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ERICOPOLY
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Posts posted by ERICOPOLY
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Read the Northbridge buyout announcement:
The proposed transaction also represents a 31.8% premium over the 30-trading day volume-weighted
average closing price for the period ended November 28, 2008 of $29.59
Clearly, it was a selling point that the premium was 31.8% over the 30-trading day volume-weighted average closing price.
So, they aren't going to want to wait another 30 trading days from today for ORH given that they are tipping their hand already and the price has/will rise accordingly (if you believe in the buyout thesis).
It would not be a great press release to say that the price is only 5% or 10% over the average 30-trading day period -- it's better to make the offer sound as generous as possible.
The $400 million note offering is scheduled to be completed on August 18th (Tuesday). I would expect they would wait to be certain they have the cash in hand first... then pounce.
Don't forget I'm heavily long ORH now so my mentality is obviously self-serving at this point.
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First named Atlantic storm today: Ana.
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Doesn't such a move have huge tax consequences? I've been holding half of my positiion since March because I can't afford to sell them any more due to taxes, I'd rather hold them. But I am talking about holdings that were opportunistic. FFH is my long term holding and I won't even touch it. Let's say that you sell FFH for a gain of $100 per share. and you now owe $30 to the IRS. And then you buy in ORH and due to buy out, you gain $30 per share there. Well you don't really gain much, do you? Maybe I totally missed something here.
Yes, there is a tax management strategy that I think you are missing out on.
Here is a short description of the strategy:
http://www.thestreet.com/story/769361/hedging-technique-opens-a-pandoras-box-of-tax-concerns.html
Basically, instead of selling your shares, you can sell short "against the box", or buy puts, or write deep-in-the-money calls. You will be hedging your gains against a pullback in the market, but won't owe any tax on the position you are protecting as long as you close out your hedge within 30 days of the end of the tax year and then hold your position fully unhedged for the next 60 days. It also resets your holding period (treated as if you bought the shares the day you close out your hedge I believe).
Read the constructive sale rules.
See "Constructive Sales of Appreciated Financial Positions"
http://www.irs.gov/publications/p550/ch04.html#en_US_publink100010318
So, if you borrow shares and sell them short, you have a bunch of cash to play with. Use that cash to buy ORH or ORH calls. Or instead you can write fairly deep in the money long dated calls on FFH (to protect from exercise, use a long date and don't go too deep) and use the cash from the premium to buy ORH calls.
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Thanks Cardboard, that definately helps!
O.K. so let's speculate that ORH won't be taken over then...
1. Andy felt that buying another 10% of ORH public shares in 3 months (1.7M shares of approx 17.2M available) was a just a good deal and....
2. Paul and Brad needed to shift $240M worth of ORH shares to some other subs just because they could OR they really needed to shore up some massive adverse development at one of the non-US subs, but decided not to disclose this in the Q2 or conference call and....
3. Prem felt that $880M of holdco cash was just a bit too light, and needed to boost it to $1.3B in the worst credit environment since WWII so they can cover $180M of debt 4 years from now....
OR
They've collectively decided that it's prudent to take $500M - $1B flyer of (25% of shareholder equity BTW) of their company on a Chinese acquisition
OR
They are buying the rest of ORH.
...c'mon!
That's what I think too, but then like I said once I switched to the ORH bench yesterday I've been a huge fan of a premium buyout ;) Maybe it's affecting my judgement. Wow, after taking FFH for a ride in recent weeks... to get the ride back-to-back from ORH will be amazing.
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I switched to ORH yesterday, and it's amazing... I nearly instantly had a change of heart regarding ORH buyout. Premium!
I switched because:
1) backing out the goodwill from FFH balance sheet, the apples-to-apples comparison to ORH on a P/B basis is pretty big
2) takeover lottery ticket
3) financial markets -- will they pull back? FFH more vulnerable.
4) underwriting profits
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Regarding ORH:
June 30, 2001:
Shareholders equity: $862,848,000
Shares outstanding: 65,527,029
BVPS: $13.16
IPO price $18
So I'm finding that the public offering was done at 1.37x book. Wow, that was a pretty good deal.
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Andy Barnard has 412,715 shares of ORH.
I can imagine he will need to be kept happy with any buyout price.
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Updated article from the Globe & Mail on FFH's 2nd Q report. Looks like Fairfax is about to close on an insurer in China. Cheers!
http://www.globeinvestor.com/servlet/story/RTGAM.20090730.wfairfaxprint0730/GIStory/#
About to close on an insurer in China?
There was a lot of discussion about why Fairfax is raising money today, but nobody remembered to mention this one.
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Why is that? A possible answer could be due to size, ratings and reputation. If the client has a choice between a Chubb policy and a Crum & Forster policy with same coverage at same price, it is likely that the client will pick Chubb. So to get that business, Crum & Forster has to lower its price. They would still be disciplined but, they are suffering from a competitive disadvantage. With same loss or claims, it means that C&F policies are priced 14% cheaper than Chubb. However, it seems like a lot to me for that reason alone, so they could still be agressive a bit to get that premium to invest since they are so good at it.
Cardboard
I'm not sure if I'm right about this, but I suspect if HWIC were managing Chubb's portfolio identically to FFH's then the ratings agencies would cut Chubb's rating due to investment risk (heavily in equities).
Can you have both the credit rating and the freedom to go heavily into equities? Or do the ratings people not care (can't imagine this to be the case).
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Okay with respect to selling uncovered calls/puts, what about margin requirements? I'm sure your broker requires you to at least have a cash balance of at least the liquidation value of the option contract (i.e. the amount of shares you're obligated to sell/buy upon exercise)??
If you can't use the rest of your cash balance, then you're not really "leveraged" are you? YOu're like an insurance company who has to maintain a reserve.
My broker requires me to maintain a margin requirement of = liquidation value of option contract + risk margin (i.e. the potential change in value of option). This is for naked writes only however ... with long calls/puts no margin needed ... obviously.
And second question;
Why write puts on puts with short term expiration dates? this is the standard convention. Wouldn't it be better to write on long term contracts? That way you 1) get a higher premium for income (usually) ... and 2) get to buy the stock at a lower price in say ... 1-2 years ... which is way better than buying it next month ... assuming the market has moved up substantially in 1-2 years. Berkshire's written put option contracts are very long dated, like 15+ years, the rationale for Berkshire's puts are the same sort of reasoning I'm getting at.
Regarding the margin requirements, you do get the put premium upfront and that cash helps you out with the margin borrowing power. This is most obvious with the deep in the money puts. Like if the stock is at $29 and you write the $60 strike put for $33. You can write that put without it impacting your margin buying power at all. Your margin buying power would be impacted of course if the stock went down, but initially the cash from the put premium is more than 50% of the strike price. I believe in that example writing the put would actually increase your margin borrowing power.
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I would caution you to infer too much from the most recent quarter. Review of the most recent three years tells a different, and I would argue, more comprehensive story:
I agree, ignoring 2009 and 2008 results makes all of the above companies look like very good, and MKL the best by far.
Cardboard layed into FFH pretty thick for not being a Chubb with a CR in the mid 80s today. Doesn't it seem equally fair to sling that at MKL?
A couple of days ago when I posted that, MKL traded at a 60% premium to ORH's Q2 book. 60%!!!!! So a person with $1,000 in ORH gets the same amount of equity as somebody with $1,600 in MKL. This means that you had better be earning at least $60 from the $600 premium you are paying for MKL if you slap a P/E of 10 on their underwriting advantage. So let's say the expected advantage is 9 full points of combined ratio, which after tax is something like the $60 that you are paying the P/E of 10 for. That's assuming premium volume is equal in size to 86% of book value.
But roughly that's how I think it works out. Anyways, they are completely different companies. As I've been saying for over a year now, I think of ORH and FFH as a hedge fund or mutual fund, and by contrast I think of MKL as more a company where you pay a big multiple for an earnings stream. Now, is insurance that good a business such that a P/E of 10 makes sense during a time when a JNJ trades at 12x?
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Somewhat off topic but involving ORH. Does anyone recall where FFH holds their ORH shares? I don't believe they are in the holding company, certainly not entirely?
Can someone refresh my memory and perhaps comment on the flexibility or lack of flexibility that FFH has with where they hold their ORH shares? I believe this asset is held within the reserves or perhaps at the subs holding company (non-regulated entities). Is it set up the same as NB or C&F?
Thanks,
The 2008 AR claims that runoff owns 17.8% of ORH -- at TIG I think.
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I'm not sure if this is true everywhere, but for people who are underwater in a state where the mortgages are non-recourse, even if they walk away from the mortgage, in the end the bank will end up putting the difference in the loan value vs the house value on the person's 1099 at the end of the year.
No that isn't the case. No tax is due. That's only for recourse loans.
However, you might be thinking of loan modifications -- if debt is reduced/cancelled but the owner stays in the home, then it's taxable. So they let the person turn in the keys and walk away without tax penalty, but the person who stays in the home with forgiven debt is hit with a bill.
See page 11.
http://www.irs.gov/pub/irs-pdf/p4681.pdf
"If you are not personally liable for repaying the debt secured by the transferred property, the amount you realize includes the full amount of the outstanding debt immediately before the transfer. This is true even if the FMV of the property is less than the outstanding debt immediately before the transfer."
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Housing construction is important in the US and it is down temporarily. But in two years time the demographics (rising population) will support new construction.
This is not Japan for at least that very reason. That was Warren's point.
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Anyway, the current multiple for ORH doesnt make sence again. Not complaining since I added some the other day but even on a comparison basis makes no sence... again.
We can bake in $350 in pretax loss and still be at book.
I cant help myself....again...
FFH and ORH have, in past couple of years, provided an opportunity to buy after the market (and their gains) have already gone up. It's like a sci-fi movie where you read the morning financial papers and you have a time machine to go back a few weeks and invest after you already know the outcome.
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MKL reported a combined ratio of 99% for Q2, and 97% for the full six months. They reported book value of $239.68.
So MKL is trading at 1.38x Q2 book value right now.
Put this in perspective. ORH trades at about 0.86x Q2 book despite doing far better in the underwriting profit department, and far better in the investment management department.
Hmm.
FFH's consolidated combined ratio was better than MKL's in Q2 -- 98.4% vs 99%. For the full six months, the comparisons are 98.5% vs 96% for MKL.
Seriously, a 40% premium for this?
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Okay, so continuing on ... let's say if we wrote a put and the market price is above the strike and the written put enters profitability ... what happens when
1. you exercise early and take the profit and
2. leave it to expire whilst the mkt value of stock is above strike/exercise price?
I assume for situation 2 that you earn the premium originally written. But I'd like to know the mechanics of it ... does the put buyer exercise/sell it back or something?
Thanks.
1)
You are saying that you are the writer of the put, so you can't exercise early. Only the buyer of the put may exercise it. You may close out the contract at any time to lock in your gains by just buying the put off the market.
2)
You just let it expire. No action to take on behalf of the writer of the put. The put buyer only exercises it if the shares are trading below strike, but even then maybe not. Back in April/May 2009 expirations I had written ORH $40 strike puts. The shares closed within 8 cents of strike each time (second time the shares closed at $39.99), and some of the shares (but not all) were put to me. This was annoying because I WANTED to acquire the shares. Anyway, the person who could have exercised the contracts perhaps did not do so for the simple reason of transaction cost outweighing the potential benefit, or the likelihood that ORH would open higher the following trading day (which happened both times).
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Misterstockwell,
"If we see that FFH can't underwrite business profitably, then is there really any reason to be an insurance company? Why not be a hedge fund? If you are paying for float, why not just borrow money and invest?"
Tears are coming off my eyes... Somebody finally got my point.
Well I hope somebody finally gets this point:
You can invest your float for 5% per annum and hold onto it for 3 years. That's 15% collected. Then you have a combined ratio of 105% and you give back a third of your gains.
You still make 10%! That's the point.
Please correct me if I'm totally wrong because it's better to be corrected now than to go in in the darkness of ignorance for longer.
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There was a period from 1982-1992 where Berkshire's insurance business had nothing but combined ratios above 100% for eleven consecutive years!
The interest rate environment in the 1980s was such that you could still be doing great even if losing a bit on underwriting.
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If you do the math with their statements and assume little acquisitions, you will find that this is a problem and that it makes their goal of 15% growth in book value over the long term almost unreachable.
Today on the conference call they stated that they plan on holding their investments over the long term, and then stated that they expect them to be generating big gains within 3 to 5 years. It sounded to me like they perhaps think of 5 years as "the long term" -- maybe not.
I should think that you certainly believe 15% is likely over the next 5 years. They have a lot of cheap stocks, and they have a tailwind from the float.
It's hard to tell whether they can do it for the next 20 years though.
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Soros is nuts if you ask me, the intrinsic value of the company doesn't change quarter to quarter.
I agree with Cardboard that a meaningful amount of Fairfax's historical growth came from issuing overvalued shares.
In this regard it is hard to argue against reflexivity. The price that FFH trades at is determined by Mr Market, and if Mr Market is willing to pay an astronomical price to the Fairfax treasury it then does in fact grow intrinsic value.
There are religions however that believe the future path for all of us is chosen... in this sense intrinsic value doesn't change, only our perception of it does as we live life forward and it is revealed to our eyes. In this case, only our estimates of IV change as our actions (including Prem's) were already decided by some God who know the IV all along, and that IV always included the peaks and valleys of Mr Market's mood.... thus Soros' reflexivity doesn't matter as this God took it into account already in his master plan of the universe.
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The combined ratio here can't be explained totally about staffing level vs business level or operating expenses.
Correct, it can only be explained partially by business level. However, double the volume of business in a hard market and I think the underwriting profits will fill in the underwriting losses we are now seeing.
One quarter at CR of 90% in hard market with double the business will fill in a year of underwriting losses at CR of 105% at present volumes.
But we don't know when it will happen. I do know however that when you buy the shares for 10% below book (even after today's spike) you have a margin of safety against three years of 105% CR.
Market won't turn in three years? Possible of course.
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Northbridge and Crum & Forster are also turning into real dogs. If they are that selective with underwriting, then someone will have to find real good arguments to convince me that these numbers are normal. They are not the numbers of disciplined underwriters. They don't walk the talk.
What happens to the combined ratio when you write less business but your expenses do not go down?
They could fire some underwriters, but it would send the message that if you hold on prices and write less business then you will lose your job. It would also leave them shorthanded when the market turns.
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I thought this thing was a "zero"? How could the greatest shortseller in history...the man who discovered the Enron fraud...with an uncompromising "negative correlation" to the major indices...be so wrong! Phhpppphtttt! I'll leave the humility to Prem, because he's a far better man than me, but Chanos can kiss my brown a**! I know Jo Ann would have loved this post. ;D Cheers!
I invested in Fairfax and it has since added a zero to my portfolio. An additional comma was needed to accomodate it.
Is that what people mean when they say it is a zero? I am looking forward to it being a double zero.
If there's a buyout of ORH, it will be done no later than...
in Fairfax Financial
Posted
1) Reward the ORH management and other large holders for sitting tight. In late 2006, ORH did a share issue and Andy wrote in the Annual Report that it was terrific that ORH shares would trade at a higher premium with the new larger float. But since then they've been buying the shares back, so it stands to reason this would piss him off now that the float is going down and thus... by Andy's logic.... the P/B premium. So to reward his patience (and those of others but I think Andy is a key enough player to focus on here). Andy's shares are worth about $20m -- putting an extra $8m in his hands at a P/B of 1.3x. I'm sure the NB management for example was very grateful to get that cash at a time when it could be reinvested. How painful can it be to reward key employees with stock and have that stock trade at a pathetic valuation despite excellent business performance? Think back to 2001 where there were combined ratios of 103.1% at ORH (excluding cat losses). It traded at a big premium then (1.37 at IPO) and today it's regularly trading at a sizable discount. I think Andy might, from time to time, wish he could sell a little bit for somewhat of a fair price.
Anyhow, this is but one good reason to take it back. Not big enough in it's own right perhaps, but if you were Andy and saw NB get treated similarly, you might be clearing your throat "Ahem... what about me?".