Letter To The Partners of Graham Theodor & Co. Ltd.:


Equity holdings as of Nov. 30, 2011 were as follows:

Holding Avg. Cost Market Value
Cash - -
Silver Bullion Trust $16.64 $22.00
Sprott Physical Gold Trust $11.98 $14.90
Claymore Broad Commodity $20.55 $22.80
Retail Holdings N.V. $17.15 $16.40
Brazil Fast Food Corp. $8.12 $11.00
Inverse U.S. Treasury 2-Year $40.54 $41.51

- Avg. Cost & Market Value shown on a per share basis.
- Weighting of positions are in numerical order

Our year to date capital appreciation is 14.5% for the total portfolio.

This compares with 1.46% for the S&P 500 index and -12.43% for the S&P TSX Composite index. This makes our relative performance 13.04% compared to the S&P 500 and 26.93% against the S&P TSX Composite for 2011.

Despite this, our focus is and will continue to be absolute returns while taking on substantially less risk than the market as a whole. Also, too much attention should not be paid to this figure for any single year, as over the longer term (3-5 years) the record regarding aggregate capital gains or losses obviously is of far more significance.

Our goals in this regard for 2012 remain the same as they did at the outset of this past year, which are:

1) Safety of our Principal

2) Satisfactory return on our capital

The second objective is subjective and will be different for everyone, but speaking strictly for ourselves it is to achieve an annualized return on our capital of over 10-12%. This threshold we know is not easy to achieve, i liken it to having to consistently jump over 6 foot high bars rather than having to step over 1 foot bars. Therefore, we will inevitably stumble on occasion, but we believe that with hard work and discipline one can achieve a fair, risk-adjusted return by investing over the long term and that is our goal, but never our promise.

A few ground rules which we adhere to and some words about our operations will expound upon our underlying investment philosophy.

Ground Rules

“Investing is most intelligent when it is most businesslike.”  - Benjamin Graham

1) We are not financial analysts, equity analysts or economic analysts. We are business analysts and businessmen and are better investors because of it.

2) We only make purchases of securities or businesses when price justifies such action and prices fall below approximate intrinsic value and a demanstratable “margin of safety” exists in our purchases.

3) We stay within our circle of competence and invest only in what we can easily understand and where we can reasonably foretell what a business will look like in 10-20 years.

4) We do not attempt to forecast or time markets, make short-term trades or otherwise speculatively “bet” on securities, in essence we are long-term investors and not gamblers or speculators.

5) Safety of principal followed by a satisfactory return on invested capital is the underlying core of our investment philosophy and what we continually strive for.

Looking at the above, some would argue that we are “value investors” i would counter by saying that we are simply investors, as all intelligent investing is “value investing” for what is investing if not the act of acquiring more than one is paying for?


Following is a snapshot of the areas in which we conduct our present investment operations.

Common Equities

This simply entails the purchase of common stock of companies in the open market. This area has represented the majority of our operations in the past and the present and will continue to play a large part going forward as we believe attractive opportunities in this area will always present themselves in more or less quantities through varying economic cycles and market conditions.

The auction based system on which stock markets operate is very beneficial to the disciplined and intelligent investor who keeps his wits about him even as other market participants are losing theirs and simply abdicating their judgement to the wisdom (or lack thereof) of the crowd.

To elaborate slightly, any marketplace in which participant’s emotions are the underlying driving force will beget considerable inefficiencies as business values will necessarily be fraught with error due to these same participants passing minutiae judgement on such values based on in-conclusive and oftentimes irrelevant information.

The subject of the in-efficiency of markets is both a fascinating and revealing one, which i hope to go into more detail on in future letters.


Traditional arbitrage entails the simultaneous purchase and sale of an asset in order to profit from a small difference in the price, gains were made by exploiting differences in price of identical or similar securities across different markets.

The advancement of technology and more specifically the proliferation of high frequency trading (HFT) has made such mis-pricings redundant as computerized trading systems immediately pick up on and exploit such opportunities in a matter of mere seconds.

Despite this, opportunities remain in highly specialized fields of non-traditional arbitrage such as mergers and acquisitions, corporate spin-offs and divestitures and liquidations (Special Situations or “Workouts” as they are deemed on Wall Street). To this end we turn our attention, as this is an area where the individual knowledge and expertise of investors intelligently applied can still reap handsome rewards. Such transactions are more complex, require a fair degree of business knowledge and the timeline for such deals is never set in stone therefore much patience and discipline is required, combined with the fact that attractive commitments are sometimes difficult to quantitatively assess.

All these factors work to detract the everyday speculator and trader from crowding into this space as quick profits appear and indeed are harder to come by than in other areas of the market. This bodes well for us, as independent thought, patience and discipline are a few of our specialties.

Indeed we have made one such commitment in the past twelve months (which i will discuss later on in this letter) and while the market is un-surprisingly slow in recognizing the intrinsic value of our holding, we care not the least as we have benefited from our position in other ways, namely in the form of direct cash distributions, which at this point in time is just as good for us as appreciative gains.

Fixed Income

We have largely stayed away from the fixed income market over the past two years for obvious reasons -

1) The risk adjusted yields currently available in both the corporate and government bond markets are inappropriately low in our opinion.

2) When one takes into account actual inflation, the returns are negative for long dated maturities (5 years or more) while short dated (3 years or less) notes do not fare much better as even a single “A” rated 2 year corporate note only returns approx. 1.64% at the present time.

No doubt, opportunities will arise in the future as interest rates rise and begin to more adequately price in risk, when that time arrives we will certainly look favourably upon appropriately priced, fixed term securities which are well protected both in terms of their interest coverage as well as taking into consideration other factors.

Until that time comes and it is very likely more than a little ways away, we will continue to look elsewhere to temporarily park our capital.

Control Positions

When allocating capital we look to acquire minority stakes in intrinsically undervalued businesses, which we can easily understand, that have good underlying economics and an honest and competent management team who genuinely enjoys what they do.

This criteria does not change in the least if we are looking to purchase a majority stake in a business. In fact, it only gets amplified as want to be absolutely confident in the quality of the company and the character of the people operating it if we are going to go into business with them.

We find ourselves increasingly looking for and finding such businesses to prospectively take control of.While it is our stated intention to take such action over the mid-long-term, we will not do so unless our investment criteria mentioned at the beginning of this letter is met.

I will have a lengthier update on this particular initiative next year as the next twelve months could very well see us begin establishing a substantial minority stake on the way to a majority in a good business which we would like to own forever.



Following is a brief synopsis about our present holdings, as well as a few words about some of the things we did right this past year, some of the things we got wrong and some of the things we should have done, but didn’t (where thumb sucking occurred for lack of a better term).

Cash Position

I don’t know what else i can say about cash that has not already been said, it’s great and everyone would like to have more of it!

Cash is our largest holding by a good measure, comprising almost 40% of our portfolio at the present time. While this can sometimes be a painful position to be in, as ideally capital will be out working hard for us. It is certainly not as painful as doing something stupid with that capital and risking loss of principal.

We continue to seek out attractive situations in which we can allocate capital while taking on minimal risk. With that said, we will not risk potential loss of principal for slightly higher yields, prospective future growth or quick speculative gains unless we can obtain a clear margin of safety at the present.


As noted above, with both government and corporate bond yields at record lows despite there being more inherent risk in these asset classes than ever, silver is one of the monetary assets in which we have chosen to temporarily park capital.

By academia’s present standards we have selected a more “volatile” asset with broader price swings which makes it more “risky”. Thankfully we do not define risk by these superficial standards instead our definition is such:

“Risk is potential loss of principal”


Sounds simple doesn’t it? That’s because to a large extent it is. We look at risk strictly in terms of what the potential likely hood is of permanent impairment to our principal investment. Short term price swings and market volatility (beta as it is often called) does not concern us in the least.

While silver will definitely take us on a much wilder ride over the short term than fixed income securities in terms of pricing volatility, we believe the chances of ultimate impairment to our principal capital are minimal.

This rings true primarily because of the low avg. cost for our silver position (Approx. $16.60 per ounce) but also due to the price floor which has been established for silver as a base metal, largely driven by its growing industrial usage as the largest component of silver fabrication demand by far is its industrial use.
To give an example, in 2010 total industrial applications for silver reached approx. 487.4 Mil. ounces, compared to 403.8 Moz. in 2009 and just 349.7 Moz. only a decade ago in 2001.

Silver’s coin and medal usage also increased to 101.3 Moz. in 2010 from 79 Moz. in 2009, while silver jewelry also showed a moderate increase, this was somewhat off-set by a decline in per ounce usage of silver in both photography and silverware from 2009. Despite this, total demand for the metal has increased to 1.5 Bil. ounces from 922.2 Moz. in 2009 and from 877.1 Moz. a decade ago.

This growing industrial demand coupled with only a slight increase in total worldwide silver mine production to 735.9 Moz. from approx. 606 Moz. a decade ago helps to explain the rise in the price of silver per ounce to over $30 at the present (as of Dec. 5) from just over $6 per ounce in 2001.


Gold demand increased year over year to 1,053.9 tonnes, reaching a record $57.7 Bil. USD as of Sept 31, 2011. Overall demand is still largely driven by jewellery with approx. 50% of demand coming from this one category, followed by investment (40%) and rounded out by technology at 10% which can primarily be attributed to demand emerging from the electronics industry in Asia.

As the demand side of the equation has experienced robust growth, the supply side has witnessed wide dispersion across the globe with no single country supplying more than 13% of global production as well as relatively flat supply as the number of new gold mines found has dwindled to under 100 in 2009 from over 900 in 1999.

While the total supply of gold expanded approx. 2% year over year in 2011 from 2010, this increase was driven by existing mine production and recycled gold rather than new production. This gain has also been off-set by an increase in gold jewellery demand of 10% from year earlier levels and 1% in growth from technology, to say nothing of the increased demand emanating from the global investment sector with total purchases of gold by central banks exceeding 53.3 tonnes so far this year up to the end of the third quarter.

Historical data for gold demand backs up this year’s statistics as both investment and technology demand are up overall from 2001, investment demand increasing from 357 tonnes to 1,149 tonnes over the ten year period and technology demand up from 363 tonnes in 2001 to 466 tonnes in 2011.

Jewellery demand has experienced a slight drop-off over this same period, but is still in an upward trend since 2009. I suspect this is largely due to the increasing price of gold over the past decade making purchases prohibitive for most people, especially in the two countries which traditionally drive gold jewellery demand, India and China and not due to their being less “demand” in the true sense.

As the supply/demand dynamics illustrate above, gold as a base metal should show modest appreciation over the long term even with the expectation that investment demand will ultimately retreat from its current levels.

Couple this with the reality of a depreciating dollar (and other currencies) over the long term and gold should stand up quite well and produce a return over the real rate of inflation going forth.

Agricultural Commodities

The Organization for Economic Development & Co-Ooperation (OECD) along with the Food & Agricultural Organization (FAO) of the United Nations recently released their agricultural outlook for 2011-2020 and i will cite some findings from their report here:

- All commodity prices in nominal terms will average higher to 2020 than in the previous decade (2000-2010).

- Rice prices are conservatively expected to increase between 15-20% compared to the previous decade, meat and poultry prices may realistically average more than 30%, fish and cheese prices are anticipated to rise between 30-40% while maize and wheat prices may avg. 15-20% higher.

- Global agricultural production is projected to grow at a 1.7% annual rate on average, compared to over 2.6% for the previous decade.

- Resource pressures in the form of higher input costs, slower technology application, expansion into more marginal lands, and limits to double-cropping and water for irrigation, are limiting production growth rates.

Recent historical data going back five years to 2006 support these premises. Prices per tonnage have increased across the board in all five major commodity categories from cereals and oil seeds to meats, dairy, sugar as well as bio-fuel.

The projected price increases by the OECD-FAO study are in fact subdued compared to the ones which have already taken place over the past 5-10 years. Which has seen Rice rise from $311 per ton in 2006 to over $517 per ton in 2010, Beef go from $3,037 per ton to $3,391 and Butter appreciate from $1,772 per ton to approx. $4,400 today.

Of course there is also the case of continual population growth (world population hit 7 billion in the latter half of 2011) with projections for the world population to reach between 9-10 Bil. by 2050 according to some estimates and the expectation that this will create greater demand for food stuffs, all of these dynamics are very intriguing but alas i am no population scientist so i cannot add anything intelligent to this score.

However, i can say that making an intelligent speculation in something that is the third most important element to human beings survival (behind air and water respectively) at a low enough price point is very likely to yield good long-term results.

Retail Holdings N.V.

Retail Holdings N.V. is a holding company with three principal assets:  

1) A 56.2% equity interest in Singer Asia Limited, a distributor and retailer of consumer durable products, primarily for the home, in selected emerging markets in Asia, which also makes consumer credit and other financial services available to qualified customers.

2) Seller Notes, arising from the sale of the Singer world-wide sewing business and trademark.

3) Cash and Cash equivalents.

I have already written an in-depth analysis on the company earlier this year, which one can view here: http://www.gurufocus.com/news/140903/retail-holdings-nv-a-closer-look

For the sake of not sounding too redundant i will not elaborate as much on the company here. However, i will highlight the primary reason a minority stake was purchased. This reason is quite simply that the company is currently valued in the marketplace at a figure which is considerably below its conservative liquidation value.

Some simple math will illustrate this. Singer Asia’s major subsidiaries are all publicly traded entities in the respective countries in which they conduct their business operations:

- Singer Bangladesh Limited: (SINGERBD) Dhaka Stock Exchange

- Singer India Limited: (SINGER) Bombay Stock Exchange

- Singer Pakistan Limited: (N/A) Karachi Stock Exchange

- Singer Sri Lanka PLC (including other public subsidiaries): (SINS) Colombo Stock Exchange

- Singer Thailand Public Co. Limited: (SET) The Stock Exchange of Thailand

Collectively the market value of these entities which is attributable to Singer Asia (Singer owns less than 100% in some cases) at the time of our purchase was approx. $303 Mil. USD. Now as we know, stock prices and market values do not equal business values. In reality, the real value of some of these businesses is much greater than their current market values. For simplicity’s sake lets use the low-ball figure of $303 Mil. regardless.

When one combines this figure with the $7.6 Mil. in cash which Singer Asia carries on its books, we arrive at a figure of $310.6 Mil. The amount from this that is in turn attributable to ReHo (56.2%) is $174.5 Mil. This figure does not include the $25.7 mil. in KSIN Promissory Notes which the company holds, that came about as a result of the Singer trademark sale to Kohlberg & Co. which is a subsidiary of Kohlberg, Kravis & Roberts (KKR) that mature in Feb. 2014 as well as the $15.5 mil. in cash which ReHo presently holds with no outstanding debts at the holding company level. When these are added to the total, shareholders would receive $215.7 Mil. in a liquidation scenario or approx. $40.69 per share in contrast with the current market cap $88.7 Mil  and per share price of $16.40.

As a further update, i am happy to report that Stephen Goodman, Chairman and CEO of ReHo and Chairman of Singer Asia and his management team has followed through on its stated mid-term goal of liquidating or selling the company and put Singer Asia up for sale for $350 Mil. USD on Sept. 8. This includes the Sri Lankan operation as well as those of Bangladesh, India, Thailand, Malaysia and Pakistan.

As of the present date, there are reports that four parties have shown interest but no terms have been agreed to as yet and negotiations are still very much ongoing. My hope is that the company can settle on a suitor or a group of suitors for the business and consummate a transaction by the end of fiscal year 2012 or early 2013. Until that time i am perfectly happy sitting back and collecting generous dividends such as the $2.50 per share special distribution on Sept. 26. which comes out to a 15.5% yield at today’s share price.

Brazil Fast Food Corp.

The quick service restaurant (QSR) industry is very competitive globally, the operating costs can be extensive and margins and thereby profits are usually small, typically ranging from 4-7% pre-tax. So why would anyone want to own a fast food restaurant?

The answer is, most times one shouldn’t. However, under certain circumstances one can venture into this particular industry:

- Established, leading franchise brand. This is important as franchising is a much higher margin business than operating restaurants.

- Quick service restaurant chains are a fairly homogeneous group, therefore economies of scale (large, diversified store count  in terms of locality) and low operating costs are vital to long-term profitability. One feeds into the other, if economies of scale are in place then that will help drive down operating costs over time.

Management of course is always an important consideration since an executive team that is shareholder oriented, honest and competent will not only usually run a far more efficient operation but will also be a pleasure to work with. In this case however, a great management is an added bonus as even the best and the brightest will have an incredibly tough time succeeding without the first two conditions already in place. As Warren Buffett once lamented:

When a good manager meets a bad business, it is the reputation of the business that remains intact.”

With that said, i believe that BFFC meets both of the first two tests and also fairs quite well on the third as present management’s interests appear to be very much aligned with shareholder’s.

On the first score, the company owns or is the master licensee for not one but three established quick service brands in Brazil in addition to also holding the master rights to a fourth emerging concept.

The Bob’s Burgers trademark which BFFC owns outright, was the first fast food concept in the country initially opening its doors in 1952. Since then Bob’s has grown (primarily through franchising) to over 735 points of sale as of March 31, 2011, 688 of these locations are owned and operated by franchisees while only 47 are wholly owned. I am willing to bet that Bob’s famous ovalmatine milk shakes have something to do with this growth, as while i regrettably have not tried one as yet myself i have heard rave reviews and am making this the top item on my agenda the next time i am in Brazil.

Bob’s brand is recognized throughout Brazil as storefronts are present in every state, the chain has a particularly strong concentration in Rio de Janeiro and Sao Paulo. Meaning that there is still plenty of room to grow before completely saturating its home market since Bob’s presence is strongest in the Southeast (Rio & Sao Paulo) & South (Santa Catarina & Parana) but not so much the North & Northeast, additionally Bob’s is still the 2nd largest fast food chain domestically behind McDonald’s and toppling the golden arches will be no small feat. The chain’s success in Brazil has also allowed it to strengthen its brand by beginning to franchise abroad starting in Angola, Africa where there are currently 3 restaurants and more recently Chile, by granting a master license to well known quick-service restaurant operator Doggis Company Group S.A. to develop the brand domestically.

On top of this, and this is where things begin to get exciting. BFFC also owns the master franchise rights to the KFC brand through its agreement with Yum! Brands as well as the largest domestic Pizza Hut franchisee in Brazil. To compare, this would be equivalent to Burger King (The 2nd largerst fast food chain in the US) also owning the rights to operate and franchise both Wendy’s/Arby’s and Yum! Brands (KFC/Pizza Hut) themed restaurants in the country. If this were to ever happen (this is unlikely due to the anti-trust concerns which would very likely be brought forth) the combined entity would create a very clear front-runner for the place of largest QSR chain in the nation. This is the fortunate spot that BFFC now finds itself in Brazil where the consumer food service industry grew over 10% in 2010 and is expected to continue this cumulative annual growth rate for the near future.

On the second point, regarding economies of scale. BFFC’s true cost savings and lower per-unit expenses should begin to be realized over the next few years as its multi-brand strategy is implemented on a larger scale than at the present while also having some time to mature. As an example, total operating costs declined to 92.1% of total revenue in the first six months of this year. This was mainly attributable to an improvement in profitability at its outlets and also due to improved franchise margins, largely because of the higher margin KFC & Pizza Hut outlets. I expect this trend to continue, despite increased expenses as a result of higher inflation as the company’s operations become more streamlined.

On the third matter of management, i am proud of what the present group has been able to accomplish since taking over operations in 1996. Ricardo Figueiredo Bomeny, the current CEO of BFFC has not only more than doubled the company’s store count from just under 320 when he took the reigns to over 735 as of this writing, but more importantly restored its operations to consistent profitability since 2004.

Even more impressive is the fact that Ricardo has set clear targets for the company of both top and bottom line growth of 15% on an annualized basis (which have been surpassed in the past and are well on track to do so again in 2011 through only the first half of the year) and communicated this to shareholders. In this time under Ricardo’s leadership BFFC’s Bob’s Burgers chain has also notched up 8 consecutive “Franchise Excellence Awards” from the Brazilian Association of Franchise (ABF) which recognized the support and work the company has provided to its franchisee partners.

More so, Ricardo has done this while receiving a comparatively meager (in comparison to CEO pay packages at similar size companies) total annual compensation of $238K.

I am counting on Ricardo and his team to pull off similar heroic feats if BFFC is to achieve its long-term goals and at the present rate, i doubt that i will be disappointed.



The Good, Bad & The Ugly

I am starting what i hope will become an annual tradition of going into depth about some of our capital allocation decisions from the past year and the successes and sometimes, inevitable failures which stem from such judgement. This should prove to be both enlightening as well as educational to both our partners and ourselves as it can be said that one always learns more from so-called failures and setbacks than successes.

With that, i am happy to report that while this past year has been far from perfect (as evidenced by our satisfactory, yet un-exciting performance) our errors were predominantly those of omission rather than commission. Therefore we can thankfully skip the ugly and go straight to the bad:

Brazil Fast Food Corp.

While we believe that the decision to purchase a stake in BFFC is one that will pay dividends (literally) for years to come, our only regret is that our purchase was not made in greater quantity. The reasoning behind this is very simple. For better or worse, it is presently our policy to “average in” to our investments. Meaning that we do not purchase the entire stake we intend on ultimately accumulating at any one time, rather we phase our purchases out over several months or more.

This is done to provide our partners and ourselves with as much opportunity as possible should a drop in a company’s or security’s market value follow immediately after a purchase has been made. Like all other human beings on the planet we cannot predict the future and unlike some market forecasters and analysts we do not even attempt to try to figure out such a complex equation. So, should a fortunate event such as a drop in prices and values occur, we can lower our avg. purchase price and thereby add to our position at an even lower valuation which is one of our foremost goals: To purchase good or better yet great businesses at prices which are substantially below their approximate intrinsic value.

Our intentions in the case of BFFC were no different. However, what ended up occurring and what there is no defense against, is that the company’s share price began a dramatic ascendancy immediately after our initial purchase, from just $8.12 per share in late January at the time of our purchase to over $13 per share by mid-late March and even higher thereafter.

While helplessly looking on, myself and my partner Graham Young made a decision not to stray from our principles and wait it out, adding to our stake only once the price returned to a level not far above our initial purchase price of $8.12 per share. This sadly never occurred through the remainder of the year. Luckily, the new year provides us with a fresh opportunity to rectify our error and we intend to do just that; as we will at some appropriate point in time increase our small stake in BFFC.

Rifco Inc.

Rifco National Auto Finance has been on our radar for a while now. Ever since i had the pleasure of meeting both the company’s co-founders, CEO Bill Graham and CFO Lance Kadatz at the Small Cap Conference in Vancouver, BC back in the early fall of 2010.

I was immediately impressed both by their shareholder oriented approach as well as their track record at the helm of the company since its founding in 2002 to the present. Rifco, based in Red Deer, Alberta provides non-traditional auto financing to individuals in every Province in Canada (Except Saskatchewan & Quebec) has increased its total loan originations from $1.83 Mil. in 2003 to $43.9 Mil. at the end of fiscal year 2011. During this same period, top line revenue has organically grown from $408K to $16.5 Mil. as has net income from $205K in 2003 to $3.01 Mil. in 2011. All the while the avg. percentage of delinquent loans (over 30 days past due) has decreased from approx. 5.1% in 2003 to slightly under 1.9% today. Borrowing costs for the co. have also come down over the past 8 years.

Easy to understand business, increasingly profitable operations, shareholder oriented management, what’s not to like? Well since Bill, Lance and their team have done such a wonderful job, it should come as no surprise that the market has responded in kind and rewarded the company with a lofty valuation. As i write this the shares are trading well above book value and at more than 18 times most recent earnings.

In such a case one must remember that the inherent margin of safety in an investment purchase is large at some small price, slightly less at a higher price and non-existent at some still higher price. Additionally, one must account for the very real possibility of error in estimating a business’s intrinsic value, therefore the careful investor will purchase a business only once a substantial discount to approximate intrinsic value exists.

While we would very much like to own a minority stake in Rifco, we will not do so at today’s prevailing price, since our all important margin of safety would be slim to none. Instead we will wait for the market to offer us a more sensible price, which it will inevitably do. We do not know when this will occur, but me and Graham are patient fellows and we are willing to wait it out.

Our only mistake here is not finding out about Bill and Lance’s treasure of a business sooner than we did, for which i take full responsibility.

IFL Investment Foundation

IFL is a closed-end investment holding company whose only operations consist of its holdings in other publicly traded entities in Canada.

IFL's portfolio consists of 17 large-cap TSX companies with the three largest holdings being:

- Bank of Nova Scotia

- Ritchie Bros. Auctioneers Inc.

- Manulife Financial Corp.

Certainly all businesses which we can understand.

The company's investment holdings are currently worth $17,028,430 while the firm's market cap is currently only $13,300,000. Meaning the current net asset value of each share is $217.50 while the quoted price is only $166.50 per share.

At the current price one could not go wrong as a clear margin of safety exists. Indeed, when IFL initially came to my attention back in late July, the market value of the company was only $14.2 Mil. or approx. $177.60 per share. Not as large of a discount but still significant nonetheless. Naturally, a position was established right? Wrong. This is the part where the previously alluded to thumb sucking comes in. Additionally, some foot dragging occurred in combination with the thumb sucking making for a deadly tag team which equated to nothing getting done.

Now in our defense (if one can even be made) we viewed IFL simply as a potential temporary holding from the get-go. Our intention was to hold on to the company’s shares only until the market realized its error and re-priced these above the net asset value of the company’s holdings. Since i am not one to settle, i thought it wise to keep searching for businesses to make permanent or long-term holdings rather than tie up funds in anything else and i just let the cash sit.

Unfortunately, this story has a bitter ending. Back in October the company’s President Scott Fraser announced that the firm will be wound up, due largely to the negative tax environment which now exists in Canada for income trusts as a result of a change in legislation stipulating that such a structure will now be taxed at the normal corporate rate (varies depending upon Provincial rates) whereas significant exemptions from such taxation previously existed.

Immediately i was saddened by this as surely it didn’t cross my mind that a portfolio liquidation would occur in such a short span of time and that my opportunity was missed. Alas, in early Dec. the company adopted a special resolution, stipulating that the corporation will cease to carry on business and that it will proceed with the orderly liquidation of its assets and distribution of the net proceeds to shareholders. Accordingly, the firm’s shares will be de-listed from the TSX-V at the close of business on Dec. 30.

While this is certainly a positive development as shareholders who purchased their shares at or near currently prevailing prices will ultimately receive a return (anywhere from 20-30%) on their investment above the acquisition price.

The distribution date of the liquidation proceeds has not as yet been determined and i will certainly be sure to include an update on this in next year’s letter assessing the damage, for the time being this adds another notch to our growing mistakes of omission list.

The clear lesson to be gleaned from this is that once a good business or indeed a security is identified, which is selling at a sensible price with a clear margin of safety present, all other considerations concerning economic conditions, market conditions or future prospects should be cast aside and a purchase should be made given the facts which are available at the present time.

Now that our self inflicted scolding or rather wrist slapping is through, lets turn our attention to some of the things we got right in the past year, to put a new twist on an old expression: Let the gloating begin!

Hart Stores Inc.

In this particular case i would like to share with you some notes i initially circulated to some partners back on January 31, 2011 concerning Hart Stores:

“The initial attraction to the company came via an initial screen whereby at first glance, the company was trading at below its net working capital (liquidation value).

After adjusting the assets down to what can be considered their true liquidation value we find that the company does not pass this test. Inventory is their largest asset and Cash the smallest. After adjusting the inventory down to approx. 40% of its stated book value (which is what we believe
can reasonably be obtained for the goods in the event of a liquidation) we arrive at a figure substantially below the prevailing price today.

If these positions were reversed (cash as the largest asset and inventory as the smallest) I would feel much better about the company's prospects than at present.”

Now let me be perfectly clear, that while the above analysis did prove to be correct as Hart Stores ultimately filed for bankruptcy protection in Sept., which it was granted and the chain is now attempting to re-structure its outstanding debts. I performed no extraordinary feat with my analysis, in fact i did not even mention bankruptcy as a likely scenario in my original analysis. I was simply able to side-step an un-pleasant scenario by adhering to a few basic principles which have been around since before my grandmother was born and which all lead back to focusing on underlying business values rather than market values, stock price movements, peer comparisons or anything else.

I detailed some of these principles in the “Ground Rules” section of this letter.

FP Newspapers Inc.

FP Newspapers Income Fund indirectly owns a 49% interest in FP Canadian Newspapers Limited Partnership (FPLP)

FPLP is a limited partnership which publishes and distributes the Winnipeg Free Press and Brandon Sun newspapers and also consists of the Canstar Community News division which publishes eight weekly newspapers also in the Province of Manitoba, including Uptown Magazine, an entertainment
weekly and The Times which has served six local communities since 1973.

With the Winnipeg Free Press having been around for well over a century, since being founded as the Manitoba Free Press in 1872 it’s durability is unquestioned, serving as Canada’s oldest running newspaper.

Its underlying economics are another question, while the newspaper and periodical industry in Canada has performed about the same as its counterparts around the world over the past decade, in that revenues have remained approximately flat while expenses have continued to rise.

In Canada, between 2010 and 2000 operating revenues have increased by approximately 3.00% per year on average, while total expenses (labor, cost of goods sold) have increased by an average of 2.7% per year over this same time period according to Statistics Canada. This 0.3% margin between
growth in revenue and expenses may not seem so bad on the surface but when you consider the fact that expenses have accelerated their upward climb at an ever greater pace since the late 1990's the trend is all the more troubling.

Nonetheless, our hat goes off to Ronald Stern, President & Chairman of FP and his team for increasing both readership and digital revenue by 25% and 5.4% respectively in 2010 on a year over year basis at FP. Additionally, they have done a commendable job expanding the paper’s digital footprint, which is a major area of focus for all newspaper publishers today. Revenue from digital is expected to grow from its current base 2% per year at FPLP through the launch of new products such as WFPtv (new digital platform for video advertising) and SwarmJam (a group buying site dedicated to local communities)

Even more importantly, the present management has had the wherewithal to distribute monies out to shareholders when it can not earn an adequate return being deployed back into the business. FP as an income fund currently has a monthly distribution of 5 cents per share, which goes to yield approx. 16.09% on an annual basis which may just be the highest corporate dividend yield in Canada.

While Ron and his team are doing their best, they are faced with a predicament which we briefly touched upon earlier and that is “when a good manager encounters a bad business, it is the reputation of the business which remains intact.”

Indeed, FP’s high cost structure coupled with its legacy liabilities have been a drag on the business this past year and has pushed operating margins lower in 2011. This in turn has caused the company’s market value to languish by some $10 Mil. since we initially looked at the business back in July from $35.2 Mil. (As at July 21, 2011) to $25.7 Mil. at the present time.

The takeaway from this at least for us, is that one cannot and should not blindly jump into businesses which appear cheap simply based on a few valuation criteria. One should look at a business’s underlying economics before deciding whether a margin of safety does indeed exist at the prevailing price or if the business is cheap for a fundamental reason.

That is the trouble with stooping for cigar butts, which Benjamin Graham mastered. You never know when you are going to pick up a dud with no puffs left in it.



This letter will be read by a varied audience, and it may be possible that we may be able to help some members of this audience and they may be able to help us.

If you or someone you know is:

(1) Looking to protect their capital (principal)

(2) Looking to earn a satisfactory return on their capital

(3) Looking to achieve the first two objectives while taking on substantially less risk than the market as a whole

(4) Is long-term oriented and can afford to be so

(5) Is looking to align themselves with people who are honest, intelligent and energetic

We will not take on partners who do not fit within the above criteria, neither will we accept capital from those who are short-term oriented and looking to simply make a quick buck while taking on a substantial amount of risk.

For those interested, the best way to reach us is to contact us directly at info@grahamtheodor.com



Anyone finding themselves in the Vancouver, BC area (not to be confused with Vancouver, WA) who is also an active investor and enjoys learning, discussing and meeting other like minded long-term investors. I hereby extend an invitation to attend the Vancouver Value Investors Club.

Meetings are hosted monthly (typically the third or fourth week of the month) by myself at the local Simon Fraser University campus in downtown Vancouver and a variety of investment case studies and lectures are usually presented after which a lively discussion ensues.

While the attendance is still small, i am hoping to gradually increase it throughout 2012, the debates are thought provoking and the fellowship is good. If you decide to make it out, i can promise you that you will not be disappointed and that you are certain to learn at least one new thing which you can apply in your own investing journey.


Theodor Tonca,