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Fairfax Financial to raise C$735 mln via equity issuance


ourkid8
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They have probably never been more conservatively financed than at the end of 2015. But they still seem to be very cautious about using their cash reserves. I am not sure why… If they still expect “stock prices to go down by a lot and to stay down for a long time”… Anyway, that’s the reason I hold a large position in Fairfax: until this global deleveraging is finally over, an investment that might benefit from deflation is welcomed imo.

 

Cheers,

 

Gio

 

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http://finance.yahoo.com/news/fairfax-financial-raise-c-735-004825057.html

 

Another equity raise, not sure why it's required as we have sufficient cash on the books.

 

I can't understand why having billions on the books in cash with hedged downside isn't enough.

 

I don't buy that they taking advantage of the current valuation - it doesn't trade at an excessive multiple to book (not even anywhere close to the high end of it's historical range) and it trades at around a 10x P/E of the average of the last two years earnings which have been reduced by a non-contribution from equities and losses on the hedges.

 

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http://finance.yahoo.com/news/fairfax-financial-raise-c-735-004825057.html

 

Another equity raise, not sure why it's required as we have sufficient cash on the books.

 

I can't understand why having billions on the books in cash with hedged downside isn't enough.

 

I don't buy that they taking advantage of the current valuation - it doesn't trade at an excessive multiple to book (not even anywhere close to the high end of it's historical range) and it trades at around a 10x P/E of the average of the last two years earnings which have been reduced by a non-contribution from equities and losses on the hedges.

 

Yep - am long and wasn't suggesting it is excessive in absolute terms.  My point is that at >2x tbv they may feel they will do well selling FFH now to buy stupidly discounted stuff in the next year or so.

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http://finance.yahoo.com/news/fairfax-financial-raise-c-735-004825057.html

 

Another equity raise, not sure why it's required as we have sufficient cash on the books.

 

I can't understand why having billions on the books in cash with hedged downside isn't enough.

 

I don't buy that they taking advantage of the current valuation - it doesn't trade at an excessive multiple to book (not even anywhere close to the high end of it's historical range) and it trades at around a 10x P/E of the average of the last two years earnings which have been reduced by a non-contribution from equities and losses on the hedges.

 

Yep - am long and wasn't suggesting it is excessive in absolute terms.  My point is that at >2x tbv they may feel they will do well selling FFH now to buy stupidly discounted stuff in the next year or so.

 

Why are we using TBV? Do they not earn a return on the preferred equity that is invested in excess of the coupon paid? Do they not have $450M in unrealized gains from their investments in associates that should be added? Are we not 2/3 the way through a quarter that currently has them earning something to the tune of $100-200M on net equity exposure and probably close to ~300M on bond exposure? Has the insurance business changed so much over the last 2 quarters that we can't expect another $100-150M in earnings contribution from that for the quarter barring a catastrophe?

 

TBV would understate the value of the companies assets. I think the full equity measure is better for the purposes of valuing them while giving some credit to the earnings capacity of their equity funding. If we include the adjustments I did above and then subtract out the 3.2B in intangibles, then your tangible book value was actually $441 per share and the offering is being done at about 1.2x... not a steep multiple by any measure. Especially since it only represents a multiple of about 10x their depressed earnings over the last two years.

 

Keep in mind that every share of common stock has $553 of bond exposure, $306 of cash, $241 in equity exposure, and $98 in investments in associates. That exposure was just sold for about $560-$570 a share.

 

Obviously there's debt and insurance business and etc. that this calculation doesn't include, but just let that sink in for moment and tell me that you think it's a good multiple to raise equity at. This transaction will not be accretive on a per share basis for anything other than the absolute slightest boost to BV/share. It would be more understandable if this was raising cash for some unmentioned acquisition, but the press release was very clear that this was being used to complete acquisitions already mentioned despite the $6.8B billion on the balance sheet.

 

Something else to keep in mind - this offering only raised $536M with this offering. They could have literally used less than 10% of cash on hand to fund these acquisitions but instead chose to offer equity at a relatively low multiple. It's just moderately disappointing. Not the end of the world but it certainly has me confused.

 

 

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Just let that sink in for moment and tell me that you think it's a good multiple to raise equity at.

 

 

I didn't say it was.  The original poster asked why it was required.  And the only answer I can think of is: given that they anticipate a market collapse, perhaps they see selling at the current reasonable price to invest at seriously cheap levels in the future as an attractive relative value trade.

 

I'm not arguing about the current FFH valuation.  It's a third of my net worth so you can be fairly confident I don't think it's overvalued (although I always use historic BV hence our multiple discrepancy).

 

As to why TBV, I tend to watch both.  TBV is clearly extremely cautious.  I'm sceptical about putting a multiple above 1 on goodwill (it can be justified, but I prefer not to do it usually) so I tend to value it using a >1 multiple of TBV plus 1x GW.  If the newly outstanding underwriting results survive the next few cats, I will allow myself to put the GW on >1x.

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Just let that sink in for moment and tell me that you think it's a good multiple to raise equity at.

 

 

I didn't say it was.  The original poster asked why it was required.  And the only answer I can think of is: given that they anticipate a market collapse, perhaps they see selling at the current reasonable price to invest at seriously cheap levels in the future as an attractive relative value trade.

 

I'm not arguing about the current FFH valuation.  It's a third of my net worth so you can be fairly confident I don't think it's overvalued (although I always use historic BV hence our multiple discrepancy).

 

As to why TBV, I tend to watch both.  TBV is clearly extremely cautious.  I'm sceptical about putting a multiple above 1 on goodwill (it can be justified, but I prefer not to do it usually) so I tend to value it using a >1 multiple of TBV plus 1x GW.  If the newly outstanding underwriting results survive the next few cats, I will allow myself to put the GW on >1x.

 

I'm ok with the 1x multiple on goodwill - I think you'll see from my post that I excluded it completely to make my figures more conservative and to get them closer to yours and still only end up at 1.2x. I wouldn't be so disappointed if this were for an acquisition but the way I see it is this:

 

Fairfax has $6B in negative equity exposure

Fairfax has $6.8B in cash

Fairfax has $12B in bonds

Fairfax has hundreds of millions in exposure to deflation (whatever the delta is on the contracts x 110B in exposure)

 

In the event of a market crash, it is likely that they'll make billions on their bonds and equity hedges. That will be on top of 6.8B in cash already held plus whatever cash their insurance operations throw off. Lastly, there is the potential for hundreds of millions in upside from the deflation hedges if sold into a recession. So we're literally talking about a Fairfax that could reasonably have $10B in powder at the bottom of a market - what is this extra $500M going to do?

 

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As an aside, and this is a genuine question not a dig, how do you get to the $441?

 

I have, per share:

$403 bv, less

$144 intang, plus

$20 unrealised gains on associates, plus

$27 quarter to date profits (your $600/22.2) equals

$306 total tbv/share compares to USD524 share price = 1.7x

 

What am I missing?

 

I haven't added the investments/prefs spread simply because you have to make such a big assumption on what the investment return is.

 

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As an aside, and this is a genuine question not a dig, how do you get to the $441?

 

I have, per share:

$403 bv, less

$144 intang, plus

$20 unrealised gains on associates, plus

$27 quarter to date profits (your $600/22.2) equals

$306 total tbv/share compares to USD524 share price = 1.7x

 

What am I missing?

 

I haven't added the investments/prefs spread simply because you have to make such a big assumption on what the investment return is.

 

I don't adjust the figure for the spread, but know that the coupon the preferred is a low bar and so I give Fairfax credit for the entire preferred equity along with non-controlling interests (we can debate the later point, don't know what to do with it really).

 

Basically I did the following (though not on a per share basis)

 

12B reported equity

450M unrealized gain in associates

300M expected gain on fixed income

150M expected gain on net equity exposure

100M expected insurance addition barring catastrophe

(-3.2B) intangibles

 

Total: 9.8B across 22.2M shares is $441.

 

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Thanks.  Personally I'd argue that the noncontrol interests don't belong to us (presumably this is shareholders other than FFH in things FFH consolidates like Thomas Cook and Fairfax India).  As for the prefs, I agree there is a spread but there are two ways to treat them IMHO:

 

1. exclude them from equity, as you would do with debt (prefs are very debt-like, after all, and you wouldn't dream of adding back the debt to the equity value just because they earn a spread on it).  You could exclude (a) the face value or (b) the market value, on the basis that they could buy them back.

 

2. include them as equity, but increase your scare count accordingly to take account of the fact that owning common stock doesn't give you economic rights to the prefs.

 

Since I haven't the foggiest clue how many prefs are out there I tend to stick with option 1!  Just my way of doing it.

 

Bottom line for me is that the p/tbv of the common is 1.7x assuming your quarter-to-date earnings.  Adding 1x intangibles gets you to 1.2x.

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Thanks.  Personally I'd argue that the noncontrol interests don't belong to us (presumably this is shareholders other than FFH in things FFH consolidates like Thomas Cook and Fairfax India).  As for the prefs, I agree there is a spread but there are two ways to treat them IMHO:

 

1. exclude them from equity, as you would do with debt (prefs are very debt-like, after all, and you wouldn't dream of adding back the debt to the equity value just because they earn a spread on it).  You could exclude (a) the face value or (b) the market value, on the basis that they could buy them back.

 

2. include them as equity, but increase your scare count accordingly to take account of the fact that owning common stock doesn't give you economic rights to the prefs.

 

Since I haven't the foggiest clue how many prefs are out there I tend to stick with option 1!  Just my way of doing it.

 

Bottom line for me is that the p/tbv of the common is 1.7x assuming your quarter-to-date earnings.  Adding 1x intangibles gets you to 1.2x.

 

Yea - it really doesn't matter when we're talking high-level though. The inclusion, exclusion, or scaling of $1-2B in the P/B multiple doesn't change much when we're talking about whether or not it was a high value or low value. Especially considering the investment portfolio could return that amount in a single year and make up for any "mistake". I'm just trying to keep things very high level using round numbers.

 

I just can't for the life of me figure out why they needed an extra $500M and certainly don't think it was because the stock was expensive or they think they'll need more cash when the market drops. I just hope we're 2-3 days away from announcing a large acquisition where they'd need the extra $500M to complete it, but I'm skeptical after having read the press release.

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Thanks.  Personally I'd argue that the noncontrol interests don't belong to us (presumably this is shareholders other than FFH in things FFH consolidates like Thomas Cook and Fairfax India).  As for the prefs, I agree there is a spread but there are two ways to treat them IMHO:

 

1. exclude them from equity, as you would do with debt (prefs are very debt-like, after all, and you wouldn't dream of adding back the debt to the equity value just because they earn a spread on it).  You could exclude (a) the face value or (b) the market value, on the basis that they could buy them back.

 

2. include them as equity, but increase your scare count accordingly to take account of the fact that owning common stock doesn't give you economic rights to the prefs.

 

Since I haven't the foggiest clue how many prefs are out there I tend to stick with option 1!  Just my way of doing it.

 

Bottom line for me is that the p/tbv of the common is 1.7x assuming your quarter-to-date earnings.  Adding 1x intangibles gets you to 1.2x.

 

Yea - it really doesn't matter when we're talking high-level though. The inclusion, exclusion, or scaling of $1-2B in the P/B multiple doesn't change much when we're talking about whether or not it was a high value or low value. Especially considering the investment portfolio could return that amount in a single year and make up for any "mistake". I'm just trying to keep things very high level using round numbers.

 

I just can't for the life of me figure out why they needed an extra $500M and certainly don't think it was because the stock was expensive or they think they'll need more cash when the market drops. I just hope we're 2-3 days away from announcing a large acquisition where they'd need the extra $500M to complete it, but I'm skeptical after having read the press release.

 

It matters a lot if it is the difference between 1.7x and 1.2x tbv!!  But on the rest I agree with you.  I felt the same when they issued to buy Brit and then promptly sold some of it.  I don't think it's a shocking price to sell equity at, so I don't *really* care, but it isn't easy to explain why they need to.

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"What is this extra $500M going to do?"

 

This is how Fairfax has obtained its stellar book value growth results from the late 80's to the late 90's or by issuing overvalued stock. It was not just with the compounding of investment results or underwriting. Size also matters now but, when you look at per share book value growth over the last 15 years by just cherry picking the best periods, you see a much lower rate. This is due IMO to a lot of stock being issued at book or just above vs 3 times during the 90's.

 

The question is: are they going to redeploy this for more value than what they are giving? Same question that Buffett is asking himself when he is reluctantly issuing stock to make an acquisition.

 

I personally think that doing it now makes sense since the stock is popular vs the market. At the same time, piling cash for piling cash and if they are to re-deploy in so-so investments, then it is not a wise decision.

 

Cardboard 

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"What is this extra $500M going to do?"

 

This is how Fairfax has obtained its stellar book value growth results from the late 80's to the late 90's or by issuing overvalued stock. It was not just with the compounding of investment results or underwriting. Size also matters now but, when you look at per share book value growth over the last 15 years by just cherry picking the best periods, you see a much lower rate. This is due IMO to a lot of stock being issued at book or just above vs 3 times during the 90's.

 

The question is: are they going to redeploy this for more value than what they are giving? Same question that Buffett is asking himself when he is reluctantly issuing stock to make an acquisition.

 

I personally think that doing it now makes sense since the stock is popular vs the market. At the same time, piling cash for piling cash and if they are to re-deploy in so-so investments, then it is not a wise decision.

 

Cardboard

 

If they had a good place to deploy an extra $500M, then there's 6.8B on the balance sheet ready to be deployed. I understand that a good part of book value growth has been savvy financing by issuing equity when it was expensive and by repurchasing equity/subsidiaries when they were cheap, but that figure was based on reported BV.

Currently, reported BV was 12B or $540 per share - making the above adjustments for current quarter unrealized gains and investments in associates gets you to $13B which is $585 per share. So, on a reported book value basis (which is what we calculate the compounded return in BV from) he is issuing equity as 0.9x-1.0x BV which isn't accretive to shareholders automatically on a per share basis like it would be if it were at higher multiples.

 

If there were really opportunities to put cash to work, then why not use the $6.8B on the balance sheet or sell a handful of your $12B in bonds? I know I don't have full information yet, but it just doesn't make much sense given what we've been told.

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This is where it genuinely does matter whether you include prefs and noncontrol because I'd argue that reported is $403 (which is also what they say).  That gets you to 1.3x and making your adjustments is 1.16.  NOT expensive - but definitely accretive to BVPS and more accretive to TBVPS.

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Most of the cash on the balance sheet is not at the holdco level. It can only come back to Fairfax, the parent, via dividends and most of these companies are insurance companies having regulators authorizing or not these dividends. Currently, they likely have a fair bit of dividend paying capacity but, seems like that they are choosing not to or they foresee a need for more.

 

I recall that Prem mentioned almost 10 years ago now that he would not let cash drop below $1 billion at the holdco level. The company has grown quite a bit since then and he is getting close to that threshold per Q3 report. However, now this is in USD. Has he mentioned anything related to that since then?

 

Cardboard

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Cardboard - you beat me to it (nice to bump into you by the way - long time). But I already wrote my post so here it is anyway :)

 

what is this extra $500M going to do?

 

I share your concerns about dilution, but we have two transactions to be completed on the upcoming months - Eurolife (say $350 million) and ICICI Lombard ($230 million). It looks like Prem intends to fund these purchases at the Holding company level. So this $500 million will maintain holding company cash at current levels. I'd rather not see a repeat of past holdco liquidity issues should we get into a turbulent market. We are much better off to be issuing equity now, versus when these aquisitions were announced.

 

I suspect the fallback option may have been to have one of the subs close on the aquisitions. But after all the progress made over the years unstacking the capital structure, I think most would agree it is better to have these at the holding company level.

 

b.

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It really is pretty amazing. Yesterday, before this TERRIBLE news hit the wire, shares were at $765, and market cap was $16.99B, let's say $17B CDN. Now they announce they are raising $735M, maybe $845M if overallotments are exercised, at $735/share. Now I don't like to have my shares diluted any more than the next guy, and I don't much like new shareholders getting $30 off the price the market was assigning to my shares, but I presume this bought deal, arranged in the last few weeks, could have happened at $735 even if shares had recently dropped to $700, so that's just the luck of the draw, good luck for people who signed up for the share issue, bad luck for ongoing shareholders.

 

But how bad is it? The new shares amount to a little under 5% of the capitilization, pre-issue, to the value of my shares does drop, by about 5% of the difference, in other words, $1.

 

When I saw the share price this morning, I wondered what terrible thing had happened to my shares. Now I see that all that has happened is that they are worth $1 less, plus whatever credibility Watsa and his team have lost. Which is zero, for me, since I trust his judgment about the fact that acquisitions in process and perhaps future acquisitions require a bit more cash than what is on hand and available. If anything, it shows great timing, since he could have raised cash a couple of months ago when  the acquisitions were announced, ICICI Lombardi on Oct 30 (shares closed at $644) and Eurolife on Dec 22 (shares closed at $659). So he seems to have done a great job minimizing dilution by issuing at a historic high price.

 

Good grief, what a temper tantrum! At least I was able to get 10% more, at $717. 

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