Cigarbutt

Additional data related to the private equity value proposition going in 2018. http://go.bain.com/rs/545-OFW-044/images/BAIN_REPORT_2018_Private_Equity_Report.pdf?aliId=12399378 "The challenge is to create more winning deals" at a time when a well known CEO reports, reflecting on 2017 potential opportunities: "...price seemed almost irrelevant to an army of optimistic purchasers." "Spreadsheets never disappoint". Interesting times.

ScottHall, I've followed this thread with interest. I understand your comment as a reminder to avoid over-reliance on mathematical models. The quantitative is often put in opposition to the qualitative but is not reasonable to see them as complementary? Do you suggest that value is only based on an ability to assess the balance between spontaneous bearish and bullish intentions? Or simply to be better than the average subjective opinion?

For those who follow this "venture", here are some potentially useful links: https://25iq.com/2018/02/23/what-might-the-amazon-berkshire-and-jp-morgan-health-care-joint-venture-actually-do/ https://www.wsj.com/articles/hidden-profits-in-the-prescription-drug-supply-chain-1519484401?mod=pls_whats_news_us_business_f http://fortune.com/2018/02/27/apple-health-clinics-ac-wellness-employees-amazon-warren-buffett/ Not clearly investable yet but Medicare Advantage type scenarios and bundled payments may become subjects of interest.

The letter contains a lot of useful data and analysis. I second John's appreciation and gratitude to SlowAppreciation and Dynamic. So, many interesting topics covered in the letter. A word here about passive investing. The growth in ETFs has so far continued unabated. Some suggest that this is not a problem as long as some residual investors continue to do the "active" work. Too easy? Here's a link that covers an asset class that has been influenced by this relatively new trend, the high yield debt market. https://www.bloomberg.com/view/articles/2018-02-26/passive-investing-has-brought-marxism-to-the-junk-bond-market The title is sensational and the conclusion contains a forecast type ending which is not necessary but the graphs and data are interesting. Passive investing is now a large part of the high yield debt market and I agree that this likely explains the increasing correlation between the different components of the asset class. Obviously, there are cyclical forces that will tend to drive spreads up and down from time to time but this increasing correlation in a very benign environment is quite unusual. (see page 17 of the letter for the two graphs showing the historical evolution of yield and spread). I submit that going in the high yield debt market requires an eyes wide open approach. I think that the rise of passive investing is contributing to the synchronized dampening of yield and spread. It is not a problem in itself. It just means that (here assuming that the credit market is cyclical) the price action and momentum in the other direction may be magnified and that may give rise to contrarian opportunities.

Basic notions in a sense but truly fascinating. Statutory accounting rules has historically focused on the solvency aspect of the numbers but that's been changing. It would be reasonable to conclude that book value as generally reported now is closer (?) to fair or intrinsic value. In the last 20 to 25 years, in general, the market price to book "gap" has increased (especially the market to tangible) but specific reasons could explain that: larger buybacks, technology, more industries now characterized by an intangible "edge". Bottom line: despite what Mr. Benjamin Graham was saying decades ago, book value as reported these days, in general, has a poor correlation with "market" value appraisal. What is nice with BRK and many others, because of the nature of businesses assembled and the "culture", reasonable efforts can result in a fairly precise adjustment to book value. Of course, in a group exercise, the final number may vary but, if done in a value-based forum, maybe, the efficient theory may apply here to some degree. :) At the end of the day though, derivation of an adjusted book value remains an individual exercise. That can involve financial notes, fancy math, comparables etc. But, at the end of the day, the premium you pay should correlate to the actual amount that you would pay for the whole company if you were a private investor. Theoretical exercise with BRK, but potentially rewarding nonetheless.

I would respectfully add that concentration in Berkshire does not meet the strict definition of concentration. -The focus has always included a large consideration for downside protection, whatever scenario, macro or otherwise. -The downside protection is "naturally" counter-cyclical as it is firmly anchored on true value. -The insurance/reinsurance side is the most "risky" but Mr Buffett, again this year in his short letter, describes how the non-insurance little correlated businesses act as a buffer against large insurable events. Even a massive event would be, after a relatively painful period, a major plus in the forward-looking insurance competitive landscape. -The non-insurance businesses are many, varied, do not overly rely on leverage and many in the group, including in the big 5, could be considered, in isolation, as a diversified entity (ie the Marmon Group). I would even say that holding BRK now is an excellent way to mitigate concentration risk because of Mr. Buffett's unique ability to maintain independent thinking in this homogenized market. Thinking about what Viking has described, I would say that, when capital preservation becomes a larger issue, there is the potential "risk" that the risk (and reward?) appetite goes down. To reconcile, Mr. Buffett mentions that you have to sleep well and only need to get a few things right. Sounds good. :)

Aberhound, "...this mark to market rule is stupid as in enhances instability in downturns and it was brought in by the mercantalists along with other similarly stupid policies during the Great Depression, removed only in 1938 and in 2007 just before the 2008 crisis." With all due respect, I don't subscribe to the "mercantalist theory" in its pure form. With all due respect 'cause I tend to respect people who are more intelligent. Would like to add the following: Going in 2008-9, it seems that many scenarios could have played out as animal spirits were in disarray. Who knows what measures were necessary, planned or otherwise, but I think (FWIW) that a major (and unusually little mentioned) factor that helped turn the sentiment tide around was the FASB "modification" imposed by Congress in March/April 2009 concerning the "relaxed" definition of mark-to market accounting to take into account liquidity distortions (rule 157 suspension). In my mind, that simple measure contributed immensely in asset value recovery. Some would say that these measures prevented perhaps a necessary restructuring and was actually part of a series of moves to extend and pretend. Some would even say that this was orchestrated. :) Kindergarten advice from Mr. Buffett: "In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price."

It is certainly possible that some reserves may stay in the ground. But the thirst for fossil fuel will continue for a while. This post is about the opportunity to get a valuable product to the end markets and the potential of a US Gulf Coast refinery opportunity. Heavy oil supply from Latin America, especially Venezuela, is expected to decline. Venezuela is in a geo-political free fall. https://oilprice.com/Interviews/Venezuela-In-Freefall-An-Interview-With-Francisco-Monaldi.html Takeaways: -The Chavez-Maduro episode was animated initially by promises for the common man and low value for democratic institutions. -The result is an inability to fully benefit from valuable reserves. -Disruptions in reserves management by these centralized states are likely to be relatively temporary as other controlling figures will take over. -Global reserves controlled by central authorities are significant and the associated social cost can be variable (expensed vs accrued). Overall, there is a reasonable opportunity for Canada. It needs to be explained and the reward has to be "shared" equitably. Tough assignment in today's world but possible. https://www.ceri.ca/assets/files/Study_157_Final_Report.pdf Venezuela vs Canada Look at oneself, desolation. Compare oneself, consolation. Opportunities don't last forever.

Read the letter in parallel to the Semper Augustus piece. Typical annual reminder how the stuff is simple but not easy. In terms of valuation, -for the underwriting side, the table of growth in premiums and float and related comments suggest that this aspect still warrants a premium but much less than in the earlier years. -for the investment side, the premium attributed may be a function of the importance that one attributes to the cash optionality that is now potentially formidable. The letter was short and to the point. I liked it. BH is a masterpiece and it may be time for the last strokes from the Master.

The Enron guys were, no doubt, very smart. In a way. The talk is interesting because it underlines that how you filter your decisions is based, at least partly, on how you define being smart. Recycling of convicts in a promotional way is certainly controversial but my own humble evaluation is that Andy Festow is a broken but reformed man (perhaps like the broken and reconstituted trophy that he showed during his presentation). The "moral" question revolves around the rules and principles dilemma that we all face from time to time. Questions raised about how individuals felt about tax loopholes were a source of uncomfortable introspection. It can be relatively easy to rationalize in order to internalize the disconnect/dissonance. Thank you for the link.

An interesting aspect of private equity is that its relative opacity can be a source of stability as mark-to-market fluctuations can be attenuated, at least for some time. "...it's easy to look at historical data and think that the performance is inherent to the model rather than based on a context that has been changing." Great insight, I agree. In a way, private equity can be seen as an asset class which has been recently characterized, using historical standards, by high multiples and high debt ratios, which makes the author suggest: "In our view, the 2015, 2016, and 2017 vintage years are likely to return close to zero percent per year if history is a good guide." At a time when PE firms are flooded by capital (as per the linked article and many other sources) and have accumulated a record amount of "dry powder". The author calls the situation "bizarre". "Facts sometimes have a strange and bizarre power that makes their inherent truth seem unbelievable." Werner Herzog

20 years is a long time. I've done very well with Fairfax and related holdings during the time period but the result has occurred in the context of a variable level of ownership. Often hoped for a stable long term position but the ingredients have never been assembled (so far). Thank you for the post FFHWatcher. Perspective helps. In 1997: NPW=1392,6 (million CDN) Total investments=4054,1 (million USD) SO=11,1 (million shares) In 2017: NPW=9983,5 (million USD) Total investments=39381,6 (million USD) SO=27,8 (million shares) Then, FFH was getting ready to acquire CFI and TIG. Now, FFH is getting ready to play offense. Humble tentative conclusion: the earning power has been multiplied and the P/B premium that needs to be applied is in large part a function of float deployment.

Technology will change our lives, more and more so. Opportunities for related productivity growth will likely materialize somehow. But, at the same time, on a daily basis, it is amazing to see how technology puts a significant drag on processes. Relevant for specifici investment decisions and also relevant for the growth in the quality of life per capita. The authors suggest that progress is not linear and that we may be on the cusp of harvesting the full rewards of digitization once a certain scale is reached. I want to believe it. https://www.mckinsey.com/global-themes/meeting-societys-expectations/solving-the-productivity-puzzle

http://www3.ambest.com/ambv/bestnews/presscontent.aspx?refnum=26205&altsrc=9 http://www.artemis.bm/blog/2018/02/06/alternative-capital-lost-in-2017-has-now-been-replaced-a-m-best/ Data about the evolving competitive landscape.

So, what is driving the cycle? Following cycles can be mostly a retrospective exercise. However, a lot of data suggest that the present market compares to the "great soft market" of the 1997-2001 period. One of the underlying factors is the advent of significant alternative providers of cheap capital. Some (eg Fitch) suggest that this may be a feature that will "smooth" the cycles, as it is felt that "efficient" capital market investors will help disperse and diversify the "risk". Last year was a great example when insurers and especially reinsurers had to deal with extraordinary losses. However, many reinsurers were able shed some of the losses to the ILS market which capacity has been already replenished (and more) by institutional investors reaching for yield. The answer to the question about this being a positive or a negative is related to an appreciation of the cycle and to what drives the cycle. My take is that the last soft part of the cycle has been so far: very unusual in its intensity and duration, cheap capital has played an increasing role in maintaining a uniform psychology among providers which contributed to less discipline vs market share and cheap capital will not be a constant feature going forward. At this point, for Fairfax (underwriting side of the business), I see them being very well positioned because of a stronger and more consistent underwriting discipline in the last few years, a relatively low NPW/capital and the incredibly high cash and liquid position on the left hand side of the balance sheet.

Did not spend time around investment Boards then but held both FFH and ORH common shares. With the privatization transaction, I felt no significant change on a net basis. I remember that the game plan was to buy back the ORH public float at some point. I submit that a way to see an investment in ORH then was, conceptually, like holding callable equity at any time with the pricing schedule "determined" by the market quotation. So, I was OK with the ORH transaction.

Fair enough and every acquisition can have a Cinderella at midnight feel to it after the fact. But, the previous operating history of Allied suggests a positive outcome over time. In 2010, FFH bought Zenith National (with a 34,5% premium to book value) in the context of declining net premiums ++ and poor reported combined ratios (post-acquisition 2010: 137,8% 2011: 127,5% 2012: 115,6%). OK, different company and different environment. But, how did one feel about that acquisition then? How does one feel about that acquisition now? With Zenith, the net premimums were low at a time when they should have been low. The negative was the relatively high expense ratio and the need to bring reserve levels to the same standards. Results since 2013 have been excellent and there is a lot more potential in the WC lines. For Allied, the scenario is different and adjustments won't be at the same levels but expectation for a similar conclusion is reasonable IMO. A certain amount of patience and confidence are required and it may take a while before the realization of value. It may take a full cycle.

Reading your last post as I was finishing this. Brit has been into the fold for some time now. Their own disclosure describes a recognition that, generally, markets have been very soft. This would point to a lower risk appetite and to lower retention of premiums even if it remains relatively well capitalized. One does not know if this was a directive coming from the sub itself or "guided" by the parent, but Brit has disclosed for instance that it has been increasing cessions on quota shares. It's a question of degree and context but I think counter-cyclical adjustments are welcome even if it means less income in the short term. Expect more of the same at Allied World?

"If I were running Fairfax I would have taken massive reserves this year....what an opportunity." It's OK to keep your opinion on the topic. I just want to underline that the decision to invest or not in Fairfax would be very easy if reserves would be "adjusted". BTW, in the news release, they document the net prior years reserve development (for the different subs). My take is that the 2017 numbers are in line with previous years and do not show what could be considered opportunistic over-reserving. YoY, the reserve redundancy is lower and that is well explained by the single casualty surprise at Allied World in Q4 and by the general decline of reserves released at the industry level. From the owner's manual (Mr. Buffett): "At Berkshire you will find no “big bath” accounting maneuvers or restructurings nor any “smoothing” of quarterly or annual results. We will always tell you how many strokes we have taken on each hole and never play around with the scorecard. When the numbers are a very rough “guesstimate,” as they necessarily must be in insurance reserving, we will try to be both consistent and conservative in our approach." (my bold)

Welcome FairFacts, I assume you refer to FFH numbers released recently. Many reasons drive the retention ratio. An interesting exercise would be to look at the insurance and reinsurance subs segmented data that will be reported in the annual report and try to identify with sub/line contributed to the change and try to define the reason(s) why it was felt that more premiums had to be ceded in exchange for reinsurance protection. Looking forward to that discussion.

Sure. Will keep going in this thread as it is relevant to FFH also. AHL (Aspen Holdings) is now trading at a slight discount to book value. The relatively long operating history, relatively low NPW to equity and relatively high investment per share (at +/- 3$ per share at end of 2017) would suggest that the shares are undervalued. The following comments will focus on the underwriting side and not on the investment side of AHL. -The positives. They seem to show discipline in the sense that they have not grown tremendously in the last few years in a market that has been quite soft and in the sense that they have often backed words with action by switching capital around different opportunities (within insurance lines and allocation between insurance vs reinsurance). AHL has a relative focus on specialty niches. -The negatives. My take is that, over time, AHL has not produced combined ratios significantly better than the industry and has had its fair share of negative underwriting results related to catastrophes. In the last few years, the trend in their underwriting result has been unfavorable and has included positive reserve developments which can not be considered to be fixed features. Overall, on the underwriting side, I think it may be reasonable to expect that AHL will continue to be an average performer or slightly better. However, AHL has existed (since 2002) in a period where industry net reseve movement has been favorable (very unusual period in terms of extent and duration of phenomeneon which would imply a very soft market). One would have to assess how AHL would differentiate itself from the industry if reserve deficiencies would become the norm for a while, especially for the longer tail liabilities. In a tougher environment, they would have to compete with survivors and with parties coming with "clean capital" just like they did when they formed in 2002. To link with the present topic, unlike FFH, AHL has grown organically. FFH has grown mostly through acquisitions and that comes with its own set of challenges but FFH combined ratio numbers from the last 5 to 7 years compare favorably to AHL. The biggest differentiator may lie in the capacity for Fairfax to fully participate in a hardening market. Makes sense?

This post is about the underwriting side of the business. Specifically trying to see the significance of results reported for the Allied World sub (Brit also). When you see larger than expected losses in the catastrophe area, it can arise simply because of the unexpected nature of events. However it may reveal a problem going along a spectrum from simply exposure, to temporary inadequate pricing to a more widespread poor underwriting/reserving culture. Actions to correct the problem should be in correlation to the severity of the problem. My understanding, from numbers reported now and before, and from specific comments made on the conference call, for Allied World (and Brit), is that the problem is likely one of exposure in the property market with catastrophe exposure. Fairfax historically has worked in a decentralized fashion for the insurance and reinsurance subs but, over the years, they have built some kind of oversight (Andy Barnard) with a focus on the underwriting/reserving culture. Once again, OdysseyRe had a very strong year in 2017 despite a very unusual year for the reinsurance industry as a whole. My take is that the exposure problem can be dealt with and I don't think that Allied World (and Brit) were bad acquisitions. It means though that the relatively favorable combined ratio profile that Allied World (and Brit) reported before the recent acquisition did not adequately reflect their "true" normalized combined ratio during an unusually quiet period for the catastrophe market. So, the implication is Fairfax may have paid too much for the acquisition. In retrospect, it would have been better to wait before making the acquisition :). But: In theory, there is no difference between theory and practice but in practice there is (Yogi Berra?). My opinion is that Fairfax has been able to build an unusually strong assembly of global players in the insurance and reinsurance segments poised to grow in the right environment and I think that the relatively unexpected numbers shown by the more recent acquisitions are likely to disappear over time. Results in the catastrophe space are lumpy and fit well with Fairfax philosophy in general. You just have to make sure that you can survive and it is best to use the cycle to your advantage. Underwriting problems can be more profound (Fairfax has had its share of exposure to this phenomenon a while ago) and here's a link discussing new developments at a company I have followed for a long time. 2017 was unusual in terms of frequency and severity of catastrophes and this has caused the tide to recede to some degree and has helped in defining the severity of the underlying issues. https://www.insurancejournal.com/news/international/2018/02/16/480985.htm Dazel, with all due respect, I submit that a "good business" would maintain a healthy reserving discipline whatever labile tax changes that may occur. I understand that firms may use timing but cooking the books, in my own evaluation, tends to cause a very significant dent in the intrinsic value calculation.

"US workforce? 20+ years of stagnating incomes coming to an end, maybe?" Just finished Homo Deus, by Yuval Harari: https://www.amazon.com/Homo-Deus-Brief-History-Tomorrow/dp/0062464310 Of course, who knows the future but his take would imply that advancing technology will tend to increase the divide between those who bring value and the regular Joe.

Good points. Employee turnover appears to be high at Amazon but I'm not sure about the age profile. Amazon is apparently even encouraging workers to quit with a 5000$ "offer". https://www.theatlantic.com/business/archive/2018/02/amazon-offer-pay-quit/553202/?utm_source=feed "Officially called “The Offer,” this proposition is, according to Amazon, a way to encourage unhappy employees to move on." The jobs are physically demanding and many stay on the job for the health insurance coverage. Concerning self-insured firms and the captive market, a practical experience (read from the scientific journal USA Today): "As the founder and CEO of a mid-sized company that employs 180 people in the United States, I know this well. In 2018, we will pay $2.8 million to insure our workers and their families. Year after year, we have wrestled with the costs of our health care plans. And despite trying every trick in the book, our per-employee costs have tripled over the past 14 years. A family plan in 2018 will cost us $27,000, which is higher than the annual salary of one-third of all working Americans. To put it another way, we are paying $13.50 per hour per employee just to cover the health care benefit. It’s a model that’s completely unsustainable, and needs to change." Employers, self-insured or not, (and the government) want to pay less. Patients are not satisfied with the value proposition. Providers are looking for more efficient processes and technology. Insurers (who now connect all these actors) don't see ingredients for meaningful change. Still early in the game and a lot of resistance expected but a potential for change. Example: https://www.apple.com/newsroom/2018/01/apple-announces-effortless-solution-bringing-health-records-to-iPhone/

"Somehow I personally consider this initiative an employer-owned PBM, that will be running on some kind of non-profit basis. Attached is a part of note 1 from Novo Nordisk Annual report 2017 released yesterday. It's ludicrous... What US politics haven't been able to fix so far, will eventually be fixed by Corporate America." John, Your last post was a source of reflection and research. This post lies halfway between this thread and Novo Nordisk (more on that later). Concerning your non-profit basis comment, some say that this has been a key long-term characteristic of Amazon :). Notwithstanding the "profit" part, because of Amazon, I keep receiving on my doorstep, delivered rapidly and reliably, affordable specialized equipment that comes from far away places. Somehow, I get connected with sellers and delivery people who otherwise would have been outside of my reach. I started looking at Novo Nordisk. If I understand you well, you seem to imply that the rebates etc are rising and affecting NVO's profitability in the context of a challenging pricing environment. Politely submitted, in my present limited understanding, it seems that the "value" of an american diabetic patient remains still relatively higher than other patients in general (ie Europe) even if pricing there is felt to be more "publicly" regulated. It seems also that the rebates and others are not passed on to the end user (the one who needs the product). Concerning your "fix" comment, It seems that what a lot of the present players are saying is: "if it ain't broken, don't fix it". This cost containment issue has been around for a long time and pharmas such as Novo Nordisk have always managed to preserve (and even increase) their profitability so this is nothing new perhaps. To help assess the cost pressure trends, here's a link related to a hot off the press report. If short on time, read the executive summary, the conclusion and the other Bloomberg link which gets the flavor of the report. https://www.whitehouse.gov/wp-content/uploads/2017/11/CEA-Rx-White-Paper-Final2.pdf https://www.bloomberg.com/news/articles/2018-02-09/drugmakers-dodge-another-bullet-in-trump-s-drug-pricing-report Government reports are, by nature, political (we don't want to get into that, don't we?) so issues may not assumed head on and the plan may change but, for what it's worth, my opinion is that 1-we may reach a point (soon?) when significantly more pressure will be applied on the profit margins 2-pharmas will need to "prove" the value of their products and 3-now there is an added component aimed at the reduction of "free-riding abroad". I understand that Novo Nordisk has a focus on diabetes (and obesity). Long term, diabetes industry dynamics may be changed by revolutionary new products (who knows when but the discovery of insulin itself is instructive in terms of the difficulty to identify where threats will come from and when) and pricing pressures may increase. However, the diabetes "market" will likely increase (a lot). Thinking of morbidity and mortality, did you know that, despite what the healines say, the global percentage of people dying violently has gone down tremendously in the last century and now, relatively, more people die from direct complications of diabetes (which is mostly a preventable disease, at least type 2)? Sugar (excess) is dangerous. One would think that preventive measures may eventually decrease demand for diabetic meds but, if history is any guide, when tobacco products were determined to be deadly products, tobacco companies were on the eve of long term stellar returns. Sometimes I wonder about the usefulness of these general discussions so, when I read more about Novo Nordisk and if I become bright enough, I may try to contribute to that specific thread. Final words related to your "political" comments and a way to go back to the essence of this thread. Health care costs have gone up ++ and, in many ways, this is not sustainable (tapeworm argument). Two links below using essentially the same data and coming to vastly different conclusions. The first link suggests that governments are too intrusive. The second link (Baumol's disease) suggests that the high prices we pay for health care may be in correlation to our relative affluence. http://www.aei.org/publication/chart-of-the-day-century-price-changes-1997-to-2017/ https://www.vox.com/new-money/2017/5/4/15547364/baumol-cost-disease-explained