StubbleJumper

Actually, what he's saying in that particular quote is that the Watsa family will never sell its interest to an outside party. He's not saying that the Watsa family won't expand its interest, and possibly take it private some day. In fact, a couple of days after that interview was conducted, FFH's substantial issuer closed and the Watsa family interest in FFH effectively increased by about 4% because they didn't tender any of their shares... It's not anything that will happen any time soon. But, it's always a remote possibility, and given how minority shareholders have been treated in other FFH transactions, that possibility should not be dismissed lightly. SJ

I know you were talking about FFH and so was I! There is little likelihood that FFH will go private, but never say never. It would require a particular set of circumstances, and a lengthy period of buybacks would be a necessary precursor because the Watsa family's economic ownership is not currently all that high. With a lengthy period of buybacks and a pile of outside capital, it could be possible. Let's just say that if the Watsa family were in the situation of the Jackman family, my guess is that they'd have gone private five years ago... My only caution is not to assume that we'll never see an opportunistic take-private bid from the Watsa family because my take is their constraint is currently financial capacity more than desire. Buffett is clearly currently disposing of his BRK ownership, so there's no question of going private. SJ

I would encourage you to not hold this viewpoint very firmly. The history of FFH would suggest that investors are best advised to ensure that their interests are aligned with Prem's interests to the greatest extent possible. There have been numerous occasions when minority shareholders of subsidiaries have been unhappy with being bought out on terms that they viewed as unfavourable (in fact, just last week FFH announced it would buy back Farmers Edge. Are the minority holders happy? I haven't seen any feed back, but I don't doubt there would be some unhappiness). Prem's interests are broadly clear as the result of his having the overwhelming majority of his personal assets in FFH shares (and not directly in the subs where shareholders believed they were screwed). The advantage of being a minority shareholder of FFH is that it would require an absolute boatload of capital to buy us out. But, if Prem could find somebody who would provide US$20-25 billion on favourable terms, I don't doubt for a minute that he would buy out minority holders if it were advantageous to the Watsa family. What is more, Prem has advanced significant hints about large scale share repurchases and has even trotted out the Teledyne example. If he actually follows through, in 10 years a family buyout might become more realistic. In any case, it's not something to lose sleep over at the moment, but I would say that it's a mistake to assume that there will never be a take-private offer and that minority holders will never be screwed. If you see a smiling shark, accept him for what he is. SJ

Working from memory, FFH had something like US$115 billion of deflation derivatives. What was that supposed to cover? Take a look at the balance sheet, take a look at the income statement, and the notional amount of those derivatives far exceeded the sum of liabilities and the expenses. So what exactly were they trying to "hedge?" Clearly, if you had, say 15% deflation you could have an issue with your nominal indemnities growing in real value, so you might want to hedge a portion of that (rarely is your ideal hedge ratio even 100%). But, to date, I have never read a compelling explanation about why the notional value of those derivatives exceeded the exposure to the underlying. It's a little like owning 100 shares of a company and then "hedging" by buying 120 put options against those shares. Anyway, I have spilled much ink about this over the past 6 or 7 years to the point where people are undoubtedly tired of my belly-aching. But I take issue with the word "hedging" in this case because usually hedging implies a thoughtful, analytical approach to risk management. But, 6 and 7 years ago, FFH wasn't using derivatives to manage risk, but rather to speculate (I use speculate in the nicest possible sense, as any time you buy a security you are speculating). SJ

You are being kind to FFH management. For both the deflation derivatives and for the equity hedges, a key point of reflection is what should your hedge ratio be? So, usually, you look at your exposure to the underlying asset and you choose a hedge ratio between 0 and 100 percent depending on your desire to lay-off risk. But the deflation hedges and the equity hedges both exceeded 100% of FFH's exposure to the underlying. When you have a hedge ratio above 100%, you are no longer hedging, you are speculating. The fatal flaw with those two initiatives was not the concept, but rather the position size. At this point, FFH doesn't need to do anything fancy. There are significant earnings baked in for the next year or two. Some of the risky investments of the past are bearing fruit (ie, Eurobank). Run the insurance companies in a rational manner, let Bradstreet be his normal fabulous self, and try to exploit value in plain sight. They don't really need to swing for the fences at this stage. This is a really good point. The challenge of evaluating the macro bets is that the more recent ones were for much higher nominal dollars. But, Bradstreet has made several good calls about the evolution of the yield curve that have earned FFH a shit load of money. But, the shitload in the past was like $500m because the company was smaller. The credit default swaps was a bigger shitload because the company was larger. The deflation hedges and equity hedges were also large, in part because the company was larger yet again. And now the excellent management of the fixed income portfolio in 2020 to 2023 has been done for yet a larger company. So, the exercise is a little complicated because a good macro call in 2003 may have been for smaller nominal dollars, but it's had an enormous impact 20 years later. Somebody smarter than me might be able to quantify all of this and net out the losers from the winners, but a simpler approach is to acknowledge that the winners have likely been more important over the long term. SJ

That appeared in Prem's annual letter last spring. SJ

It's most likely a holdco cash issue (see note 5 of the Q3 financials). FFH holdco actually has very, very little cash and true short term investments available. They had about US$650m of cash and easily liquidated securities at the end of Q3, and $400m+ of "derivatives" which is probably some form of short-hand for the TRS. To buy back a meaningful number of shares, they would need to either make a much larger series of dividends from the insurance subs, float some new debt, or tap into the revolver. The dividends from the insurance subs have been limited for the past few years because they've been growing their book at an impressive clip. The growth in premiums reported in Q3 was low compared to the past couple of years, so that's a bit of an alarm that makes me question just how much longer the hard market will endure. If premium growth continues to be slow for the next few quarters, it will put FFH holdco in a good position to extract larger divvies from the insurance subs. If those divvies are very large, then you might see some buybacks during 2024. The $2B revolver could be used to buy back shares, but it's not something that I'd like to see. The revolver is there for emergencies and for seizing highly unusual opportunities. I wouldn't want to see the revolver routinely tapped. SJ

I probably wouldn't increase a credit line to Farmers' Edge, but if I did choose to do so, I sure as hell wouldn't lend them short-term money at 6% when I can lend the Government of the United States money at 5.4% for 90 or 180 days. SMH. SJ

I think you are being a little too generous with FFH management on this. The accumulation of BB shares was an error of commission. Folks on this board noted it, time after time, as management took the active decision to invest increasing amounts in a company that had limited prospects. The failure to reduce the BB position during 2021 was an error of omission, and that was noted vociferously by folks on this board. In short, there has been a long and unhappy history of management making poor decisions about BB. Now, making poor decisions is something we all do. Sometimes we make a series of poor decisions, which has been the case with FFH's series of decisions to allocate increasing amounts of capital to BB and to not reduce that capital allocation when the opportunity presented itself. During this month, we have seen yet another strange decision by FFH to lend money to BB at a 1.75% interest rate for either 3 months or 6 months. On the face of it, that is yet another poor decision in a long series of decisions about BB which have not been optimal for shareholder value. The fake headline giving the appearance of yet another poor decision was merely icing on the cake for something which has been a source of frustration for shareholders for more than a decade now. I will be the first to acknowledge that FFH has made a pile of money from 2021-23 and will probably make a big pile in 2024 and, with a bit of luck, a decent pile in 2025. That is all good and fine, but it still doesn't really excuse management's seeming inability to make rational decisions about BB. When the remaining BB position is ultimately closed (hopefully in 2024 after the company splits) somebody can do the counterfactual study about how much this unfortunate series of decisions has cost shareholders. How much capital will we recover from the total amount invested, and how much should FFH have obtained from that amount of capital invested over the past 10+ years? Will the cost (including opportunity cost) of those decisions be $75/sh? Maybe more? Let's hope that we will see better decisions about BB on a going forward basis. SJ

Maybe Prem is taking a page out of Kestembaum's book? When Stelco wanted to buy back some shares, but the share price was a little higher than book, Kestembaum went out and bought a Canadian Football League team and talked about how poor Stelco's future was. The share price went down, Stelco bought back a shit load, and voila! So, maybe Prem saw FFH trading at roughly adjusted-BV, and wanted to buy shares cheaper than that? Solution, just put out a few announcements about lending Blackberry money at an interest rate well below market, buy a few Blackberry shares and buyout the minority holders of Farmers' Edge and that'll push down FFH's share price. It's ingenius! SJ

The issue in my mind is not the few million bucks that it'll cost to buy out the minority holders. The bigger question is how long will it take to find a chump to buy the entire company from FFH, and how many capital injections will Farmers require during those years that FFH is seeking a chump? It is quite possible that the capital injections could be much larger than the take private amount... SJ

Anybody who had read the prospectus should have known not to touch Farmers' Edge with a 10' pole. It was pure poo poo, and I recall noting that my esteem for FFH management had dropped when I read the details about just how bad the company was. Now it looks like FFH wants to own 100% of that poo poo. I am having trouble imagining how they will eventually exit the position without wasting more FFH capital on Farmers. SJ

Yeah, your numbers are right, it suspect it was just a bit of rounding. Shareholders definitely will be better off now that a portion of the proceeds from those debs are reinvested. FFH was getting 1.75% interest, and pretty much any US treasury will yield ~5%, so that part is good. The part that isn't good is that the whole $330m isn't being reinvested at the higher rate. I don't love the idea of extending any more credit to BB, but if FFH is going to do it, they should at least demand market terms. For 3-month debt that would be, what, perhaps ~8% or something instead of the 1.75% they actually accepted? So, it looks to me like FFH is being shorted about $2m of interest over three months (and worse if it is extended to 6 months). It is entirely possible that there are unknowable reasons for that. But, that's part of the problem. Prem has gotten so involved with BB through his position on the board and his relationship with management that it's hard to tell whether he's acting to maximize value for FFH shareholders of to fulfil some other goal. SJ

That looks like roughly the right recipe to get a 15% ROE. You need either outstanding investment results and to break even on the underwriting, or you need a bit of underwriting profit and a good investment return. The recipe with a 97-98 CR and a 7.3% investment return looks like it would roughly do the job. On page 15 of his annual letter, Prem included an interesting table on CRs and investment returns. It's been unusual to simultaneously get both solid investment results AND profitable underwriting. Some years (like in 2023, probably!) you get both and it provides a fantastic ROE. SJ

Well, that's the mental short-cut. But, you are also making a few unstated assumptions, right? When you say that 5% with 3x leverage = 15% ROE, implicitly, you are assuming that: Underwriting income - Interest expense - Corporate overhead - Income tax = 0 or a positive number Most years that assumption will not hold. SJ

I would refer you to page 20 of Prem's annual letter from last year. On that page you will find the table that he publishes every year, which depicts the growth in BV every year since the company's inception. You will see that in the past 20 years, achieving 15%+ growth in BV has been the exception rather than the rule. SJ

Frankly, this looks somewhat irresponsible by FFH management. The chances of the BB share price rising US$6 (and therefore it being worth converting the debs) between now and next spring are approximately zero. So, in effect, FFH is issuing 1.75% 3-month commercial paper to BB in an environment where sovereign guaranteed 3-month t-bills are trading at 5.40%. The idea of extending such a bull shit arrangement to May 2024 is even more ridiculous. This stinks. The sooner that FFH is done with BB, the better. SJ

I think you are being very generous on your 3% chance of the world falling in love with FFH and bidding it up to 1.7x, 1.8x or 2.5x BV. A family-controlled Canadian company with a dual-class share structure that isn't even listed in New York? There's not a lot of love for those! It would require a sea change in sentiment to drive that outcome in three years. I agree that there's a meaningful likelihood that it could trade for less than book in three years. It's not the most likely scenario, but it has happened often enough to FFH that we shouldn't discount that potential. And,other family-controlled Canadian companies have experienced long periods of this sort of thing. I would suggest that the likelihood of this is less than the 30% that you've posited, but there's still a meaningful chance that it could happen. The most likely scenario is that FFH trades between 1x and 1.2x adjusted BV. And, frankly, for me that would be perfectly fine. Chances are that FFH will grow its BV by 40%+ over the next three years, so even if it trades at 1x BV in three years (effectively no growth in valuation) it'll likely be a perfectly acceptable return. But, if we get a bit of luck and it trades at 1.2x a book value that has grown 40% over the next three years, then you're looking at quite a nice little return... SJ

@VikingThanks for the reply. I worry that you are misinterpreting cautious optimism and cautious enthusiasm with bearishness. There are four or five posters on this forum who have been wildly enthusiastic about FFH's last couple of years and have equal optimism about the next couple of years, but prefer not extrapolating that out too far! 1) and 2) It is always possible that we will see a 95 or 96 CR and treasuries yielding 4-5% over the next five years. But, if you return to the content of Prem's annual letter to shareholders and examine the history of CRs and sovereign debt rates, you will probably find that simultaneous profitable underwriting AND solid treasury yields is an exceptional circumstance. It's a circumstance that has made FFH a nice pile of money over the past year or so, and hopefully will continue to do so during 2024 and 2025. But that table depicting cost/benefit of float and bond rates reflects the competitive dynamics of the industry. The the financing differential (bond yield less the cost of float) widens out, capital has historically poured into the industry and profits tend to be competed away through lower underwriting standards. The current financing differential is roughly 11% (ie, benefit of float is ~6% in 2023 due to a 94 CR, and prevailing sovereign debt rates are ~5%), which is more than double the long-term average. Personally, I expect to see some reversion to the mean, but I am hoping that it doesn't happen too soon! 3) No, compounding isn't dead at all. The only reason why anyone would be a long-term FFH shareholder is the belief in compounding. I'm not sure that I'd assume that FFH will get a 10% return on the earnings that it reinvests, but there will definitely be some sort of return. Prem publishes a table in his annual letter that describes FFH's investment returns, and there have been a few periods with that kind of return, but it's exceptional which is consistent with the lumpy-returns mantra. Nobody is assuming that FFH management will suddenly get stupid. But, equally, the assumption needs to be made that other companies' management teams don't become stupid either. FFH is making lots of money in a hard market and when the ROE eventually turns due to a softening it's not because they have become stupid. It's because everyone else has been competing furiously for premium. SJ

Oh? You have some compelling explanation about how a 12% ROE might be obtained in 2026 without continued favourable CRs and continued favourable interest rates? Nobody is assuming that the earnings from 2023 or 2024 will be lit on fire, but you do need to get an ROE from them.... I find it instructive to periodically review the table depicting FFH's annualized growth in BV that Prem publishes every year in the annual letter. SJ

You might ultimately be right. Your projection for Dec 2025 BV is roughly US$1200. What ROE is required to meet your $150/sh normalized EPS in 2026? Roughly a 12% ROE, right? It could very well happen if operating conditions don't deteriorate too badly. Alternatively, it is possible that the hard market will have turned before 2026 and that interest rates on sovereign debt may attenuate by 2026. Everyone is free to make the assumptions they want, but assuming that strong operating conditions will persist for long periods is something that people do at their own risk and peril. SJ

I would suggest that the best thing to do is completely ignore the analysts. They've rarely demonstrated much of an understanding of FFH. We know very well that FFH is certain to show strong growth in BV during 2023 and is likely to have a very good year in 2024 (likely 15%+ growth in BV). Short of an implosion in FFH's valuation, we will experience good, or possibly very good returns over the next year or two, irrespective of what some analyst says. But, the analyst has made a bit of a point, which is that there might be limits to growth in valuation. On this forum, there is understandably a great deal of enthusiasm about FFH and that is sometimes projected long into the future. The logical conclusion of that enthusiasm is the view that FFH is worth a much larger multiple of EPS or of BV than its current valuation. When an analyst suggests that FFH is worth ~1x BV, he has his feet anchored firmly in the past. Every year, in the letter to shareholders, Prem publishes a table depicting the change in BV/sh (page 20 of last year's letter). If you look at, say, the past 20 years, you are looking at an annualized increase in BV of a bit less than 9%, with a great deal of annual variabilty. Add the dividend to that growth in BV and we've seen a decent, but unspectacular return. It is not surprising that an analyst might say that this sort of long-term performance might be worth a valuation of ~1x BV. It is possible that FFH has experienced a fundamental shift and that its future will differ materially from its past 20 years. Perhaps FFH's goal of 15%+ annual growth of BV will become the rule rather than the exception. But, you will forgive the analyst and the market more broadly for waiting to see that fundamental change rather than immediately awarding a higher valuation and hoping that it will ultimately be justified by improved long-term operational performance. In the mean time, FFH currently trades at US$900, which is roughly Q3 BV adjusted for the excess of market value over the carrying value of certain positions that are not M2M. FFH shareholders will likely get a good return over the next couple of years on the basis of strong earnings alone, with no requirement for growth in valuation. If FFH ends up trading for 1.1x or 1.2x adjusted-BV in 2025, so much the better. But, the market's skepticism is well earned through 20 years of adequate, but unspectacular returns. SJ

With FFH currently trading right around adjusted-BV, and with a ROE of 15%+ expected for 2024, they shouldn't perceive much pressure to close out the TRS. Even if there's no increase in P/BV and we find ourselves at 1x next November, that's a 15%+ growth in the stock price which is considerably higher than the floating rate. It will be a more challenging decision in a couple of years once CRs start to inch upwards and interest rates start to inch downwards, which will put a bit of pressure on that ROE. For me, the liquidity issue is the risk that I'd like to see FFH manage. FFH's share price can drop $100 at any point. In fact, as the share price has grown to US$900, the likelihood of having a fluctuation of $100 has probably become higher (ie, when your share price is $500, a drop of $100 is enormous, but not so much when you are at $900 or $1,000). FFH needs to be ready to send a $200m or $400m cheque to the counter-party at any point in time, which needs to be taken into consideration when considering the holdco's cash and liquidity planning. SJ

That nicely summarizes the principal levers. A couple of comments: I am looking forward to seeing the interest and dividend number for Q3. I think you've significantly improved the method for estimating interest income, so it will be interesting to see how closely reality tracks your estimate. I suspect it will track reasonably well. Thinking back to Q3, wasn't it a reasonably light Q3 for cats? Usually Q3 is the worst for hurricanes and other nasty weather, but I'm having trouble recalling much in the way of really large storms. I guess Hilary was a remarkable storm, but my recollection was that the insurable damage wasn't too bad. I think we will be pleasantly surprised for Q3's CR. SJ

I prefer to get my earnings estimates from @Viking on COBF.... SJ