petec

I'm not sure most people realised *quite* how much value had been built! Most people were too busy getting their knickers in a twist about the hedges to notice what was happening on the other side of the world in FC and Lombard. As for what have you done for me lately: a) bought 44% of Seaspan at 5x earnings just as it exits a capex cycle springs to mind. b) the market will always pay a premium for predictable, or at least visible, gains. I prefer paying book value for companies that have a history of doing smart, but unpredictable things. Plenty of the investments here could do very well over the next 1-5 years and plenty more will be made. Well Pete, that was the point. You make your money when you buy, not when you sell. Crystallizing gains feels nice, but we should rather spend our time and attention focussed on what is currently being done to build value. I certainly don't question that good deals are being made that are improving IV, and seaspan is just one of those deals. More importantly, the insurance operations and investments seem to be aligning nicely for improved operating earnings. Those are the things that are being done lately that are actually creating value. sj Oops - I thought you were suggesting that they hadn't done anything lately. We are on the same page.

+1 You can hope all you like but I fear the big buyback ain't comin'. The cash is earmarked for buying the stubs of Brit (FFH have the option to buy OMERS' 29.9% from 2018 and the ticket will be over $500m) and Eurolife.

I'm not sure most people realised *quite* how much value had been built! Most people were too busy getting their knickers in a twist about the hedges to notice what was happening on the other side of the world in FC and Lombard. As for what have you done for me lately: a) bought 44% of Seaspan at 5x earnings just as it exits a capex cycle springs to mind. b) the market will always pay a premium for predictable, or at least visible, gains. I prefer paying book value for companies that have a history of doing smart, but unpredictable things. Plenty of the investments here could do very well over the next 1-5 years and plenty more will be made.

Yes - it's been superb. What I am interested to see is what happens after the Quess spin. Someone who met FFH recently says they think Thomas Cook itself is very undervalued, so there may be more to come. and I wonder if they plan to reduce Quess once the holding is at the Fairfax level given the headline valuation. But that is pure speculation - I don't know Quess well and if it can keep growing at the historic rate the valuation isn't so eye-watering.

Point taken, but for me there is a link. I have learned (largely!) to be able to tell when I want to buy something for the right reasons (deep value, differentiated understanding) vs the wrong reasons (I've done a lot of work, I like the idea of the company, etc.) I can't explain it well but it just feels different and it's quite consistent which feelings have worked well, and haven't, in the past. That's why in your shoes I'd be interrogating that subconscious of mine to understand why it wanted a particular analytical outcome! Still the question was idle interest and we are wandering off topic...

One other thing I would add is I think capital has been flooding into the insurance markets for the same reason it has been flooding into the bond markets: a desperate hunt for yield. It's therefore possible that rising rates will do FFH a lot of good on the bond side and on the underwriting side.

Out of interest, why? Emotional attachment, or because your subconscious actually thinks this is a good option?

And by the way I am not trying to persuade you. Each to their own. But when someone posts a logical anti-thesis I feel I need to test my ideas against it to see if they stand up. Always a useful exercise.

Actually I think quite a lot of American (and I assume Canadian?) English is closer to old English than English English is (if you see what I mean). But I couldn't resist the dig.

Cigarbutt Very interesting post and one I agree with to a very great degree. Where I differ is on the interpretation of Fairfax's investment moves. First, hedges. We can debate the hedges ad nauseam but I've come to the conclusion that they simply decided the cost - financially but I suspect also to the morale of the investment team working below those who were making the macro calls - was too great. Trump provided a catalyst and an excuse. Like that or loathe it, that was the right call: 2017 would have been a horrible year with the index hedges (they still lost $400m on the individual ones!). Plenty on here have voiced outrage at the bet taken, the sizing, the explanations, etc. I take the view that it is a lesson learned, and what matters is that the hedges are gone and are not coming back and that makes it much easier to see into the future. Second, "playing offence" - sorry but as a Brit I need to spell it properly ;). I have actually come to the conclusion over time that Prem is not good at communicating to the market and this is a prime example. Sitting in cash, which is what they have done, is not playing offence, and that phrase should never have been used. They have been clear about the risks that they still see, but with a pro-business government in the US driving global GDP they may not come to pass soon and hedging them is too costly. That doesn't mean they are bullish on equities or bonds - in fact they've been explicit that they don't necessarily expect equity indices to do well, and you can tell that they agree with you on corporate bonds by looking at how many they own (not many). What they do expect is for individual opportunities to arise ("stockpicker's market"), and cash on hand is helpful when opportunities appear. I also differ on needing to know where the train is going before hopping on. What I need to know is that there is a high probability of a decent destination, a low probability of an awful one, and a ticket price that doesn't reflect those probabilities. I think that's where we are here. Supporting my view of a high probability of a decent destination are all the things that have gone right over Fairfax's history. The hedges tend to cloud over everything at the moment but when you look at the history of compounding, the transformation of the underwriting, the ability to build businesses from scratch, the acquisitions of amazing insurers (Zenith etc.), the phenomenal performance in India, and the extent to which Fairfax seems to have become a talent magnet, I tend to think more good things will happen than bad.

Depends what you mean by lower for longer. If you mean rates won't go back to historical norms you're probably right - there's too much debt and the world could not survive it. Amazing to think that the 2y was at 6.5% in 2000. Those days are gone, and all else equal that must slow Fairfax's rate of compounding because earning 6.5%, levered by float and with no credit or duration risk, is a very nice way to make money. However, current rates still provide a very nice tailwind of 2.25% on near-cash (2y treasury) while they wait for better opportunities. That tailwind has not been present for a decade. Those better opportunities will either come along one by one as they did last year or, as Dazel says, if rates or spreads spike then a lot will come at once. Either scenario is positive for Fairfax.

Dazel I may have misinterpreted the comment I was replying to. I thought you meant Bradstreet would be hoovering up corporate bonds in the market right now. I'll be surprised if that is true - corporate spreads are still tight and ultimately it is only when they widen that you get disproportionate opportunity in corporates. However, if you're saying that as conditions tighten specific opportunities will present themselves for Fairfax, then I agree entirely. Ultimately I suppose what I am saying is that while a dislocation might be starting, it is only starting. Fairfax didn't spend the last 10 years worrying in order to get sucked in at the first hint of trouble. They are extraordinarily well positioned and they will be patient and wait for fat pitches. P

Good spot. They seem to be refinancing quite a bit at the moment although I haven't calculated the impact. These bonds actually yield 3% as they were issued below par but still, I'll take it!

Why would he buy corporates when spreads are still near all time lows? Or am I wrong? I would think he might be pulling the trigger on 2y treasuries at 2.3% with little duration risk. But I don't think you're getting paid for risk in HY corps yet. This isn't what Fairfax has been waiting for - yet.

Thanks!

Do you have a source for this?

Yes. There are some good presentations on the investor website and you can make a case that Greece will start reflating soon which would be great news. However the ECB stress tests in May will be key. Even if capital levels are ok the ECB and Berlin may insist on dilutive capital raises - they want Greece to exit its bailout this year and they don't want it to collapse back into bailout in a couple more years. Now, you might argue that even if they issued 100% more shares you'd still only be at 0.5x book...but that's the risk.

+1 and a politer reply than I nearly wrote!

+1 Ultimately I think good, motivated underwriters can grow float by spotting opportunities less capable people don't. Berkshire is one of the best underwriters around - and Fairfax, thee days, is also superb.

Hi StevieV. My post was just an explanation of the theory in response to a question about the pref/warrant deals. I didn't actually meant to imply that leverage would grow. But it's a good question. First, there's every reason to believe that premiums will grow in line with nominal GDP or faster and therefore float ought to do the same. If you don't believe that then you must believe either that insurance premiums will shrink as a % of GDP or that Fairfax will lose share. Yet insurance is materially under-indexed in developing parts of the world so it is likely to grow faster than GDP globally - and Fairfax will capture more of that than many north American insurers because it does a material amount of business in those developing areas. Also, my base case would be that well run, disciplined underwriters might take share over time because they'll have equity when others are struggling. Fairfax has a good history of finding niches and growing in them, and I won't be surprised if Fairfax take share in places where existing business is small (LatAm, Eastern Europe) and in India, where Digit is a startup and could grow very fast. Second, we know they can write a LOT more premiums in a hard market - possibly as much as double. That obviously doesn't double float immediately, but it does grow it. Third, we know they will buy the stubs of Brit, Eurolife, and AWH. That will add to float. And while big acquisitions may be off the table, I fully expect continued tuck-ins. In the long run that may not be enough to maintain leverage - Fairfax's mix may shift towards operating buisnesses - but that hasn't been too bad for Berkshire!

They are using float. The holdco cash is probably going to be used to buy the OMERS stakes in Brit and Eurolife when those agreements come due. But I wouldn't necessarily differentiate between float and holdco cash. The point is that float levers your equity - you get to keep the investment returns on a far greater amount of money that what you invested in the business. Here's how I understand it: The leverage is derived from the fact that when you sell an insurance contract, the buyer effectively lends you money (premiums come in now, claims go out later, and you get to sit on the money in the meantime). The cost of the leverage is derived from the CR. The amount of the leverage is derived from the value of the premiums you write and the duration of the contracts. So for example, if you write $1bn in premiums every year on contracts that expire after a year (e.g. a typical house insurance contract) you'll have about $1bn in float, because you get to sit on one year's worth of premiums before the claims go out the door. If your CR is 100, then that leverage is cost free. Bit if you write $1bn in premiums every year on contracts that expire after 10 years, then (once the business is mature) you'll have about $10bn in float, because you get to sit on 10 years' worth of premiums. If the CR is 98%, then you're being paid to borrow that money. Of course, long tail is riskier than short tail - you can't predict the exposures so well and something you didn't foresee, like asbestos causing cancer, can come back to bite you - so you have to be very careful with underwriting. So, let's say you have $1bn in equity and you write $1bn in premiums every year on 3 year contracts. You'd have $4bn in investable assets ($1bn equity and $3bn float). If you can underwrite at 102% you're going to lose 2% of premiums a year in underwriting profit: $20m. If you can invest $4bn in a 7-year Seaspan debenture at 5.5% you're going to earn $220m in interest for a total of $200m in annual income, before holdco costs and tax. If you've also got warrants exercising at $6.50, and the Seaspan share price goes to $13, then towards the end of the debenture you're going to exercise the warrants for $8bn(!!), paying by forgiving the debenture. Not a bad return on your $1bn of equity. That's the impact of levering equity upside using float. A few points to note: - I have oversimplified the relationship between contract duration and float, but I think the basic principle holds. - Fairfax currently lever their equity about 2:1 using float, not 3:1. But they could probably double premiums in a hard insurance market. If you double premiums across the board it would take time for float to double, but logically you'd get there if the hard market lasted long enough. Unfortunately I suspect the regulator or the ratings agencies would panic long before they got to 4:1 levered, but there's scope for some growth. - underwriting profit in any given year is calculated off the $ of premiums, not float. That said, you can look at the float and know, if the average CR over all those contracts is 98%, that you're getting paid 2% to borrow. - float gives you huge investing leverage whether or not the CR is over 100% - it's just that the cost of that leverage is lower with a lower CR. That's why this model is so powerful for compounding if you can get both underwriting and investing right. - the debenture + warrant deals are great in theory because the downside is bondlike, so the regulator looks at these as bonds, but in most cases the warrant strike price is quite close to the share price at inception, and the shares look reasonably cheap, so there is near-full equity upside. That's powerful, if they can do it with a significant proportion of that big bond portfolio. If they can do $1bn a year on 5-7 year terms then they can basically convert $5-7bn of that bond portfolio into securities that have bond downside but equity upside. That more or less doubles their equity exposure but only on the upside. Get that right and lever it with float and the impact on shareholder's equity could be spectacular. I hope this helps but sorry if I am teaching grandma to suck eggs.

that would require fairfax india to list in india for the minority shareholders of these companies? not sure about the exact rules, but as an investor in the indian markets, i dont know of any foreign company being dual listed in india. the reverse exists where a few indian companies are listed in the US via ADRs I think he's saying that FFH would give the shares to FFH india in exchange for FFH india shares. Since they are both in Canada, I don't think there would be an issues? oh ok, got it. just change of control for thomas cook. Yeah I was merely wondering if they would "tidy up" the Indian holdings into FIH - partly to avoid the impression of a conflict of interest and partly to make my notes neater ;)

What are the odds of Fairfax's Thomas Cook and Quess stakes being swapped for Fairfax India shares at some point?

Reading all three letters I am really struck by the quality of managers these guys are able to attract. E.g. the guys they've hired to build Digit (who previously built Bajaj Allianz and then spent 5 years in Munich at senior levels in Allianz)) and the guy they have running Philafrica Foods (ex CEO Nestle China). There are impressive people just about everywhere.

Yes - extraordinary - and cheap!