics relating to the Net Worth Sweep in the Court of Federal Claims. Plaintiffs in other courts have now obtained access to these discovery materials and are amending their complaints to make use of this information. Meanwhile, the government is fighting tooth and nail to withhold over 12,000 documents, and I believe those documents contain very incriminating evidence against the defendants. 9 So, we are advancing the ball down the field strategically and at an increasingly accelerated pace. It doesn t look that way when you take a look at the price of our preferred stock, yet we are making substantial progress. Daniel Schmerin: To pick up on that, in a speech just last week, Mel Watt, the conservator of Fannie and Freddie, expressed serious concern about the inability of these two companies to retain capital. In fact, he highlighted the escalating risks of this perpetual conservatorship. Do you believe that Fannie and Freddie will need another bailout? Bruce Berkowitz: Mel Watt is telling the truth. If you ask Director Watt if the Treasury Department is helping or hurting Fannie and Freddie, do you know what he will say? Treasury is hurting, and in fact making the situation much worse. The Treasury is significantly constraining his ability to effectively manage the conservatorship. He d tell you that the sheep dog has turned into the wolf. Fannie and Freddie have over $5 trillion of liabilities outstanding, yet Treasury is milking them of all their income and forcing them to operate with no capital. It s absurd. If
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