FFH Announces $650 million Equity Bought Deal Financing

[Munger_Disciple]

I used to think this (a dividend is the same as selling at book),  but I'm not so sure this is true.

 

Why not? When a company pays dividend of $1, its cash account as well as its book value immediately get reduced by $1.

[wknecht]

I used to think this (a dividend is the same as selling at book),  but I'm not so sure this is true.

 

Why not? When a company pays dividend of $1, its cash account as well as its book value immediately get reduced by $1.

Yes agreed, but that doesn't mean it's the same as selling the stock at book. 

 

For that to be true, excess cash would need to be valued at the same book multiple as the rest of the equity. But cash doesn't deserve the same multiple as the rest of the capital deployed in operations. By default cash is valued at 1x, maybe higher in Watsa's case but not necessarily the same multiple as the rest of the capital that has been deployed. Hence the stock falls by the same $1, and the P/B rises.

[Munger_Disciple]

For that to be true, excess cash would need to be valued at the same book multiple as the rest of the equity.

 

This doesn't make any sense to me. By definition, book value includes any cash held by the company. There is only one single stock price for the whole company at any given time and there is no separate stock price for its cash. If the company has sensible things to do with its earnings, it should retain it. Otherwise it should pay it out. But it is idiotic for the company to pay a dividend when it can internally compound capital at a high rate. When you need cash, you can manufacture your own dividend by selling a portion of your stock holdings if the company is internally compounding at high rate (w/o paying dividends). In this case most of the time the stock trades at a premium to book (example: P/B of FFH currently 1.3-1.4) because of good rates of return on incremental capital invested.

[giofranchi]

 

Ok! I understand your point! I get greedy sometimes! ;D

 

 

Don't we all!

 

By the way Pete,

small shareholders without cash could always sell their rights in the market and receive a sort of special dividend… It is true they get diluted, but is also true they somehow get compensated for that.

 

Cheers,

 

Gio

 

[KinAlberta]

Companies can trade below 1X book for years and some of those companies may not be dividend payers so your need for cash may not align with market conditions.

 

Off the top of my head, some other considerations: dividend tax credits, capital gains taxes (and LIFO/FIFO issues), trading commissions, odd lot liquidity issues (mostly with remaining odd lot position).

[cwericb]

I also suspect that dividends create demand, thereby increasing stock price. Some investors shy away from non-dividend paying stocks.

[Munger_Disciple]

I also suspect that dividends create demand, thereby increasing stock price.

 

This is precisely the sort of trap that Ben Graham advised us not to fall into.

 

Some investors shy away from non-dividend paying stocks.

 

Like Berkshire in the 80s? And Markel now?

[Partner24]

The  main point is that is not a good thing to issue a dividend and then issue stock below intrinsic value. It's simple math.

 

Let's that that we are 10 persons that own a bank account worth 1000$. 1 share each. Each owner share is worth 100$.

 

At the beginning of the year, I pay every owner 5$. They receive the 5$, but their share is now worth 95$ and the bank account now have 950$. Still, 100$ in their hands in total (let's not take taxes into account here). 5$ cash and 95$ of shares value.

 

Now, I need to fill the bank account and issue 1 share at 50$. The new investor is happy because he paid 50$ for a share that was worth 95$ before the transaction.

 

Now the bank account is still worth 1000$, but we are now 11 holders having a share worth 91$ each.

 

That little "50$ out, 50$ in" transaction let every"before transaction" holder 4$ poorer. This doesn't make any sense at all and if every holder keep thinking that it is a good way to make money and to found their personal expenses, these capital allocation decisions, if they are done frequently, will make them significantly poorer over time. The only persons that win in these financial transactions are the new holders.

 

[Munger_Disciple]

The first priority for management is to reinvest in the business if they can earn good rates of return on newly employed capital. If this is not possible, then they should buyback shares if they are trading at a meaningful discount to intrinsic value. If the stock is trading well above intrinsic value, then they should payout as a dividend assuming no reinvestment opportunities.

[Munger_Disciple]

By the way, even if stock is trading around intrinsic value, it is better to buyback than pay a dividend because shareholders avoid dividend taxes. In California, federal+state dividend taxes can add up to as high as 37%. So this is not some theoretical issue we are discussing.

[cwericb]

Munger, it is simply supply and demand.

 

There are some investors who will not buy non-dividend stocks.

 

Therefore if you don’t pay a dividend, you reduce the demand for those stocks by that number of investors. If you reduce the demand you tend to reduce the price. It has nothing to do with Markel, Birkshire or anyone else, it is simply the law of supply and demand.

 

And yes there may be someone out there who will not buy dividend paying stocks, but has it stopped any of the people here that are complaining about the dividend?

 

[Partner24]

Therefore if you don’t pay a dividend, you reduce the demand for those stocks by that number of investors. If you reduce the demand you tend to reduce the price. It has nothing to do with Markel, Birkshire or anyone else, it is simply the law of supply and demand.

 

That supply/demand thing might work in the short term, but not in the long term. That's Benjamin Graham and value investing 101 principles. The voting machine work in the short term, but in the long term Mr. Market is a weighing machine that will find the intrinsic value of the business.

 

You don't want managers who fall into that voting machine trap and make irrational decisions to please people who think like that, because if they do, they'll get the shareholders that they deserve.

 

 

[cwericb]

In no way am I suggesting that FFH management is, or should be, offering a dividend in an attempt to increase share price. I was only commenting on what exists.

 

The fact that they DO offer a dividend makes the shares attractive to a wider range of  investors. For instance there are any number of dividend funds out there who’s sole purpose is to invest in dividend paying stocks. I don’t know of any funds that purposely do not invest in dividend stocks. A lot of individual investors operate the same way.

 

That is where the law of supply and demand comes in. The more people who want to invest in FFH, the more upward pressure on the share price.

 

I believe that for many years Prem Watsa has been taking the same $600,000 yearly salary. That is a mere pittance (note: not to me!) in comparison to CEO’s of other companies the size of Fairfax.

 

But management has chosen to offer a dividend rather than put themselves in a position whereby they must sell off shares every year to supplement their income. If they did not do this can you imagine the outcry that would follow every time Watsa sold shares in Fairfax? The same principle works for a lot of longtime smaller Fairfax shareholders who have a lot of their money tied up in Fairfax and do not want to have to liquidate shares every year for income.

 

Others may not agree, but I am just fine with Prem taking his $600 K salary rather than soaking the company for untold millions every year. Essentially he gets paid the same as all of the other shareholders. That’s incentive and I am fine with that.

[gfp]

Exactly right - they pay a dividend so Prem can "make sure that my family survives."  Simple as that -  from the 2000 annual report:

 

"This brings me to my own compensation arrangements. For many years now I have felt that as a controlling shareholder involved in the management of the company, my compensation should be closely linked to all shareholders. So from 2000 onwards, my compensation will be a fixed salary of $600,000 with no bonuses. This compensation will not increase annually, and if 1999/2000 is repeated, could decrease!! However, to make sure that my family survives, Fairfax will examine instituting a dividend – yes, a modest dividend – in 2001 at an annual rate of $1 or $2 per share. Going forward, the only difference between me and you, our shareholders, will be my salary of $600,000 – which based on recent performance, many of you may think is too high! While the payment of a modest dividend results in double taxation to most of you and is not as economically efficient as retaining all our profits and compounding at high rates of return (as we have done for the past 15 years), this was the only way I could think of to bring my compensation in line with your interests. While I may have generated some sympathy from you, I should add that I continue to travel well – in fact a little better recently because we sold our Lear Jet for US$2.5 million (cost US$1.8 million) and purchased a Gulfstream II for US$6.2 million."

[cwericb]

In general Prem is attempting to make all Fairfax shareholders partners in the company. How many other CEO's have not taken a raise in 15 years?

 

While some here have posed very good reasons for not paying dividends, Fairfax is an exception.

[Munger_Disciple]

I know it is considered blasphemy to ask the following question on this board, but I will do it anyway: Why can't Prem and his family "survive" by selling a tiny portion of their family holdings in FFH in stead of forcing a taxable dividend on all shareholders?

 

Let us see the damage done just from dividend taxes imposed on all shareholders: 22M shares times $10 per share dividend means $220M in dividends, and at average tax rate of 28%, shareholders are poorer by $62M a year.

 

Then you consider that while on one hand they are paying a dividend of $220M, they are turning around and selling additional stock almost simultaneously to raise $650M. How can anyone defend this as rational policy?

[fareastwarriors]

I know it is considered blasphemy to ask the following question on this board, but I will do it anyway: Why can't Prem and his family "survive" by selling a tiny portion of their family holdings in FFH in stead of forcing a taxable dividend on all shareholders?

 

Let us see the damage done just from dividend taxes imposed on all shareholders: 22M shares times $10 per share dividend means $220M in dividends, and at average tax rate of 28%, shareholders are poorer by $62M a year.

 

Then you consider that while on one hand they are paying a dividend of $220M, they are turning around and selling additional stock almost simultaneously to raise $650M. How can anyone defend this as rational policy?

 

 

I don't think there is an easy answer to that. One can try to ask that at the AGM. Let us know what he says.

[cwericb]

You know this is really simple.

 

If I disagreed so adamently with the way a company was run, I wouldn't be invested in the company.

 

There are many of other companies out there that don't offer dividends and pay their execs salaries of millions of dollars plus obscene bonuses and then when the companies get in trouble they fire the execs and pay them even more to leave.

 

Long ago Fairfax made the dicision to operate in a different and a very transparent way.

 

The policy set 15 years ago is ultimately fair to all. As far as the Brit deal is concearned I get the feeling that it was something that came about very quickly and FFH handled it in a way they decided was best. If you don't trust or don't like the way management operates, why would you be invested?

 

 

[nodnub]

I know it is considered blasphemy to ask the following question on this board, but I will do it anyway: Why can't Prem and his family "survive" by selling a tiny portion of their family holdings in FFH in stead of forcing a taxable dividend on all shareholders?

 

Let us see the damage done just from dividend taxes imposed on all shareholders: 22M shares times $10 per share dividend means $220M in dividends, and at average tax rate of 28%, shareholders are poorer by $62M a year.

 

Then you consider that while on one hand they are paying a dividend of $220M, they are turning around and selling additional stock almost simultaneously to raise $650M. How can anyone defend this as rational policy?

 

A few thoughts...

 

Maybe he wants to keep his shares and preserve his stake in the company he built.  Wouldn't you want the same if you built it?

 

Also might be related to the fact that he owns multiple voting shares (10 votes per share) and he doesn't want to give up voting control?

 

Seems pretty rational to me.

[oddballstocks]

This is a really interesting thread to read.  It could be a case study for why companies should remain private.

 

Equity financing isn't ideal, but Prem seems like a standup guy and I don't get the feeling he's trying to pull a quick one on shareholders.  This is his company after all.

 

I would prefer a manager who owned shares and paid themselves a dividend verses a crazy pay package or constantly selling down their stake.  But I could also see why a manager would want to be private, no message board quarter-backing going on.  If a private company wanted to sell shares to a PE firm to invest no one would care, they'd figure the owners were doing the best they could.  If a private company paid a dividend vs taking giant salaries no one would complain.

 

I agree with whomever said above that if you don't like what Fairfax is doing then don't invest.  There is no mandate to hold FFH in a portfolio.

[Alekbaylee]

Why can't Prem and his family "survive" by selling a tiny portion of their family holdings in FFH instead of forcing a taxable dividend on all shareholders?

 

Why do most people choose to borrow money from the bank to buy a car, furniture or even a house when they could sell a few shares and pay these items cash? Because they have objectives and a plan and stick to both.

[Munger_Disciple]

Prem is a great guy with integrity. That is not what this discussion is about, nor is it about people giving unsolicited advice to others about buying/selling FFH. I am currently not a shareholder, but owned FFH in the past. Regardless I don't see any contradiction in owning shares and voicing a differing opinion (to management) on an important issue such as capital allocation. It is done all the time, for example Buffet's disagreement with KO's comp policy last year.

[fareastwarriors]

Prem is a great guy with integrity. That is not what this discussion is about, nor is it about people giving unsolicited advice to others about buying/selling FFH. I am currently not a shareholder, but owned FFH in the past. Regardless I don't see any contradiction in owning shares and voicing a differing opinion (to management) on an important capital allocation issue. It is done all the time, for example Buffet's disagreement with KO's comp policy last year.

 

That's a fair point. And I think most, if not all, of us agree with the fact that issuing dividends and then diluting shareholders is not the best use of capital. 

[Partner24]

This is a really interesting thread to read.  It could be a case study for why companies should remain private.

 

If you think that private company shareholders don't voice their opinions and get into disagreement sometimes, just take a look at your local yellow pages and see if there is some corporate lawyers out there that live not so bad.

 

 

 

 

[nwoodman]

What are the chances we look back in a few years and say it was a mute point how they financed it.  I think they have just pulled another Zenith.  This is a nice set of results!

 

http://www.reuters.com/article/2015/02/25/brit-results-idUSL5N0VZ14620150225

 

Cheers

 

nwoodman