petec

Brief history of the Farmers Edge investment: Dec 31/17: 46.1% owned with a Fair Value (FV) of $ 95 million and a Carrying Value (CV) of $88.1 million (the 46.1% interest acquired for $95 million on March 1/17) Dec 31/18: 49.2% owned with a FV of $66.6 million and a CV of $66.9 million Dec 31/19: 50.4% owned with a FV of $43.8 million and a CV of $41.0 million Sept 30/20: 50.4% owned with a FV of $43.8 million and a CV of $41.0 million Note: All amounts in USD. Are you sure you're capturing all of the investment? The investment is via convertibles and warrants. From memory (I need to check the red herring) Fairfax has convertibles worth $220m. I don't think they were written down to $40m but could be wrong. I'm wondering if your figures represent the value of the convertibility feature plus the warrants (i.e. the equity) but not the debt? Is that possible? I'd love to be wrong. Edit: having checked the 2021 thread where this was discussed in detail, according to the prospectus Fairfax has $273m of convertible debentures ($225m principal plus accrued interest). It also has warrants. Were these written down? If not then I don't think the carrying value of $40m can be right. Edit 2: the final prospectus confirms that the consolidation ratio will be 7:1. This means that Fairfax's cost for most of thwir shares will be $2.40 (the conversion price of the debs) * 7 = $16.8. So Fairfax won't make much of a gain on the debentures at the IPO price. They will record a gain on the warrants but they only have about 2.5m of them after the conversion (so a gain of about $40m). Here's another try... Value of Farmers Edge shares held by Fairfax at IPO: US $340.3 million (25.023 shares x CAD$17 x .80 conversion to USD) Investment into Shares: Sept 30/20: Carrying Value of $41.0 million for 50.4% per Fairfax Q3 2020 financial statements Plus another 9.5% acquired immediately prior to IPO from the following: Conversion of Fairfax Debentures and Accrued Interest: US $219.5 million (from final prospectus CAD $274.4 x .80 conversion to USD) Fairfax purchase of portion of shares held by Osmington prior to IPO: US $19.2 million (from final prospectus CAD $24.0 x .80 conversion to USD) Total Investment by Fairfax into Farmers Edge shares prior to IPO: US $279.7 million ($41.0 +$219.5+19.2) Accounting Gain to be Recognized by Fairfax Upon IPO of Farmers Edge: US $60.6 million ($340.3-$279.7) Ok. So the equity and the debentures are carried separately on Fairfax’s BS? Because if not (ie if the debs got written down and are included in the $41m) then the gain is much bigger.

I agree. Was thinking some 5y and maybe pockets of opportunity in corporate.

It will be interesting to see if Fairfax have found any bond opportunities in this little yield spike. Can’t imagine they’ve moved big but they might find something.

As part of the IPO, the convertible debentures are converted into shares. SJ And the warrants are exercised, and Fairfax buys $24m worth from another investor.

So, it's good if FFH can IPO these outfits and book a gain. It pushes up their equity number and gives a bit of slack on the revolving credit facility covenants. It might even enable some of the insurance subs to increase their underwriting volume. It also gives a higher profile to those companies which might turn them into acquisition targets in the future (ie, it could facilitate an exit). However, while this will increase reported earnings, it looks like there will once again be a bit of a quality of earnings issue in 2021. If all four IPOs come to fruition during 2021, it will likely give the appearance of high earnings, but clearly this is not something which is repeatable every year, nor do the "earnings" from these exercises result in any cash that can be used by the holdco for debt repayment, dividends or share buybacks. While the gains are a credit to management and reflect good decisions made in the past, when thinking about the longer term valuation of FFH, it might become important during 2021 to use some sort of adjusted income number. It's a good outcome, but it will definitely muddy the accounting numbers for the next year or two. SJ Stubble, i like many things about what Fairfax is doing with the IPO process: 1.) additional disclosure provided on companies and their business models 2.) significant funds raised from IPO will help companies be successful in future 3.) timing of IPO’s is very opportunistic (given high demand) and look to be at premium valuations 4.) significant funds raised from IPO will hopefully eliminate need for Fairfax to provide any further funding in future. This is a big deal and should help cash flow at Fairfax moving forward. 5.) with shares publicly traded Fairfax will have mechanism to exit more of position in future if that is what they want to do 6.) post IPO, with shares publicly traded, investors will have much better visibility into valuation of Fairfax’s many equity holdings (and reported BV) Absolutely right. The point about cash flows is huge. These things can now grow without imperilling Fairfax's ability to do the same. It's true that earnings are overstated when there is a gain. But equally they are understated when there isn't one (hopefully). Personally I think it's wiser to value this using book value and a sense of what X% CR + Y% investment returns - holdco costs could yield on average over time. I no longer worry about cash at the holdco. Prem has proven that whether it is outright (Riverstone UK) or via the discount window at his personal LOLR (OMERS) he can access cash by selling stakes pretty much whenever he wants. And crucially, he can do it well above BV, which "underwrites" the goodwill at the holdco.

Brief history of the Farmers Edge investment: Dec 31/17: 46.1% owned with a Fair Value (FV) of $ 95 million and a Carrying Value (CV) of $88.1 million (the 46.1% interest acquired for $95 million on March 1/17) Dec 31/18: 49.2% owned with a FV of $66.6 million and a CV of $66.9 million Dec 31/19: 50.4% owned with a FV of $43.8 million and a CV of $41.0 million Sept 30/20: 50.4% owned with a FV of $43.8 million and a CV of $41.0 million Note: All amounts in USD. Are you sure you're capturing all of the investment? The investment is via convertibles and warrants. From memory (I need to check the red herring) Fairfax has convertibles worth $220m. I don't think they were written down to $40m but could be wrong. I'm wondering if your figures represent the value of the convertibility feature plus the warrants (i.e. the equity) but not the debt? Is that possible? I'd love to be wrong. Edit: having checked the 2021 thread where this was discussed in detail, according to the prospectus Fairfax has $273m of convertible debentures ($225m principal plus accrued interest). It also has warrants. Were these written down? If not then I don't think the carrying value of $40m can be right. Edit 2: the final prospectus confirms that the consolidation ratio will be 7:1. This means that Fairfax's cost for most of thwir shares will be $2.40 (the conversion price of the debs) * 7 = $16.8. So Fairfax won't make much of a gain on the debentures at the IPO price. They will record a gain on the warrants but they only have about 2.5m of them after the conversion (so a gain of about $40m).

Bear in mind rates and inflation don’t have to move the same way. I can easily imagine a period of financial repression, with policy designed to drive slightly higher inflation while keeping rates low. Dangerous game to play, but ultimately the only realistic solution to high debt levels.

It’s a platform for investing in infrastructure that allows them to attract third party capital. I don’t know whether FIH will just own a stake or take a fee for managing it. I don’t see a negative other than complexity. As a FFH shareholder I’d rather see FIH trade at fair value and issue equity to fund Anchorage internally, because more fees to FFH!

Announcement re efforts to renegotiate holding company debt at Atlas Mara: https://otp.tools.investis.com/clients/uk/atlas_mara1/rns/regulatory-story.aspx?cid=744&newsid=1453476

Xerxes, you’re right that they might lock in too soon. But there are a lot of “ifs” in your thesis and personally I’ll wait until it’s happening before I worry about it! The one thing I think you might have wrong is the speed of an inflationary bond bear market. Yes, the bull has lasted 30 years - but the inflationary bear that preceded it was much quicker. Once people think inflation is coming, they start getting rid of cash, the money velocity rises, and inflation can come thick and fast. But as others have said, we may be a long way from the turn yet.

No, what I mean is that as they expand underwriting in the hard market float will grow. I think float/equity is about 3.3x at the moment. It can go to about 4x. That means more bonds and interest per unit of equity. Higher leverage basically, but via float, not debt. I disagree re losses in a bond bear market. That’s true if they choose to extend duration before the end of the bear. But if they stay in the short end of the bond market, they can keep rolling bonds onto higher rates throughout the bear, without incurring losses.

Biggest driver of this line will be rising float/equity (I think they will get to 4x) and any rise in interest rates.

The mention of container handling terminals made me wonder what sort of synergies there might be with Seaspan. Then I realized how Stelco could play into that as well. I thought the railways comment was interesting. Dear lord does India need investment in its railways. Seaspan and Stelco are independent so I wouldn’t draw those links necessarily, although something could happen.

https://www.thehindubusinessline.com/companies/fairfax-preps-for-bigger-play-in-infra-sector/article33896181.ece

Thanks for posting the presentation; i had not seen it before. The $100 in EPS is not a crazy number if you look at it as a rolling number from Q4 2020 (from when the presentation was made). Q4 came in at $36. We could easily see another $64 from Q1-Q3 2021 = $100 EPS. Agreed, although I think he meant ongoing. $20bn NPW, 90% CR, $500m in interest and dividends, and enough investment gains to offset holdco costs, and you're there. Unlikely, but not impossible, that they can sustain this for a couple of years.

Viking I largely agree with you although it’s worth remembering some of these tailwinds could vanish as fast as they appeared. I also think 95% CR is a probability, not a possibility. Excluding COVID they were at 93% in 2020. Can’t remember if this has been posted before: https://moiglobal.com/jeffrey-stacey-202101/ I particularly like his speculation on $100 in EPS ;)

Can’t make any sense of the 28.8% number though. I thought they’d owned over 30% for a long time. RFP is projected to make $240m of FCF over the next two years. Could make for a nice dividend.

Just checked Bloomberg and it says 37.47%. Resolute took the shares outstanding down from 87.1m to 81.5m in the second half of 2020 which is punchy!

Actually I think they own 37.something percent. They had 33% but Resolute has been buying back shares.

The other key part of the economics that we don’t know is OMERS’ anti-dilution clauses. The prices at which FFH injected equity were sometimes sky-high.

That’s really interesting, thanks. Probably a dumb question but where did you find the Brit filings? It’s pretty eye-opening to think the Allied World deal probably looks like this too. Works for FFH if they can grow BV >10%, but they didn’t. I suspect Eurolife is the only OMERS deal that was truly a win-win.

I think the 516/516 might be the result of a tax structure. Could the deal have been designed to provide a return via dividends instead of capital gains? But yes, in principle I agree OMERS is basically providing debt finance albeit I think they do take equity risk: - I am not sure FFH have to buy back the stake if they don't want to. - The valuation of Brit came down from 2018 ($251.8m for 11.2%) to 2020 ($206.6m for 10.5%). Looking at it another way, by my maths FFH has paid a total of $1.85bn for 100% of Brit (before then selling 14% back to OMERS). I think that's a good chunk more than they originally wanted to pay, for a lower BV since Brit BV has barely grown.

Additional perspective. Point 1: the difference in valuation is, in fact, larger. Point 2: it doesn't matter that much because FFH is likely to pay back OMERS over time based on the recent valuation (+ a dividend +\- 9%) Point 3: it's interesting though that, using their own (FFH-OMERS) internal private appraisals, IV growth at Brit had CAGR of about 8% since acquisition. Point 4: so the market just needs to recognize this now over time although delayed gratification may be indicated if buybacks are part of the picture. The 220M in Q3 2020 included an accrued dividend of 13.6M and the capital returned to OMERS appears to have been based to a pre-defined formula established at acquisition (summer 2015). So, the principal component paid back to Omers was likely based on a summer 2015 about 1.7B valuation. Still, these capital allocation moves raise some uncomfortable questions. I need to go through the numbers in proper detail. At the time, Fairfax said they had the right to buy the OMERS stake at cost plus about 7% per year. Brit didn't have to pay a dividend but if it did, OMERS got preferential rights. As you say, this only makes any sense if OMERS had downside protection, but Fairfax didn't mention this.

Perhaps. What it says to me though is “weak hands”. Can you imagine Berkshire ever playing such nickel and dime shenanigans! Yes and no. Clearly it would have been better to have more capital in 2020. But in the absence of that, selling Riverstone Europe and using OMERS as a LOLR allowed Prem to capitalize his better subs, buy back shares, repay revolvers, and prepare to increase his stake in Digit. So I’d characterize it as a weak hand played well.

Minor observation: In q3 FFH bought the last 9.4% of Brit for $220m implying a value of $2340m. They've just announced the sale of 14% at $375m implying $2679m. Obviously we don't know what Brit's BV is given its 125% CR in 4q and returns on investments, but in simple terms its good to see them selling at a higher price than they paid!