StubbleJumper

Yes, that's true. FFH has been making a tonne of money over the past couple of years and will probably continue to do so for the next few years. So, what an investor needs to figure out is whether that is just a cyclical phenomenon, or whether this time it's different. SJ

The first time was 20 years ago, and the people who made such claims were sued back to the stone age. Muddy Waters has been much more careful about what they've written. There are no outright mistruths that I can see, just convenient misinterpretation and innuendo. Anyone with an accounting background will snicker about most of that document. SJ

Wait a minute. People "keep coming around?" When was the last episode of people coming around and making such claims? SJ

No. Say what you want about Prem's investing skills, but he is not a particularly clear and cogent communicator. When he answers a question, he doesn't really provide a response, but instead tends to do what I call the "Prem fuddle" where he mumbles around in circles about something that is only tangentially related to the original question. If he only did this for the questions he wanted to avoid, I would understand and I would admire him for being so crafty. But he does it for EVERY question, even the softballs. What we need is for Jen Allen to give a 2 minute spiel about the rules for writing down assets due to permanent impairment, and FFH's annual process for doing this. There's a legitimate reason that Farmer's Edge or Digit have not yet been written down as much as Muddy Waters would contend should be done, and that reason is the actual accounting rules and the annual internal evaluation process. There's nothing nefarious there. So, we need Jen as the expert (and as a solid communicator!) to briefly walk through the rules and the process. After she gives a clear and cogent explanation, then perhaps Prem could chime in with his usual indecipherable "Prem fuddle." And so it goes with the IFRIS adjustments. Jen is a solid communicator and should walk us through the reason why FFH is now using IFRIS, how the rules work, and the outcome. She has already done this on past calls and did a great job of it. Well, it seems that she needs to do it again in the context of yesterday's report. And then after a compelling explanation from Jen, perhaps Prem can chip in with his usual few comments that go in circles. This CC is actually important. The only response that Prem should be making should be something that he reads word-for-word that was written by Jen and the rest of the C-suite. Keep the extemporaneous comments to a minimum and preferably have the stronger communicators provide technical explanations where they are appropriate. SJ

No, Sanj, that's the one thing that Muddy Waters actually got right. FFH hasn't had lumpy returns, it has rather had two-stage returns. The first stage was from 1986 (FFH's inception) to roughly 1999 where BV grew extremely rapidly and far exceeded Prem's bogey of 15% annual growth. The second stage is from roughly 2000 until now when the 15% bogey has only been achieved in 8-out-of-23 years. Every year Prem publishes this table and it is extremely important. If you believe that 15% will be routinely achieved, then FFH is easily worth 2x BV. But then you need to get a notion very clear in your mind why FFH's performance would return to a level closer to it's initial growth phase rather than remain at levels similar to the past 20 years or so, and you need to have a solid hypothesis about why the industry economics that have juiced the returns for the past three years would carry forward for the long-term. That, or you just understand that FFH likely won't ever be worth more more than 1.5x BV. Of all the bullshit in that report yesterday, the comment about not achieving the BV growth rate was about the most fair and the most accurate. But then again, last week, FFH was only priced at 1.1x BV so that's probably about right for the results of the past 20 or so years. SJ

Well, that's what's so funny. The report bemoaned the fact that some paper gains were triggered 4 or 5 years ago from Grivalia properties, buy it never took a paragraph to examine the current value of Grivalia. Well, that's pretty obvious because Grivalia is now Eurobank, and as you say, the market value far exceeds the carrying value. So to what end should someone bellyache today about the paper gains triggered 5 years ago when those paper gains are fully supported by an even higher market value? And so it goes with APR Energy. The report grouses about the possibility that it was dumped on Seaspan to avoid a paper loss at FFH, but it doesn't go that next step and evaluated the value of APR today. Well, now APR is part of the Atlas position, and the fair value of that position is far greater than its carrying cost. So, what's the point of bellyaching about that transaction from 3 years ago? It's the same story with Odyssey and Brit. The report throws a hissy-fit because there were modest paper gains triggered a few years ago, but it never went that next step to make the argument that those insurance subs were less valuable than the new carrying cost. And certainly now three years later, there's no argument at all that those companies are more valuable than their carrying cost. Let's just throw a pile of shit at the wall and see what sticks. SJ

The Watsa family's economic interest in FFH isn't actually all that high. There's about 20 million publicly owned shares, so Prem would need to find US$20-25 billion or so if he wanted to take it private. And to find that $20 billion, it would certainly result in a loss of family control as part of the deal because who would offer up $20b and accept the existing dual-share structure? SJ

Well, that was an interesting slide-deck. The author was quite right to point out that FFH has not routinely beaten Prem's 15% BV growth target. Every year, Prem publishes a table in his annual letter that depicts the growth in BV and the growth in share price. If you exclude the first 10 or 12 years of rapid growth, it's been pretty pedestrian ever since. However, FFH isn't trading at 1.5x BV either! If it routinely achieved that 15% target, it would easily be worth 2x book, but it doesn't so it's not. It really is a funny criticism. As always, I highly recommend that people in this forum look at that table several time during the year and reflect upon whether the past three years represent a fundamental shift, meaning that 15% will be routinely achieved in the future, or whether whether it's a relatively brief favourable period. There seems to be a great focus on what happened during 2020. As I have suggested in the past, Prem came uncomfortably close to driving FFH into a wall during 2020. He played his cards brilliantly to get through that particular set of challenges. What the author should have done is to take Prem to task over having tapped into the revolving like of credit for general operational purposes before Covid19 even hit, which exposed the company to the revolver's covenants. Most of the rest of the deck seems like silly-bugger stuff. Clearly many of us have some discomfort with the various OMERS transactions and the fact that OMERS always seems to be effectively guaranteed an 8% or 9% return on its capital. These transactions are, effectively, quasi-debt. But, the really silly bugger stuff is pointing out the accounting gain triggered by the Odyssey transaction and the return for OMERS. In what world does he think that Odyssey's true value wasn't far higher than its carrying value in 2021? And in what world does he think it was a bad deal to "borrow" a billion even at 8% or 9% to buyback shares at US$500. It beggars belief! While all of that was a nice walk through the past where quality of earnings was a regular concern, perhaps he would be better served to look at the past couple of years and comment on the current quality of earnings. The earnings for the past three years are real and they are large. And the earnings for 2024 are real and are large. The guy's proposed haircut to BV is roughly a year's worth of income at current run rates, so that's pretty funny. SJ

Excellent! It's good to get that capital back and now that Prem is no longer part of the BoD, perhaps FFH will find a way to dispose of the equity investment. It would be nice to close the books on this one. SJ

Well that promises to be interesting. I wonder what terms BB will get from a lender other than FFH. SJ

Well, you don't necessarily want to wait until the last minute. I was a bit surprised that FFH was even able to float debt at 6% when you could instead lend money to the Government of the United States for ~5%, so in some respects, it was a good time for them to seek credit. In fact, they probably ought to have borrowed a bit more so the holdco could improve its balances of actual cash (not the imaginary cash outlined in Note 5 of the financials). SJ

The short answer is that Prem Watsa is an investor who had a side-business of insurance, not an insurance guy who had a side-business of investing. The motivation for Prem ever buying an insurance company was likely for the simple reason of having access to large gobs of other people's money to invest (ie, large gobs of float). SJ

In the past, Prem routinely included a small table in his annual letter, depicting FFH's return on common stocks, the return on the S&P500, FFH's return on bonds and the Merrill Lynch Corporate Bond Index (an example of that table can be found on page 17 of Prem's 2015 letter). For me, the general insight over the years from that table is that FFH's true strength was fixed income investing, which is a good thing for an insurance company that must keep two-thirds or three-quarters of its investments in fixed income products. In a more general sense, it's worth reading and re-reading Prem's annual letter several times. He includes several tables that are key to understanding the prevailing economic conditions of the insurance industry and how FFH has generated wealth (or not!) within those economics conditions. When Prem includes a table or a section on a particular subject, it's usually there for a very good reason. I am not too sure why the table on investment returns disappeared over time. Perhaps it was that FFH had a period of unfavourable comparisons to the index, or as @Viking perhaps it's because such a large chunk of FFH's investments are private placements or otherwise unusual investments. Or perhaps with M2M accounting, Prem figures that shareholders don't really need that little table anymore because we can more or less figure it out ourselves? Not sure. SJ

That's a good framework for thinking about this. My preference is to think about the pessimistic scenario (but not the catastrophic one), and then to happily accept any outcome that ends up being better than that. I tend to give a haircut to 2025 and 2026 out of an abundance of caution, and I don't tend to get too enthusiastic about the P/BV expansion because historically the market has been reticent to grant FFH much of a premium. What that gives me is a reasonable floor of perhaps BV of $1,300 at Christmas 2026, and no growth in valuation. So, ignoring the divvies, that pessimistic case is ~40%+ growth in the share price over three years, which would be a perfectly acceptable return. The moons and stars might remained aligned for the next three years to enable FFH to continue to get strong underwriting profit, the economy might not slide into a recession which will enable the operating companies to continue to get strong operating results, and the market might take a more favourable view of FFH and award it a higher P/BV as it has done occasionally in the past. If those things happen, I'll be a happy guy. But, I have a large enough portfolio allocation to FFH that I am unwilling to assume that current favourable conditions will persist. At some point, I will need to be rational and trim my position, and that needs to be informed by the pessimistic scenario. Oh, I don't think board members are generally myopic about any of that. We know very well that FFH has remarkable earnings capacity and has had a good investment track record. In fact, Prem published a table depicting historical outcome of this on page 20 of his letter last year, and has publicly set a goal of achieving 15% annual growth in BV on a going-forward basis. The challenge for a long-term investor in FFH is to reflect a little about that table on page 20 and Prem's stated goal. If you believe that FFH will routinely clear that 15% hurdle on a long-term basis, you would happily accumulate shares up to a price of perhaps 1.3x or 1.4x BV (ie, 15% growth in BV priced at 1.4x gives you a PE a shade over 9). But, if you are like me, when you look at that table on page 20 and you squint a little, maybe what you see is something considerably lower than 15% annual growth in BV. The long-term results could be different on a going-forward basis, but investors would be well-advised to be mindful of the long-term past results. SJ

Yes, but the mental framework dates back to when sovereign debt rates were higher, so insurance companies routinely lost money on underwriting. So, there was an investment return and a cost of float (because the CR was more than 100). The cost of float was the cost of financing (ie, the amount you paid to use someone else's money for a year). If your investment return exceed your cost of financing you made money, at least before admin costs. Over the long term, your financing differential has been 4-4.5%. This year it's been 6-ish% (94 CR) plus 5-ish% from treasury bonds, for a total of 11-ish percent.... SJ

There's a relationship there, but it's not perfectly clean. That table is intended to convey the financing differential for the insurance companies. So, the short form of that is, in approximate terms, (portfolio return% - cost (benefit) of float%) x premiums to surplus ratio = ROE for the insurance sub. But it's not really that clean because the cost of float is calculated on a calendar year basis rather than an accident year basis, so the skeletons in the closet appear from previous years and advance forward to future years. What is more, for most of those years, unrealised gains did not appear in the investment returns, so much of the value that was created didn't show up until assets were disposed (sometimes 3 or 4 years later). But, the thought process is very much the driver of value creation in an insurance sub even if the accounting metrics are imperfect. SJ

Didn't they just sell a slice of that airport to OMERS a couple of years ago? And now they are buying another slice? SJ

Would you want to do that? Really, you just want your capital back with a return. Foreclosing on actual real estate and hoping you can eventually sell it to get your capital back doesn't sound so enticing. Sj

@netcash1It's interesting that Bradstreet et Al have chosen now as the time to reach for yield. When they picked up the $2b of Pacificorp debt at 10%, I raised my eyebrows, but it was a smallish bond investment at an attractive rate. If the next $2 billion have a similar risk-reward profile, it's pretty aggressive. If it works out, the results will be outstanding. But you don't get 10% without taking on a bit of credit risk. The easiest thing in the world to do for FFH would be to sit back and roll the US treasuries as they mature. It would lock in good profits for the next few years. But it requires some balls to reach for yield. Let's hope it works out! SJ

+1 The pandemic didn't put any (many?) insurers out of business, but it should be instructive for us. What didn't happen was an enormous hit from business interruption claims. Thankfully, the legal framework prevented that ridiculous cat claim. But what if it had not done so? What if there would have been a couple billion of BI indemnities at FFH? And what if Ffh's reinsurers had been hammered with enormous claims as a result? Go back in history almost four years. In spring 2020 credit markets seized up briefly, equity markets went into the shitter, and FFH reported significant M2M losses on its equity port, and moderate cat losses from covid. At that time, the company had already tapped its revolver for general corporate purposes before that virus even broke out and they were already subject to the covenants. Imo, FFH came uncomfortably close to violating those covenants in summer 2020. Had the cat claims been meaningfully worse or if the collectibility of ffh's reinsurance receivables had been called into question (ie reinsurers who can't pay or won't pay), Prem might have driven the company onto a wall. For me, it was masterfully managed by Prem given the cards he had available, but it was uncomfortable. The lesson is to not fuck around. Have plenty of capital and plenty of Holdco cash. Keep a revolver, but never put yourself in a position where you might be reliant on the kindness of bankers. SJ

@Crip1 We have seen one quarter of slower premium growth, which may be the beginning of a trend, or it may be simply an aberration. Personally, I hope it's the latter, but we know every hard market must eventually turn. You are correct that the subs can release more capital to the Holdco if growth does slow (we will see in the next couple of quarters). That being said, in the short-term, FFH has been running light on Holdco cash this year, which carries its own risk. In this most recent note flotation, they've shown they can borrow at 6% over 10 years and we know that the holdco can buy treasuries at ~5%, at least in the short-term, so what does it cost to float an extra $300m or $400m of debt? For me, it's basic risk management. SJ

No, my point is not to convey some sort of crisis, as the regulators have approved significant dividends from the insurance subs, so as you say, a short term cash need can be addressed at the stroke of a pen. But, as always, during a hard market, that stroke of a pen does not come without cost. SJ

I'm not Sanj, but I'll chip in a viewpoint anyway,. The Holdco requires cash for interest, the annual divvy, corporate overhead, and the pref divvies. Sometimes it will require cash for debt repayments, and sometimes for "re-purchasing" minority positions in the subs from outfits like OMERS. Add on a buffer, and that's the basic need. Then consider the strategic opportunity. Suppose the market goes to hell and FFH suddenly trades at 0.7x adjusted-BV. How much cash would be required to hammer the gas on that NCIB and repurchase 1 million shares? I'd say roughly $750m.... Add it up, and maybe $2b of short-term securities that can actually be easily liquidated might be about right (that derivative line in Note 5 might not count). SJ

I guess we will see when the AR is released in April, right? FFH does have US$280m coming due in August. It's possible that they might have taken care of this (or some other notes) early, or it's possible that they are just being cute and simply plan to repay that debt in August when it comes due. In the mean time, they get to use the cash for general corporate purposes and it buys another 8 months before they need to issue a larger than usual divvy or float some other debt. Fine in either case. They have been obviously running short on actual cash unless you hold the view that the derivative line in Note 5 is actually something that they could easily liquidate and use (meaning that the derivative was speculative rather than for risk management or other strategic objectives). Sometimes the Holdco sources - uses forecast exercise is instructive. While FFH does have a large revolver available, I dislike that option because they are subject to covenants and need to be renewed relatively soon (ie, they are usually 3 years or less between renewals). It is preferable to not be reliant on the kindness of bankers. In Spring/summer of 2020, Prem came surprisingly close to driving FFH into a wall because of those covenants. SJ

Good. I would have preferred to see $750m, but $400 makes a difference. They have been blatantly short of actual cash and short term marketable securities at the Holdco level, so this is long overdue. SJ