What Bothers Berkowitz about Pharma

Mike Breen: Greetings, this is Mike Breen from Morningstar in Chicago. I am speaking via phone today with Bruce Berkowitz, the manager of the Fairholme Fund.

How are you, Bruce?

Bruce Berkowitz: I am great. Good talking with you, Mike.

Breen: Bruce was recently named Morningstar's Domestic Equity Fund Manager of the Year for 2009, but also the Fund Manager of the Decade, for the past decade. Congratulations, Bruce.

Berkowitz: Thanks. Thanks to Morningstar.

Breen: No problem, we just call them as we see them. And for background, the Fairholme Fund returned about 13% a year over the past decade, during a time when the S&P 500 basically broke even.

Bruce and his team made a series of remakes to the portfolio over that time, selling things when they were high and getting into cheaper areas--very successful. Congratulations, Bruce.

Berkowitz: Thanks. That was the last decade; now it is time to move on.

Breen: Absolutely. As we discussed before, that concludes the history portion of the interview. Now we will move into the "what have you done for me lately" phase of it.

Your new portfolio just came out just the other day, and you have actually made quite a few moves with the Fairholme Fund. Maybe you could start by letting us know about a few things that you have sold recently that previously were substantial positions in the portfolio.

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Berkowitz: The big sales were Pfizer, defense related, Boeing, Northrop. At Fairholme we continue to sell that which is cheap to buy that which is cheaper. When we went into the drug industry and the defense business, it was defensive, we saw a storm coming. And we were right; these companies have maintained reasonably good earnings.

But to some extent we were mistaken, because we found that when you are in a tremendous crisis, everything is correlated. And we were hoping that the companies would protect us more than they did. But we did all right.

But now that we are through this financial earthquake, even though we expect maybe a few more aftershocks, we do expect a more normal environment. So we are shifting from defense to offense, and we need the cash, so we have moved on to some new positions. We are absolutely sure companies we have sold will do quite well. But I think we can do a bit better as our optimism about the future grows.

Breen: With Pfizer in particular, that was taken down from a double-digit position, and you still have a small stake, a couple or three percent. Were there any company-specific issues there that were maybe not clouding the entire future picture, but maybe making you a little less confident?

Berkowitz: What bothers me about the pharmaceutical industry is the use of very low tax rates based on offshore businesses. But that money eventually has to come back to the U.S. It is going to be somehow passed to shareholders where taxes will be taken. So the use of very low tax rates is somewhat bothersome, even though it is GAAP.

And of course, the only other area that always bothers me in almost all industries is the recurring nonrecurring expense. In the pharmaceutical business it seems to be tremendous amounts of recurring nonrecurring expenses, which is the nature of the business.

That is all, those are the parts that bother me, but we are fully aware of them, and the price was right. But with the further collapse of the financials and the health insurers, there became a better proposition.

That is, investing is all about what you give versus what you get. So we are constantly looking at the price of securities versus our expectation of the amount of cash that those securities will generate over the lifetime of the investment. And since a dollar doesn't know how it is made, and we have to put ourselves in the shoes of our shareholders every day, we are going to go for the best possible risk-reward ratio.

Breen: OK. And to clarify you actually made a decent return on Pfizer. You bought it in '08 and averaged down a little bit, so it is not as if you did not have a return, correct?

Berkowitz: We did OK, but nothing to write home about. I don't look at it as a win, nor do I look at it as a loss.