giofranchi

Thank you BP6, If I have understood correctly, the main risks you see are: 1) Their stock picking performance will continue to generate very poor results, 2) They are financing the acquisition of Allied in a way that won't maximize shareholders' return. You said you have discussed a lot about FFH with people you trust and who know FFH very well. And you have come to the conclusion there is something wrong at FFH. Do you see other risks beside 1 and 2? I am really interested to understand if people who know FFH very well see risks that I might have overlooked. Cheers, Gio Gio, Your summary of my comments are not entirely accurate however I will try my best to respond to your questions. My conclusion to sell a portion of the shares in FFH that I have held for 16 years was made after consideration of a number of factors however bottom line my ability to simply ``trust in Prem`` is not what it once was. I did not say that FFH`s stock picking will continue to generate very poor results. I do not know what the future holds neither does the FFH team or any poster on this board. I did say that Prem owes his shareholders a detailed explanation of his exit strategy for 3 of his largest losing equity positions (Blackberry, Eurobank, Resolute Forest). Others may disagree with this—that`s okay. I will not reiterate the numerous concerns that have been written about by other posters however they all factored into my decision. In addition however I have become concerned with the following items: 1) FFH`s leverage was often discussed as the reason for the equity hedges. I accepted this explanation. What disturbs me is that FFH did not take advantage of a sell-off in the preferred share market to lower their leverage by buying back the preferred shares in the market at well below their issue price. The various FFH preferred share issues were done at $25 per share and yielded about 5% at issue. They all traded down substantially to levels as low as $11-12 per share earlier in the year due to the drop in bond yields. Despite having the authority to buyback these shares in the open market FFH chose not to do so. I don`t know about you but issuing shares at $25 and buying them back at $11-12 seems like a good trade to me. 2) Prem continually touts the longevity and experience of the management team as a key positive for FFH. This was great when the team was in their 40`s however they are now approaching their 70`s. It is time for Prem to also articulate the succession plan for all the key members of the management and investment team. As one individual I know says—``when Brian Bradstreet retires I will sell all of my FFH shares``. Prem has agreed to stay on until at least his 75th birthday. Great---what about the rest of them. I do not believe we can count on all of the key members to stay around as long as Buffett and Munger have done at Berkshire. 3) Board governance is also an area I have some concerns with. The lack of diversity and new blood (and in my view Ben Watsa does not count) on the board cannot be overlooked. 4) What is the Eurolife acquisition really about. As we all know—life insurance is a vastly different business than property and casualty insurance. It`s okay if FFH is now diversifying into life insurance but tell us that. I suspect that FFH`s Eurolife investment was simply another capital raising exercise for Eurobank disguised in another form. 5) The conference call to discuss the Q3 2016 results was held on November 4, 2016. At that time Prem was still extremely concerned about the US and global economies and as a resulted maintained the equity hedges and deflation protection. One week later---after the US election---FFH announces that everything is all right with the world and reduces the equity hedges by 50% because of Trump`s election win in the US. Simply put---I call bullshit on that explanation. I could go on however I will stop here. I trust you get a sense that my decision to sell is well thought out and based on a detailed analysis of the issues as I see them. Hopefully these comments assist you in deciding what to do with your FFH shares. As Uccmal said in an earlier post---what Prem has created at FFH is amazing. I could not have done it. He is to be applauded for what he has accomplished. Despite this I can no longer give him a pass when there are a series of issues at FFH that I have grave concern with which are not being addressed to my satisfaction. BP6 Excellent post. I disagree with some of it, but excellent nonetheless. Probably the single thing making me most bullish on FFH is all the old guard shareholders throwing in the towel! I intend to hold my shares for a very long time and compound at a decent rate. My main concern for that thesis is succession. I have sold some shares for two reasons: 1) To open a position in JPM: I am late, but if Mr. Dimon is right about an "American Renaissance" in business, I think the next 5 years might be very good for the whole financial sector. And JPM imo is the best among big banks. 2) To increase cash: I have used FFH until now as a "good substitute for cash". Now I don't think that thesis is defensible anymore. FFH remains a meaningful position in my portfolio. Cheers, Gio

I am not so sure... Have you ever found an insurance company which was able to "engineer" a CR in between 100% and 102%? In my experience, either you get a good underwriter (CR of 95%) or you get a bad one (CR of 105%). And if I had to choose, I would like FFH to keep underwriting profitably, even if that would mean to grow its float more slowly. Cheers, Gio

Hi Viking, Thank you for shedding some light on your experience with the board, your financial goals, and your personal life. I surely like your posts very much! Merry Xmas to all board members and enjoy your holidays! Cheers, Gio

+1 Gio

I like anything that makes me think Prem is still very motivated to do well and grow the company. Will we ever witness a 5 years period in which: 1) Bond returns are strong, 2) Equity returns are strong, 3) Underwriting returns are good? Of course I cannot tell, but I am sure we won't if Prem, Mr. Bradstreet, Mr. Barnard, etc have lost the drive to achieve great results. Though I don't know if this new Africa fund is a good idea or a not so good one, at least imo it shows that FFH's management is still eager to work hard and (hopefully) do well. We'll see! Cheers, Gio

Yes! They certainly do! Thank you. Cheers, Gio

I agree: I like North America, large cap cos, strong balance sheets, lots of fcf, great brands. Cheers, Gio

I don't think they need an edge in India. The demographic story is compelling enough to justify the investment imo. (Just look at the money AMZN is spending in India!) Cheers, Gio

Could you explain? Another FFI, this time called FFA? India I understand and like. In Africa what is their edge? Cheers, Gio

Thank you BP6, If I have understood correctly, the main risks you see are: 1) Their stock picking performance will continue to generate very poor results, 2) They are financing the acquisition of Allied in a way that won't maximize shareholders' return. You said you have discussed a lot about FFH with people you trust and who know FFH very well. And you have come to the conclusion there is something wrong at FFH. Do you see other risks beside 1 and 2? I am really interested to understand if people who know FFH very well see risks that I might have overlooked. Cheers, Gio

Thank you for sharing your decision! Could you be a little more precise about the risks you see going forward? I am trying to understand if I am missing something really important here. Cheers, Gio

To keep investing in insurance companies, which might perform satisfactorily in a bear market and which by the way are their true circle of competence, while keeping lots of cash, is imo to play defense... Simply they are no longer playing defense against a 1 in 70-80 years event, but they are playing defense like they should be doing at the end of a regular business cycle. That's at least my point of view on their recent moves. Cheers, Gio

Al, don't you think insurance is a good business to be in during a bear market? In 2008 BRK's BVPS decreased much less than the general market because its insurance businesses saved the day. And I don't think FFH is rushing all of a sudden into the stock market: they have taken away the equity hedges, probably because they think a pro-business government in the US might drastically reduce the chance of something very bad and very long hitting the stock market, but they still have nearly $10b of cash. And I guess they will keep the flexibility to take advantage of opportunities that might arise in the future. Should a 30-40% correction in the stock market come, FFH stock price will surely go down with the market, but they might still be in the position to take advantage of lower prices, while their insurance companies might (hopefully) go on generating underwriting profits. Is it such an uncomfortable/risky position to be in right now? Especially with FFH stock price that already is low? Cheers, Gio

I couldn't agree more! Actually they had bought JNJ and WFC... unfortunately they also sold them... I have never really understood why. I remember Watsa commenting about JNJ in 2010: "We like JNJ very much: today it seems nobody wants to hold a company that can gradually but steadily increase EPS 10-15% annualy. JNJ is such a company and we are happy to hold it". Then, just a couple of years later FFH sold its investment in JNJ... Cheers, Gio

Pete, I agree. And basically I think the change is an healthy one and should be welcomed. Many people though disagree. And that's why I would like to know if they see risks that I might have overlooked. What can go wrong? How probable is it? And which will be the consequences on the whole company? Cheers, Gio

Partner24, Since 2011 these are the results: EQUITY (cumulative): $628 million HEDGES (cumulative): -$3112 million BONDS (cumulative): $2950 million CPI (cumulative): -$570 million UNDERWRITING (cumulative): $1333 million It seems to me that, if we are to blame Watsa for something, it is because FFH has been a very poor stock picker in the last 6 years: the idea of a 100% hedged stock portfolio should be that your stocks go 1%-2% higher than the stocks you have shorted. Of course you would expect to make a very meager profit overall, but still a profit... not a loss of -3112 + 628 = -$2484 million. In other words, if FFH had been a good investor in stocks, and equity gains equaled losses from hedges, in the 6 years from 2011 to today FFH would have earned 2950 + 1333 - 570 = $3713 million. Starting in 2011 with an equity of $7.4 billion. Not bad! Watsa has always said he was worried about a 1 in 70-80 years event that could shock the markets... Sincerely, were you sure that event was never to come? I know I was not, and I don't blame him for protecting FFH. Instead, what I would surely like to know are the reasons why they have chosen equities that performed so poorly... Furthermore, those $3 billion of earnings in bonds imo were very much related to their macro views: FFH held onto long term US bonds for at least three years after Buffett started calling them the worst investment. And the reason was they thought yields could continue decreasing because of disinflation in the US and deflation in Europe. Finally, they have picked almost the best time possible to sell those bonds, just before Trump got elected. Another macro call that turned out to be right. This is how I view the recent past. But, as I have said, I would prefer to talk about what lies ahead. Cheers, Gio

Joel, if I have understood correctly, Allied shareholders will receive $5 in cash per share as a special dividend from Allied + $5 in cash from FFH. Those $10 per share won't stay inside the combined company and therefore should not be included in its BVPS calculation. Of course, I might have misunderstood! Cheers, Gio

Of course I agree, Gary! Just look at my portfolio: they are all businesses and/or industries which have grown a lot in the past and which imo still have much room to grow in the future. The fact is also FFH could grow! If only Prem & Company would make the right decisions... And this I am interested in talking about: which decisions are they making NOW (not 6 years ago... we all know the bad decisions they made 6 years ago) so bad that could sink the boat even from these already depressed levels? Cheers, Gio

Gary, downside risk is important imo, because in this market I don’t see many good bargains as FFH is right now. If downside risk is somewhat mitigated from the current share price level, I can keep my shares until some good bargain comes along. Then I might decide to sell some FFH shares and invest the proceeds elsewhere. Not so if there are good reasons why FFH’s multiple should compress further, or FFH should start posting unexpected losses. Therefore I would like to know if someone sees threats that might have escaped me. Cheers, Gio

It is undeniably true that lots of things have changed. And I am considering what to do with my FFH shares. I would like to know where people see the most downside risk today: 1) Valuation: I don't think so, FFH shares are not expensive. 2) Balance Sheet risk: lots of cash, manageable debt, I don't see a great cause for concern here. 3) Investment performance: it seems to me that a lot of pessimism is already priced in. 4) Uncertanty regarding this new acquisition: Allied has an average 90.5% CR since inception (15 years), and an average ROE of 12.4%. 1.3x BVPS doesn't look too expensive a price for a company with such a good and long track record. Am I wrong? 5) Has Watsa lost his mind? Is this where the most downside risk lies? Do people think Watsa will lose the trust of FFH employees and as a consequence of FFH shareholders? 6) Other reasons? Would you elaborate? Cheers, Gio

What do you mean exactly? It seems to me that from Zenith to Brit they have made a series of great acquisitions in the insurance field. Their investment abilities in stocks can be very much critiqued of course. Not their abilities in buying good insurance companies at fair prices, imo. By now they have proven many times their focus has rightly shifted from poor insurance businesses for a price well below BV to good insurance businesses for a premium to BV. And Allied seems to perfectly fit this healthy change. Cheers, Gio

If FFH issues $4 billion in stocks, there will be 8.7 million new stocks outstanding (assuming today's price of US$461). As of September 30, 2016 there were 23.2 million stocks outstanding. That would bring the total up to 31.9 million stocks outstanding. Net income combined is projected to be $740 million. Therefore, EPS after the acquisition will be $740/31.9 = $23.2. EPS before the acquisition are $443/23.2 = $19.1. Of course, you might argue that FFH + AWH deserves a lower multiple of EPS than FFH alone... But I would not be sure why: if anything, the combined entity looks to me as a more diversified, better financed, and stronger company than FFH alone. Cheers, Gio

If Prem is paying 1.3x BVPS to acquire Allied, he probably thinks Allied's FV is higher. If he were signaling that FFH is not cheap, it would mean that he thinks FFH's opportunities for BVPS growth going forward are much smaller than Allied's. I don't think that is the case. Imo it is still more of the same: Prem wants to keep the flexibility that cash gives him. As for why now, maybe Viking is right... or maybe simply because Allied's management was not willing to sell the company while its stock was too cheap... Cheers, Gio

Of course, I don't like further dilution... But: 1) Insurance is their business, and very few people know it better than FFH. Therefore, the risk of a major mistake is very much mitigated imo. 2) Allied seems to be a very high quality company: average CR during the last 10 years of 87%, and a CAGR in BVPS of 14%. 3) As shown in slide 14, the transaction seems to be accretive to BVPS after considering the impact of new shares issued, while also decreasing the total debt / total capitalization ratio. Cheers, Gio

I would also consider VSCIX, or another ETF of US small caps. A requisite before investing in a company for me is a long and successful track record of reinvesting its earnings for growth. Most probably after successfully reinvesting its earnings for 10-15 years, a company is no longer a small cap. Therefore, it is very rare that I invest in a single small cap company. But a basket of them is another story, and I surely would like some exposure to small caps: many will fail, but some will turn out to be 10x baggers. Overall I believe results will be satisfactory. This being said, I clearly don't think it is the right time to invest in VSCIX, and I would wait for a serious correction. Cheers, Gio