Cardboard
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Posts posted by Cardboard
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SD,
Why do you expect the share price to pop following conversion? I think that it is a non-event. The market already assumes that this is going through. Have we heard of any opposition or possible showdown tomorrow? None. They also got Fairfax in their back pocket and most vote as management recommends.
What the market wants to hear about is the current level of profitability. They want to know if this company can finally make decent money at pulp spot rates that honestly cannot be much better. Q4 was bad, Q1 was disappointing (discounts on NBSK, little to no earnings on RBK). We need some guidance from these fellows. Half the quarter has gone by, so it should not be that hard to compute. Show us the money, then the pricing for the rights will be a heck of a lot better. That is what I read from Mr. Market and I should say that I cannot fully disagree.
Cardboard
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Dazel,
Regarding pulp prices, one thing that I think is very positive for SFK recently is the narrowing discount between BHK and NBSK. In mid-March, Europeans were paying $100 U.S. less per ton for BHK or an 11% discount, today it is $71 less and a 7.5% discount.
It just shows the tightness in the market since BHK is an inferior pulp (substitution driving a higher BHK price) and BHK is quite important for SFK since it is a big driver of the price obtained for their RBK.
Cardboard
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SD,
I have to disagree with you on this one:
"But there is nothing that says you have to start on the Final Prospectus immediately thereafter;"
The issuance timing of the preliminary prospectus is crystal clear and the issuance of the final prospectus is based on time required to receive regulatory approvals afterwards. I don't know how else I can interpret the agreement with Fairfax.
If they don't like the price, they will have to postpone or cancel the rights offering. Or come up with a new prospectus with other terms. Playing with the timing of the issuance of the final prospectus after having in hand all regulatory approvals, which is the condition to issue, IMO is a breach of contract unless approved by Fairfax.
Cardboard
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SD,
FYI, it sounded more like you had sold common and bought debs in your previous post.
Now, regarding the obligation to go ahead:
"Timing of Rights Offering. Subject to and in accordance with the terms hereof,
the Corporation agrees that it will file with the Canadian Securities Commissions: (i) the Preliminary Prospectus, together with the other requisite
filings and documentation, no later than 2 Business Days following closing of the
Conversion, which date shall not be later than June 30, 2010 (the "Outside Filing
Date"); and (ii) the Final Prospectus, together with the other requisite filings and documentation, on or before the day which is two Business Days following the date on which all necessary approvals and consents are received from the
Canadian Securities Commissions and the TSX that are necessary or advisable, in the Corporation's opinion, acting reasonably, to proceed with the filing of the
Final Prospectus and completion of the Rights Offering. The Corporation will use
commercially reasonable efforts to obtain a receipt (or analogous decision
document) as soon as possible following the filing of each of the Preliminary
Prospectus and Final Prospectus with the Canadian Securities Commissions."
Based on the agreement with Fairfax quoted above, the preliminary prospectus has to be filed 2 business days following the conversion (May 27?, see below). Now, regarding the timing required to obtain what is necessary to file the final prospectus, it is about 10 calendar days based on a previous situation that I have seen. That puts us on June 8 or 2 business days, 10 days after.
The vote for conversion is happening tomorrow and the court hearing is the next day or May 20. They said that they could convert as early as May 25 if it goes per plan and by the sound of it, they want it badly. Will they delay indefinitely past the court order? Not likely. They also have an interest to move quickly since the SGF and GE loans are conditional upon conversion.
It seems to me that the only way out of this is for Fairfax and SFK to mutually agree to postpone or cancel the rights offering. Or they declare some kind of material event. If not, this is happening rather quickly based on the terms of the agreement.
I wish I could be more optimistic, but this is what they agreed to. I am also not totally clear on Fairfax intentions. It sounds like that they want to average down to end up with some return on this investment (current cost base of $4 a share?). Also, a move above 20% ownership will likely require equity method of accounting which has some implications for Fairfax (taxes, reporting, etc.)
Cardboard
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Reading now the related text in the 10K from C&F, I don't think that it is a "penalty" or fine.
"Crum & Forster’s insurance subsidiaries are subject to state laws and regulations that require diversification of investment portfolios and that limit the amount of investments in certain investment categories. Failure to comply with these laws and regulations may cause non-conforming investments to be treated as non-admitted assets for purposes of measuring statutory surplus and, in some instances, would require divestiture. Either of these could result in the Company having to sell an asset when market conditions would not otherwise warrant a sale. In 2009, under the Delaware Insurance Code, the Company recorded a nonadmitted charge of approximately $81.8 million, net of tax, due to the Company exceeding Delaware’s statutory limits for investments in equity securities."
It is more of a temporary charge against the calculation of statutory surplus by Delaware. It is done net of tax to account for the amount of tax payable upon real sale. My take anyway.
If I am correct, it is still interesting information for shareholders to know or what can be held in equities at Fairfax before getting into these. At the moment, they have more than enough statutory surplus to write the current volume of policies. However, if we were into a hard market or needing most of our statutory surplus and stocks were attractively valued, you can see where this regulation could limit the investment portfolio.
Cardboard
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A penalty of $81.8 million, net of tax and there is no mention of that in Fairfax AR? Sounds like material stuff to me. Why not using calls or other derivative to avoid that. Where is that recorded on the income statement? What is the penalty at other divisions if any?
Cardboard
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I have always wondered about this provision in these kind of documents. Do you know someone or a case where this has been used? It forces the corporation to pay you for your shares instead of you selling them on the open market. In this case, it would take only 1% of outstanding shares to prevent the conversion to pass and along with it all financing activities. The condition could get waived, but it could create delays. Still, why setting the bar so low?
Right to Dissent
Pursuant to the Interim Order and the Plan of Arrangement, Unitholders have Dissent Rights with respect to the Arrangement Resolution, as though the Units were shares of a corporation governed by the CBCA, by providing a Notice of Dissent to the Fund at 1010 de Sérigny, Suite 100, Longueuil, Québec, J4K 5G7, Attention: Patsie Ducharme, Vice President and Chief Financial Officer of SFK Pulp, by 4:00 p.m. (Montreal time) on the last Business Day immediately preceding the date of the Meeting, provided such holder also complies with Section 190 of the CBCA, as modified by the Interim Order and the Plan of Arrangement. It is important that Unitholders strictly comply with this requirement and understand that it is different from the statutory dissent provisions of the CBCA which would permit a Notice of Dissent to be provided at or prior to the Meeting. Provided the Arrangement becomes effective, each Dissenting Unitholder will be entitled to be paid by the Fund the fair value of the Units held by such Dissenting Unitholders determined as of the close of business on the last Business Day before the Arrangement Resolution is adopted. See Appendix B and Appendix E for a copy of the Interim Order and the provisions of Section 190 of the CBCA, respectively. It is recommended that any Unitholder wishing to avail himself or herself of his or her Dissent Rights seek legal advice, as the statutory provisions covering the right to dissent are technical and complex. Failure to strictly comply with the requirements set forth in Section 190 of the CBCA, as modified by the Interim Order and the Plan of Arrangement, may result in the loss or unavailability of any Dissent Rights. Beneficial Unitholders who wish to dissent, should be aware that only registered holders are entitled to dissent. Accordingly, Beneficial Unitholders desiring to exercise Dissent Rights must make arrangements for such Units beneficially owned to be registered in such holder's name prior to the time the written objection to the Arrangement Resolution is required to be received by the Fund or, alternatively, make arrangements for the registered holder of such Units to dissent on such holder's behalf. Pursuant to the Interim Order, a Unitholder may not exercise Dissent Rights in respect of only a portion of such holder's Unit. See "The Arrangement – Right to Dissent".
It is a condition to the Arrangement that Unitholders holding not more than 1% of the outstanding Units shall have exercised Dissent Rights in respect of the Arrangement that have not been withdrawn as at the Effective Date. See "The Arrangement – Conditions Precedent to the Arrangement".
Cardboard
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Uccmal and Dowfin,
The answer lies in metrics such as Earnings per Share and Book Value per Share pre-deal and post-deal. You don't get diluted per say in your ownership % of the business if you participate, but the business itself gets diluted on a per share basis.
Cardboard
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"Just got a reply from IR, FFH will have to subscribe fully for its own shares before the 20% kicks in."
Alertmeipp,
Just curious, who got back to you on a Sunday? FFH or SFK?
Also, I don't know if you have all seen it or not, but there was an Early Warning Report issued on SEDAR on Friday, indicating that Fairfax did not own anymore any convertible debenture of SFK. All sold in 2007. There was an error in the Fairfax press release on May 12.
Cardboard
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I think that you nailed it Myth. You can't buy anything in pulp with $40 million or even $100 and if you are about to see a big chunk of change due to a sale then you don't issue a bunch of shares at a dollar.
The other thing that really annoys me is this conditionality around the conversion:
"Each of the components of the Refinancing Transactions is conditional upon the closing of the reorganization of SFK Pulp into a corporation, which is subject to the approval of SFK Pulp's unitholders at our annual and special meeting to be held on May 19, 2010, and upon the closing of all the other components of the Refinancing Transactions (collectively, the "Closing")."
There is nothing in this refinancing that could not be done within the income trust structure. If there is tell me. I would really like to learn.
There is also this notion that somehow big U.S. investors will show up post conversion due to liquidity? and other? and drive the share price up. The big change that you will see for certain post conversion is for management to issue the Fibrek Share Option Plan. The special one-time grant with conversion at $3.50 and $5 make you feel good, but don't forget about the regular grants which will be done at market price.
They should convert because they need to convert due to Canadian law changing in 2011. That is it. And not tie this to everything else.
Instead of management getting involved in financial engineering and the like, I would much rather see a higher sense of urgency and creativity to cut cost at the plants, improve selling prices (15% to 20% lost to discounts in an ultra tight market? unreal), improve processes, whatever. Generate cash the hard way. If we have had an extra $20 million in cash on the balance sheet due to better earnings, then the SGF and GE would have likely signed off on similar lending conditions without the $40 million share issue.
Cardboard
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You have a stock market worried about the economy: pulp? And I think that the issue you are raising is a problem for most. Look at it this way.
For example, if you own 50,000 units or $70,500 worth at current price, you will be forced to spend $22,105 just to maintain your current stake in the company: $40 million divided by 90.473 million units or $0.442 required per share owned. Mutual fund or not, that is money that you may not have available and a big jump or 31% above your current holding value.
Also, there is no value creation here. Shareholders are handing out to management $40 million in cash from their own cash reserves to make the company's balance sheet stronger. The operating business is the exact same, but there are now more shares outstanding. You have more of your own capital invested and at a lower rate of return. For an investor, it does not seem like really good allocation of capital. And the more the share price comes down, the worse it gets. You can argue that this brings more certainty to the business and eventually a return to you, but then you have to ask yourself, what were you doing before invested in this risky venture? Speculating?
Fairfax knows this and that is exactly why they are the back-stopper and asked for this discount of 20%. They don't like being forced to come up with $7.5 million in cash just to maintain their current stake in the business. By being the back-stopper and at a discount, they commit in theory $40 million, but they have a chance to reduce the dilution impact from this cash raise by lowering their capital invested per share ((market value of current holding + discounted price x new shares)/total shares now held) below others who just subscribe or don't subscribe at all.
If you want to benefit from the discount like Fairfax, you have to apply for the additional subscription privilege and hope that many will not subscribe or not fully in the offering. If everyone participates fully in the offering, then the discount really does not exist for anyone including Fairfax. We become all diluted equally by the cash raise and that is it.
Now, if the market keeps tanking and SFK with it, they may have to postpone or cancel this rights offering. We have uncertainty on the issue price and uncertainty on the timing. The market may start to create uncertainty around: “Do they badly need this cash?” I don’t get it. When you need cash, you get it now. You don’t announce your intentions weeks and months ahead of time, create massive uncertainty and then make your share price collapse so much that you can’t raise capital anymore. I didn't think that they needed it, but now that they feel it is needed, I wish they would have taken another route.
Cardboard
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I really like HYD too. Trades at $0.43, has $0.77 of net-net working capital, book value is $1.30 and EPS for 2010 should be around $0.10. You cannot find an energy service company in Canada trading at such low metrics. It is at least double that much and I don't know any where you can buy well below the liquidation value of current assets alone.
However, I was terribly wrong with my initial purchase. I never expected the drilling downturn in Canada to be so long and brutal. The good news is that they came out leaner, the debt paid off, no dilution whatsoever and have 60% more rig building capacity with their new plant finished in 2006.
I expect that it will take them quite a while to return to peak utilization, but the news and capex increases from most energy service firms in Canada this quarter is very encouraging. What they have developed on the international side during the downturn is also a huge plus and something that should eventually boost earnings past their previous peak.
Cardboard
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SD,
First of all, book value will grow by $40M since it is equity that they are raising but, you cannot add $52M to book value if they call the debentures. This is like repaying debt and all that would change on the balance sheet is cash on the asset side and the elimination of debentures on the liability side. There is a small adjustment to equity for the equity component/accretion, but that is only a few millions.
Second, to obtain something like $2.08, it means that the shares need to trade at $2.60. That is a heck of a price hike from today's level. It is not impossible, but based on this, I doubt it:
"shall be equal to the lesser of: (a) the volume-weighted average price of the common shares on the TSX for each of the trading days on which there was a closing price during the five trading days immediately preceding the date of filing of the final prospectus, less a discount of 20 per cent; and (b) the volume weighted average price of the common shares on the TSX for each of the trading days on which there was a closing price during the 40 trading days immediately preceding the date of filing of the final prospectus, less a discount of 20 per cent."
They expect a closing around July 20, but the final prospectus will be mailed to shareholders well before. Closing to me, means that the rights have been exercised. So the condition of 40 trading days means that May and June are likely the ones to watch for. So since the beginning of May we have what? $1.60. Remove 20% and we are issuing shares at $1.28.
In any case, the size of this issue makes it manageable. IMO it is not optimal, but it provides cash which will be needed if pulp heads back quickly to something like $800 a ton or to the point of LessthanIV.
Cardboard
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Lots of optimism here!
The debt deals are fine, but mathematically the warrants are dilutive to you and to Fairfax no matter how you slice it.
If you participate in full in the rights offering, you will continue holding the same share of SFK afterwards. The problem is that there will be more units out there, likely 30 million, the business will generate the same earnings and there will be $40 million more in cash. This means less earnings per share even after assuming a reduction in interest paid due to the cash raised. The only way around that would be to issue the shares at such a price that the reduction in interest paid with the $40 million divided by the new shares is equal to current earnings divided by 90.473 million units.
It is the same for book value, unless the units are issued at $4.78 or current book value per unit, it is dilutive on a per unit basis.
Even on an EBITDA/Enterprise value, this is dilutive because the cash raised is obtained at a lower price than current trading price. Here the discount of 20% is the issue.
IMO, it is a safer route, but the upside in SFK shares has been reduced. That is if they remain an independent entity. However, if their intention is to sell and the additional $40 million makes them look stronger or less of a distressed seller then they can obtain a better price for their assets or the company. That is very short term thinking since cash is coming on the balance sheet anyway at current earnings. So you could argue that a higher sale price per share would have been obtained anyway.
ATSG is a great example of a company that went through extreme duress and never issued shares to help them out of it. As it came out from its troubles you can see the upside that was generated. Here the upside should be less because there is a hit on the value per share.
Cardboard
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I think that BP is getting interesting in terms of valuation. However, there is a history of catastrophes here that isn't present at other majors:
- Deadly blast at Texas refinery in 2005.
- Major oil spill in Prudhoe Bay, Alaska in 2006.
- Platform catastrophe today.
If you recall, there was quite a bit of hand slapping following the 2005 and 2006 events and the stock valuation vs others has never fully recovered from these events. Cost cutting was blamed.
I think that this stock may go down some more over coming weeks/months. More lawsuits will come out, initial clean up cost estimate will likely climb and the U.S. government after issuing severe warnings to BP in the past about its U.S. operations may take some drastic actions. There is a cause for the blast and they will say that it could have been prevented. Sometimes it is a chain of simple small things leading to a big one.
There is a passage in one of Peter Lynch's book (Beating the Street or One Up on Wall Street) on when/how to buy into companies being hit by disasters. He was looking mainly at utilities such as the owner of Three Mile Island. You can also look at what happened to Exxon following the Valdez and more recently to Merck following Vioxx and Maple Leafs Foods following a listeria outbreak.
IMO, there is another side to this event. Democrats were totally opposed to expanding offshore drilling during the Bush years while this thought got relaxed with Obama's energy plan. See State of the Union. I suspect that we may see quite a political backlash relative to offshore drilling (they are already saying no to any new offshore drilling permit). Think also about the kind of fear that will be present in the media in just two months from now as hurricanes start to roll into the Gulf.
Status quo for Obama or the democrats does not seem feasible considering this background, their support by environmentalists (Al Gore and vast following) and a mid-term election coming up. We may now see a higher push toward onshore natural gas as a near term alternative source of energy. Nuclear, solar and wind will certainly see higher interest, but the quantity of energy generated or lead time is an issue.
If this happens, with wells depletion at high rates, an economy recovering (think chemical production and electricity demand), Boone Pickens' plan gaining traction and an industry that has been operating at very low rig utilization rates for a few years now, perceived never ending supplies may turn out to be just that; a perception. I suspect that we could see higher natural gas prices in the short term. This could finally lead to quite a resurgence for conventional reservoirs drilling or an activity that has been almost abandonned for the past couple of years.
Cardboard
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"Other than temporary impairments – At each reporting date, and more frequently when conditions warrant, management evaluates all available for sale securities with unrealized losses to determine whether those unrealized
losses are other than temporary and should be recognized in net earnings (loss) rather than accumulated other comprehensive income (loss). This determination is based on consideration of several factors including: (i) the length of time and extent to which the fair value has been less than its amortized cost; (ii) the severity of the impairment; (iii) the cause of the impairment and the financial condition and near-term prospects of the issuer; and (iv) the company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of fair value. If management’s assessment indicates that the impairment in value is other than temporary, or the company does not have the intent or ability to hold the security until its fair value recovers, the security is written down to its fair value at the balance sheet date, and a loss is recognized in net gains (losses) on investments in the consolidated statement of earnings. For debt instruments classified as available for sale, subsequent reversals of impairment losses are required when, in a subsequent reporting period, the fair value of the instrument increases and the increase can be objectively related to an event occurring after the loss was recognized."
I have not worked with auditors, but I guess that whenever they see a security that is 50% or more below cost and that has been for a certain period of time, that they will question management about it. They don't study the specific securities so to them, a double or triple does not exist. If something is materially below cost, then to them it is likely to end up being a realized loss at some point in the future.
So, management teams are forced to show this loss through the income statement which has the effect of reducing earnings. I guess it is a way to ensure that GAAP earnings are more reflective of what is truly going on. If not, earnings over time could be inflated since these losses are not realized and not flowing through the income statement. They would only appear within comprehensive income and book value. Somebody must have cheated in the past showing great profits and hiding unrealized losses, especially when securities were carried at cost on the balance sheet. So they came out with this accounting rule.
Cardboard
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I remember in the old days that Odyssey Re was opportunistic in terms of where to deploy its underwriting capacity.
If there is no to little competition in the lines issued by Chubb, then why not go after these? C&F should be a smaller, more entrepreneurial organization. Based on what you found, they are already knowledgeable about these lines, it is just that they are underweighted.
There is also the tail of course. Casualty and workers compensation have a longer tail than property (longer time holding cash before paying claims) and that may explain some of the difference. Are they going more after these? However, you have to remember that you need to hold more capital to write these so there is a trade off.
I don't know. I have been following this company for over 10 years, held it for many of these years and have been at times a fervent defender. I have never seen them deliver much underwriting profits, more the opposite. It seems that we always have to get into complex explanations to explain the unexplicable.
The Street has stopped beating its head against the wall and has decided that 1.0 book value is it. Since they are the ones deciding what you can get for your shares might as well accept it.
Cardboard
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BMO just raised its target on Fairfax to $420 a share from $400 CDN. They came out very impressed with their investment gains and mention that their forecast could be beat if investment gains continue at this pace. They are worried however about coming Zenith and its "troublesome" 123% combined ratio.
Here is the hiccup and why I am trying to bring to the board some attention to underwriting results.
BMO's target is 1.0 time book value of what they think book value will be a year from now assuming investment gains of $4-5 a quarter. They essentially have no clue what it will be just like most of us. It is a guess. Book value then becomes the only valuation metric that they are using and that is what is so damaging. There is no premium attached for investing acumen or for any possible upside. It trades like a closed end fund or whatever the easiest approximation of liquidation value is at any given point.
Other insurers trade based on book, but also based on a multiple of earnings. That is how they manage to trade above book.
So if you don't mind the company trading right at book value for the majority of its lifetime (we are 70-80% of the time in a soft market), that is fine since growth in book value should deliver you good results. But, if you were looking for a revaluation of Fairfax, like I was, I think that it will be disappointing.
Cardboard
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Thanks for the info.
Actually, I have taken another look at Domtar and they seem more positive about the pulp business than what I recalled. In the recent past, their goal was to dominate uncoated free sheets (pretty much there) and to sell off almost everything else. They actually sold some timber mills very recently.
Indeed, they are a very large producer of market pulp. Here is the capacity and breakdown of these facilities:
Dryden, Ontario: 319,000 ADMT
Kamloops, B.C.: 477,000
Plymouth, North Carolina: 444,000
Woodland, Maine: 398,000
They have very little operations in Quebec, so I don't see much synergies potential with SFK St-Felicien. It is a different story however with the U.S. plants which are right next door to theirs. RBK is probably also a big attraction to them based on that:
"In our manufacturing system, we have expanded Forest Stewardship Council (FSC) Chain-of-Custody certification to our entire mill network. What does this mean? We can now produce FSC-certified products at any of our mills across North America. This will help us further develop our Domtar EarthChoice® line of sustainable papers. We are working on increasing the availability of FSC fiber to continue to grow this brand through various initiatives with industry partners and suppliers, namely the Carbon Canopy project."
Also, maybe that they now see market pulp as a good business on its own and that could make them interested in SFK St-Felicien too? I guess that the rumour may not be that far from reality.
Cardboard
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Onyx1,
The triangles are shown in the 10K. I don't know if you will find the details you are looking for in their 10Q but, why digging so much? Here is the combined ratio for Chubb for each year between 1997 and 2009 from a version of Value Line that I have and their 10K:
1997: 96.9%
1998: 102.3%
1999: 102.8%
2000: 100.4%
2001: 113.4%
2002: 106.7%
2003: 98.0%
2004: 92.3%
2005: 92.3%
2006: 84.2%
2007: 82.3%
2008: 88.5%
2009: 85.6%
Also, these guys have been shrinking their net premiums earned in each year since 2005. If they were playing games, should it not appear somewhere in a 13 year span? Buffett also held that stock in 1999-2000 telling me that he has some respect for the firm.
I am starting to think that the problem is that Fairfax expands much faster than the industry in the upturns, but isn't reducing enough during the downturns. Start with 100 at 105%, go to 200 at 95%, shrink to 150 at ???. Insurance demand and pricing is likely growing right in line with GDP and inflation. That is why we see the combined ratio never get really low during the upturns, but it gets really high during the downturns. It seems like a different strategy than "traditional" conservative and disciplined underwriting where the goal is to get an underwriting profit under whatever condition. Also, if it was all head count related, it would show only in the expense ratio, but we are seeing an increase in the loss ratio.
It is more like trying to accummulate a ton of float during the upturns and retaining as much as possible while trying to minimize the cost during the downturns. I don't have a problem with that. Of course, it is more risky if you get poor investment results and poor underwriting results at the same time. You can unwind many good years of profits and growth in book value if that happens: a lumpy 15% is better than a smooth 12%. But, a lumpy 12% vs a smooth 12% is what?
I would simply like management to state what they are trying to achieve since others in the industry striving for disciplined underwriting seem to use a different method and are obtaining different results.
Cardboard
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Libor.plus1,
You are absolutely correct to be questioning this company. Here is what I think changed for Level 3 in the past 3 to 4 years:
1- More focus on delivering services directly to enterprises vs relying on carriers. Big new source of revenues and profits and only starting to gain traction.
2- Big players: U.S. government, Google, pushing carriers to do something to improve internet speed.
3- Significant consolidation in the industry and many players disappearing.
4- IPhone and IPad. Clearly demonstrating the need for faster, larger wireless networks. It is not just at the tower level, but between towers that the infrastructure is inadequate.
5- The economy is resuming its growth, which should lead directly to higher demand for bandwidth.
6- A share price that is now so low to reflect all possible bad news, without any reflection of any positive news.
I have kept an eye on this company for almost 10 years and decided only recently to enter since I think that the upside vs downside risk is now very promising. It reminds me a bit of big cell tower operators after the 2001 recession which were all considered caput under heavy debt loads. See how it changed with demand and profits.
Cardboard
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I believe that we need to reconsider the likelihood of a hard market in the near future. To me, the Chubb results are very telling and I encourage you to at least read this short press release:
http://finance.yahoo.com/news/Chubb-Reports-First-Quarter-prnews-3367809713.html?x=0&.v=1
These are not the type of numbers that we saw at the end of the 90's which was then followed by 911 leading to the hard market of the early 00's. For Chubb it was running between 100-103%. We are nowhere near depressed conditions. What if the hard market is 3 to 5 years out? We are currently running 17.9% higher than these guys on the combined ratio.
By the way, these guys are not fishing in some kind of special pond. Their net premiums written are about 2.5 times the size of Fairfax and their biggest division is their commercial unit which should be in direct competition with Crum & Forster unless I am completely wrong. For their commercial unit vs C&F the differential in combined ratio is 13.4%. In q1, their net premiums written declined 1% while C&F increased 3.6%.
Cardboard
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Book value is $383.83 U.S. per share.
IMO, that is really the only thing that matters at this point. So, the shares will likely trade closer to that amount over the coming days and then you might want to sell and then buy again if we see a gap again between their holdings vs the market. They may pop and go a bit higher than book, but I suspect that they will trend back toward book.
If you want a more classic insurance company, then look at Chubb, Markel or others. These companies will also tell you the impact of q1 catastrophes, but you will notice that they are still well below 100% on the combined ratio including these (93.6% including 12.3% of catastrophes for Chubb). By the way, I doubt that they are undisciplined, cheating with reserves or that discounting reserves or not explains much on the massive gap.
The end result is simple, no living analyst will ever assign any value to Fairfax's insurance businesses since they almost never generate any profit. How do you value that? Then you have some interest and dividend income that looks repeatable, but then most of it is used to pay off interest charges, runoff costs and underwriting losses. A multiple of earnings? What earnings? The only thing that goes up is the value of their portfolio holdings, but that is highly erratic. So, what we are left with is something very similar to a closed end fund where all that matters is the gap between its trading price and NAV which in this case is book value since it is the quickest, dirtiest way to get an handle on it.
The market likes simple yardsticks and doing complex math like we have seen on the MKL vs FFH post is not its thing. Simply listen to the analysts questions tomorrow and you will see what I mean. Most of the time, they don't even know half of the company's details being discussed here on this board.
Now, this may change when we enter a hard market since at that point Fairfax should generate underwriting profits. However, I suspect that there will remain a gap in the combined ratio between them and some of their best competitors, so Fairfax could trade at some multiple of book (say 1.5), but the competitors may then trade at 2.0.
Conclusion: Fairfax should deliver over time a better rate of return to its shareholders than its competitors since they are very good investors. Growth in book value will be the key indicator. However, you will need a lot of faith in their continued investing outperformance since it is not more boring figures such as underwriting profits and interest that are very cummulative that will drive return on equity.
For me, the run is over. I knew that they would show good investment results and was hoping that this would finally help close the gap in valuation between them and some of their competitors. At least get some recognition for their investing talent but, based on the above, I will stop hoping.
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On the 80's networks, you need relays every 40 km and need to switch back from light (optical) to electric signal. On Level 3's network, you stay with light all the way and relays are 100 km apart. Also, stations are 160 km apart on the 80's networks while 600 km apart on Level 3's network.
The 80's networks are also not fully optimized in terms of route: sometimes you use your competitor to transmit your signal, sometimes you travel more distance for nothing.
All together, the operating cost is about double. If they could have resolved these issues to drive their costs down they would have, but they can't.
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Macro vs micro
in General Discussion
Posted
I typically hold a majority of small illiquid companies in my portfolio and that is because they appear the cheapest or offering the highest retun possible in what could be found in the stock market. Generally, I am close to fully invested.
2008 has tought me that macro matters and can destroy what looks like terrific value at the micro level. You can do the best analysis in the world, know all about reading balance sheets and income statements, but if things get really bad in the economy, what looks like a sound company can end up BK. Deciding to go to cash in early 08 was also a macro call and meant to purposely ignore value investing opportunities.
It appears that we could be getting back into this mode again: a double dip recession or worst. The recovery could also continue, but the key is that no one knows. What I hold currently appears to me terrific, but it won't look as terrific if earnings collapse or if the market offers again the kind of valuations seen in late 08/early 09.
To be clear, I understand that volatility of the stock market is one thing, but the macro impact of something like a depression on your holdings cannot be dismissed. Think of the impact on something like SFK for example.
If you are in a similar situation as mine, what are you doing now to hedge the unknown? A possible abyss just months away?
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