petec

To clarify - there is a schedule of *options* for Fairfax to buy back. From what I hear they are unlikely to do so. I think the key part of this deal is that they have deconsolidated Riverstone UK, meaning it can lever up without affecting the FFH balance sheet. Apparently it needs to lever up to compete. I don’t think FFH will want it on their BS in future.

The deal was worth $100m in HN shares when it was announced. Less now, and as you say we don’t know what was paid for Carillion so it’s hard to judge success. Also, at the time we were told Quess advised on the deal but didn’t have the cash to do it themselves, so it’s a bit odd they’ve now sold it to an entirely different operator. Prem said (on the AGM call I think) that there is $1bn more to come in monetisations, which suggests to me they’re basically getting out of the entire private non-insurance portfolio.

Would you ever expect them to trade above par, given how low rates have gone? I need to look at the terms again.

Value investing suits resource sectors very well. Nobody knows where commodity prices are going in the short term, but they’re fluctuate fairly predictably around the marginal cost of production in the long term. That creates the opportunity for value investors to buy when the market is panicking. In theory at least, cyclical sectors are far more likely to provide value opportunities than non-cyclical ones, where the value opportunities are rarer and more company-specific.

I wish Prem could write that clearly. The section on value investing is good. Also annoying to see RFP announce a $100m buyback and not execute any of it in 1Q.

Thank God the leader of the free world is an intellectual colossus, eh? Hardly so. However, the US can take a few punches while Brazil cannot. It’s mostly because theYS can print $ and borrow trillions for almost nothing. Brazil cannot do that, their currency tanked already and they have issues with inflation as is.. Agreed. That said, Brazil has been on a disinflationary trend for 30 years and pre-covid, inflation was well anchored in the low-mid single digits. The pension reform done last year was a big step towards controlling the deficit, which will help. And while the president is a moron the finance minister is superb and the administration has been doing a great job of improving business conditions. Your point stands, but there are counterpoints, and the real question is: what's already priced in?

Canacol BBU

Dundee has agreed to sell 20m shares in DPM at 6.35 and warrants for a further 10m at 8. C$127m to Dundee and $C207m if the warrants are exercised.

@Viking - thanks. On Emerging Markets, a couple of thoughts. Currency will be a drag over the long run if local inflation is higher than dollar inflation. But currencies are very volatile around that long term purchase-parity trend. EM currencies are largely cheap today and more likely to be a positive than negative contributor on a medium term view. Also, the inflation that drives EM currencies down over time also drives nominal GDP, revenues, and profits up over time. In the very long term it is likely a wash in that sense. The real impact of inflation a higher cost of capital. As a result of this, the best EM companies are some of the best stewards of capital I know of (but some of the others are awful). Bottom line: for long term investors like Fairfax I don't worry about the impact of currency but I do worry about political risk and I always look at ROIC in real terms. EMs certainly have their problems. A good way to think of this is that India's GDP/capita is $2,000. With all the technology, knowledge, and capital available in today's world it takes a really shit system to keep GDP/capita down that low. Even Brazil is 5x richer. But the positive side of this is that relatively small improvements in the system can have outsize effects. Progress is slow, but many emerging markets are moving forwards with better institutions, better regulations, better business conditions. And technology is turbocharging the process. The availability of technology to the man on the street, no matter how poor or poorly educated, is just incredible, and it is beginning to allow him to throw off the systemic shackles. A farmer who had to rely on the middleman to tell him the price of his crops can now check online. A family that can't access basic education can now get it on a phone. A bank that has not been able to address 50% of the population because the price of processing account and loan applications in branches is prohibitive for small amounts, can now address everyone via an app. This is transformative. India and Africa may not reach our standards of living - possibly ever - but they will make enormous strides over the lifetime of Fairfax's investments, and lots of money will be made along the way. As a related aside, one of the things that intrigues me about Fairfax is whether they will be able to share knowledge effectively across their sprawling empire. For example they have Digit in India. Can they export that approach to Fairfax Latin America, or Atlas Mara, or even Eurolife? Can CIB teach them how to operate UBN or CSB? There's a lot of cross-seeding in the portfolio - Richie Boucher (who led the turnaround of Allied Irish) is on the board and risk committee at Eurobank, and Hisham Ezz Al-Arab (the CEO of CIB) is on the board of Fairfax Africa. On paper there is enormous potential here and I almost feel Fairfax needs someone to coordinate this (as Carmilani is set to do on the insurance side).

Thank God the leader of the free world is an intellectual colossus, eh?

India story seems to be a mirage. Though we have heard many plausible explanations on why India is what China was 20 years ago, the ground reality seems to suggest a very different picture. In fact this is self-explanatory when one looks at the last 10 years, both in terms of the growth of the economy as well as the market returns. The S&P dollex 30 has given less than 20% total return in last 10 years and almost negative since the current government came to power 7 years ago. So much for the supposedly "world's fastest growing economy" !! This performance is with the fantastic global tailwind of low oil prices, low interest rates, flood of cheap money apart from the usual demographics, large market size etc that people talk about. There is no change in the modus operandi of buying political votes by distributing free money at the cost of investment in infrastructure, health, education or other economical development. India continues to run twin deficit, have high unemployment, has trade deficit, saddled with bad loans in the banks/NBFCs, poor infrastructure, heavily dependant on imported oil/gas etc and we don't even want to discuss the poor corporate governance, weak judicial system, bureaucracy and red-tapism etc. I can give concrete examples of industry after industry that are getting killed due to bad policies. Sorry to have side-tracked this post which was about Prem's letter and Fairfax. Actually, that just makes the analogy with China even better. The Chinese index has been one of the worst-performing in the world over the last 30 or so years. On the bright side: 1) I think you make the most money when you go from bad to less bad, not from good to great. There's a plausible argument that India is going from bad to less bad. 2) Growing EM's offer huge opportunities for investors in high-quality, deep-moat, high-ROIC companies that benefit from a growing middle class, even when the relevant index (often dominated by capital intensive old world companies) aren't doing well.

I think this is absolutely right. But I would love to know how you came by the information about Ajit Jain?

Yes, it’s pretty normal for an analyst to cover the same stock for a long time. Dwelle knows Fairfax well.

I am not arguing it is not a liability. But there are liabilities we don't capitalise. I am on a 3 month notice period. Does my company capitalise that liability? No. The fact that the economics are different does not mean one side is taking a massive bath on the deal - it just means they're sharing the risks and rewards in a different way. If the price of planes doubles in your example, the beneficiary is the airline in one case and the lessor in the other. Surely that's a different economic outcome?

Yes. I tend not to for one-off deals that were used to create a company some time ago, but I do for ongoing rollups.

Well that's kinda the point ;) Nobody thinks accounting is perfect. We all adjust accounting to get at what we judge to be the underlying economics of the business. IFRS recently changed its treatment of operating leases. It seems fair to ask whether the change was right.

OK. First, I should have clarified that I am thinking about operating leases here - in other words, leases where you don't own the property at the end of the lease. On the asset side it should be blindingly obvious that the economics of owning a property are different to the economics of owning the right to use a property for a defined period. On the liability side there are two key economic differences: I don't have to put up equity for a lease, and I don't own the property at the end (as I would with an amortising mortgage). In other words, I do not have to employ any of my capital. There is also a practical difference: some lenders look at LTV across the whole portfolio when assessing a mortgage on a single property. I don't think most property owners do this when considering a lease but I may be wrong. The combined effect of these factors could have a significant effect on (for example) a retailer's ability to grow. One of the key uses of ROIC is to assess the rate at which a business can grow without needing financing, so capitalising leases for ROIC might give a false output here. It may be that the answer is to capitalise operating leases for some purposes but not others. But overall I think they are more economically equivalent to a fixed operating cost than a debt obligation.

Doesn't it? If I lease a space for a restaurant, my economics are very different than if I borrow money to buy the plot.

What do people think about the capitalisation of leases? On the one hand, leases represent a commitment to pay, and so can be looked at as debt and capital employed. On the other, a) leases don't represent a capital outlay, so they're not capital employed, and if you include them for ROIC you'll underestimate potential cash flows. b) there are plenty of commitments to pay that don't get capitalised as debt. For example, a company has to pay its employees (contractually for their notice period, and logically for the life of the company) but these costs aren't capitalised. Do you include lease liabilities in EV when valuing companies or in invested capital when calculating ROIC? I tend to think they should not be capitalised, but instead thought of as increasing operating leverage.

Bloody hell! How much power does this court have?

Stelco did an interesting deal a couple of days ago for a) iron ore supply for 8 years and b) an option to buy a 25% take in a low cost iron ore mine at a price they describe as being well in the money based on their scenario analysis. The deal presentation is worth a look for anyone interested. Stelco may not be a great business, but I am inclined to agree with Prem that it is well managed. Capital allocation has been strong. And it will generate a lot of cash over the years (in bursts). The only thing I don't like about it is the employee liabilities. These are fixed, which is good, but they're understated on the balance sheet because they're discounted at a high rate. I can't make up my mind whether to capitalise this liability at the balance sheet value or the undiscounted value.

This is a very good way of putting it. They made some excellent investments, but they made too many duds, and they hedged. My guess is hubris and/or complacency (which are highly linked at a subconscious level) plus distraction (time spent on assembling and managing Fairfax's sprawling insurance business, rather than on investing) led to them applying simplistic heuristics (e.g. low p/bv, or supposedly great management) to investments rather than doing really hard investigative work.

The opportunity cost - in capital but more importantly in time - has been immense. What's interesting is how few decisions they were away from doing really well over the last decade. If they had (1) not hedged, and (2) invested in (say) Microsoft and JNJ, both of which were cheap, instead of (say) Blackberry and Resolute, then we'd be having a very different conversation. It really does not take a lot to turn this ship. In light of this I find the extensive discussion about the broader investment team encouraging. I very much like some of their investments here, especially Atlas and Eurobank, so I don't want them to sell everything and start again. And I don't want them to give up their value style - I can easily invest in the momentum* stocks of the day myself, if I want to. But I do want them to protect downside better. They did this brilliantly with Atlas (consider that despite coronavirus, which was more or less completely unforeseen, Atlas still trades above their going-in price) but extraordinarily poorly with Resolute, the initial investment in Eurobank, Stelco, and others. In the letter and the AGM call Prem was quite clear that the team has an increasingly significant influence, both via direct management of part of the portfolio and via input on Prem, Brian, and Roger's decisions. I think this shift will accelerate, if only for psychological reasons - giving up control is not easy, but once you've accepted the need to start it's easy to take the incremental steps. I expect the old guard slowly fade into the background here. Actually, I speculate whether the purchase of preferred shares by insiders isn't a sign of this. Some of these guys are of an age where income might be more important than capital growth. At some point the position will be reversed: Wade & team will run the portfolio and Prem, Brian, and Roger will consult. *This is not an implied criticism of these stocks - it's just that I consider value and momentum to be at opposite ends of the spectrum, not value and growth. You can be a value investor in growing stocks, but not in momentum stocks.

+1

The problem with the cigar butt framework is it isn’t really what they do. To me, cigar butt investing means investing in a declining company at a price that makes up for the declines. Maybe a few holdings fit that description but there are plenty that don’t (Eurobank, Seaspan, Quess, Kennedy Wilson, BIAL, BDT, ICICI Lombard, TCIL, CIB, CSB, UBN, etc etc). My critiques of Fairfax’s long equity investing are that: 1) they are happier with leverage than I am. 2) they are wrong too often. The combination is dangerous. Edit: I’ll add 3) I don’t understand why they held Quess at 30x, and even wrote about how fast growth justified Indian valuations at those levels, but then dedicated a page of the annual letter to why businesses like Microsoft (a FAR better business than Quess) don’t deserve that sort of valuation.