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Fairfax logic


Guest Dazel
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This has been discussed a bit on a previous thread but I would love to hear a more focused view of why Fairfax delists from the NYSE.

 

To me it is a very cocky move for Prem to delist from the NYSE...there is more of reason than $10 million and we all know it.

 

I know a number of posters have benefitted from the amount of options that were traded which were facilitated by the NYSE listing. Those that benefitted most were able to buy options low sell them high and then purchase again after a drop(common sense). However, this has been a constant trading pattern for Fairfax shares for the entire NYSE listing (coincedence?). This however, did not benefit Fairfax, it hurt them as the percpetion of a stable blue chip company. Blue chippers do not like volatility. Hence the shareholder base consists of deep value investors. Well guess what. Deep value investors do not pay more than book value...we rarely pay 80% of book value. Sorry, if I am Prem I would like a blue chip following...it would be nice to at least trade at book!

 

 

More on Options

Their may be some exceptionally smart posters here that were able to make a lot of money wrting calls and puts and arbitraging with NYSE stock but I think the majority of money was made by the hedgies. However, in some cases Hedgies got greedy and used naked shorts as well as other means to make sure they made money on their options. This will be gone.

 

The world is buying Canada

 

Canada has the strongest banking system in the world. Our dollar is soaring and net inflows of capital are being injected into our assets. There are many reasons for that...mostly USD weakness. Russia is even going to buy Canadian assets for their currency reserves (what has the world come to). Who cares?

There is a supply demand issue for blue chips in Canada...there is no supply and a lot of demand. When you are a foreign investor you are not just buying currency you want return. Do you buy Fairfax which continously trades below book for years with a 5 PE (for years) or do you buy oil sands or our banks with 4%  guranteed dividends that are growing? Easy answer because they are not value guys that are buying here...they are pensions...mutual funds etc. It is sad to say but these lemmings will not buy until they see something go up...and they will buy at 1.3 times book.

 

I think that Fairfax is looking to eliminate all of the trades that are going on that keep Fairfax stock in a range for others to make money off it. They think that trading patterns will change without the US listing. They do not want more liquidity in their stock they want less so that people look long term like they do. They are a Canadian gem that has an incredible story to tell. For our american friends on this board, you will be much happier if we trade at 1.3 times book value.

 

I could be wrong so would love to hear the boards thoughts.

 

Dazel.

 

 

 

 

 

 

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Great post Dazel.  Yes, I think you have nailed the rationale.  The NYSE listing cost quite a lot in the past, driving down the share price when Fairfax needed to raise capital, and having a TSX listing only should avoid a fair amount of that risk.  Only one regulator to convince to keep an eye out for attempts to game the price.  I also belileve the company will continue to report in USD, and pay dividends accordingly.  I would like to see dividend be predictable, something like 4 pct of book perhaps, or even 2 pct, but just establish a policy and don't tweak it.  Probably quarterly dividend too would be preferrable.

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The delisting shifts both share (TSX) & option (MSE) trading onto Canadian exchanges. Higher trading volumes, more liquidity, better enforcement, less hedge fund influence, easier accounting (IFRS vs GAAP), no more SoX costs, bigger fish in a small pond, etc. Daily operational advantages.

 

Investors can buy in either USD or CAD, but see the reporting in USD. To a foreign investor the 15% increase in BV is not going to look like a 5% loss simply because the USD devalued 20%. To the US investor, the 20% USD devaluation will make it look like a 35% return - & they'll be able to over-weight as their portfolios foreign allocation increases. Higher demand.

 

Simplification. 1 company (FFH, NB, ORH, C&F), 2 exchanges (TSX, MSX), principles based regulation, etc. Far easier to expand float, split shares, do private placements - should they wish to.

 

SD

 

 

 

 

 

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Keep in mind that there's an element of affronted pride here...... as a 'Big Board' listing is essentially what capitalists are supposed to 'aspire to'. The voluntary delisting underlines that the NYSE is just the servant, not the master.

 

Were FFH delisting from a 'lessor' exchange (ie: Frankfurt) - there wouldn't even be a discussion.

 

SD

 

 

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I have not yet completely wrapped my head around this one. Bottom line is FFH may no longer need to tap US investors for $ (i.e. US listing was ALL about being able to raise $ to repair the balance sheet and more recently to buy back the subs).

 

If FFH continues to post strong results my guess is they will begin to aggressively re-purchase FFH shares. Perhaps getting all the trading on one exchange makes this future move easier?

 

All things being equal, I see this move as lowering demand for FFH shares (US investors) = lower price. I wonder if FFH will be viewed as a true blue chip in the coming years. Their business WILL NOT BE PREDICTABLE in a way that analysts like. Regarding future trading patterns, I also wonder if this move will change things.

 

If the stock moves to below .9 of current BV (it is getting close) I will likely start nibbling. Underwriting will be poor; interest and dividend income will be very good and investment returns will be a crap shoot. The only near term catalyst I see is FFH buying back stock and this will only happen if the price drops (likely well below the $345US they just issued equity at). I do agree that in 5 years the stock will be significantly higher and it is for this reason I would like to get a core position re-established.  

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If you (we) put ourselves in the shoes of the guy running the company, the headaches of having listed on a US exchange at this point out weighs the benefits.

 

Access to capital no longer required as in the past- lets get the hell out of dodge and away from the yahoos who tried to take this baby down.

 

Still 100,000 shares short so we're prob going to see some crazy non sensical pricing coming up for those needing to fill.

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Remind me again why shorts have to cover before FFH delists from NYSE?  Can't shorts eventually cover their short using the exact same shares but trade them through the TSX?  Isn't shorting simply selling FFH shares today and buying them back later?  Who cares where they obtain the shares?

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I think the shorts are an after thought...they could have already covered there was a spike in volume on monday.

Fairfax is truly an international story...as a shareholder would you rather have Fairfax spend time on a NYSE listing and the headaches I listed above (a make work project) or would you rather them take ICICI Lombard public in India or consolidate the Brazilian assets with ORH"s  south american assets to list in Brazil or do the same in Asia on the Hong Kong exchange. The only reason to do this of course would be to unlock value. The NYSE has not only not unlocked value it has kept Fairfax below book value since they listed.

 

Here is an example...I was in New York last week talking to a Hedge Fund manager and Fairfax came up...I was talking about how I liked the management...He said yeah but do you really like the media business? He was of course thinking of Fairfax media in Australia. Amazing.

 

New York has given Fairfax the stigma of short selling and lawsuits...most people in their right mind run after those headlines. They do not bother to look at the numbers...In Canada Prem is "The Buffett of the North" and the man who made a killing from the financial disaster. The short sellers have stopped paying the Globe and Mail long ago and Fairfax is very highly regarded in the media here now. The Canadian banks are flush with capital and the world will be the demand for the shares...as was said earlier they are a small fish in New York and No one cares about the story obviously.

 

 

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You all have good points regarding the delisting. However, FFH probably didn't give it enough thought about the collateral damage. Someone equated owning shares as owning a car, no matter thru which dealership in US or Canada. Well, try buying a car and get it across the border and go thru all the paperwork and pay all the taxes, then you know. All these can be some how mitigated if some decent time is given to the US investors.

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Guest longinvestor

 

I think the shorts are an after thought...they could have already covered there was a spike in volume on monday.

Fairfax is truly an international story...as a shareholder would you rather have Fairfax spend time on a NYSE listing and the headaches I listed above (a make work project) or would you rather them take ICICI Lombard public in India or consolidate the Brazilian assets with ORH"s  south american assets to list in Brazil or do the same in Asia on the Hong Kong exchange. The only reason to do this of course would be to unlock value. The NYSE has not only not unlocked value it has kept Fairfax below book value since they listed.

Here is an example...I was in New York last week talking to a Hedge Fund manager and Fairfax came up...I was talking about how I liked the management...He said yeah but do you really like the media business? He was of course thinking of Fairfax media in Australia. Amazing.

New York has given Fairfax the stigma of short selling and lawsuits...most people in their right mind run after those headlines. They do not bother to look at the numbers...In Canada Prem is "The Buffett of the North" and the man who made a killing from the financial disaster. The short sellers have stopped paying the Globe and Mail long ago and Fairfax is very highly regarded in the media here now. The Canadian banks are flush with capital and the world will be the demand for the shares...as was said earlier they are a small fish in New York and No one cares about the story obviously.

 

For FFH nothing (I mean nothing) good came out of the NYSE listing. I get the distinct sense that Prem is simply firing the NYSE

 

If one connects the dots between what Patrick Byrne has been saying for years, the whole NYSE stock trading business is a severely goosed situation. This was not how it was before the 80's, probably all the way back to the period just befoe 1929 when we are told by WEB that there was much hanky panky then as there is now. There are simply too many worms under the rock today.

 

Also, Prem is clearly focused on growing his insurance biz in other parts of the world, Poland, India, Brazil, Singapore etc. What a distraction it has been for Prem, not to mention untold millions of unrealized return potential for the long termers.

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Smazz, are you suggesting the number of shorts scrambling to cover will necessarily be greater than the number of US shareholders scrambling to sell due to issues with their brokerages and limits on foreign securities?

At first thats what i thought but with the 2 dynamics, and who knows where the current shorts came into the game.. who knows - just one of many theories how delisting may or may not have an effect.

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Fired is probably too harsh, but the FFH board is probably disappointed with the NYSE and SEC enforcement.  I pulled some clips (below) from a couple of older annual reports to get Watsa's words.  In the 1st clip, Watsa explains his rationale.  In the 2nd clip, Watsa describes the initial short attack and his first tentative reactions -- he's a much wiser soul now after the last 7 years. 

 

Strategically, international growth is part of the next wave; US markets are likely to be stagnant/flat for several years (Hoisington thesis); FFH is well capitalized; FFH will continue to report in US$ (possibly informal US GAAP as well as formal Cdn GAAP); TSE provides single market quote; underwriting of any future debt/equity tranches comes from the home Cdn market; etc.  So, the NYSE has become less relevant to the FFH strategic story.

 

-O

 

====================

Going back to the 1999 AR:

  • You will note that as a Canadian company reporting in Canadian dollars, we have always
    hedged our foreign exchange exposures when we purchased companies in the U.S. or in other
    countries. At the end of 1999, we have approximately 75% of our business in U.S. dollars and
    approximately 75% of our employees are in the U.S. For these reasons, we plan to go to
    U.S. dollar reporting and also list on the NYSE within the next two years. The exact timing will
    be dictated by the appropriate time to unwind our hedges. While on the subject of hedging, it
    is interesting to note that since we bought the first of our U.S. companies at the end of 1993,
    the Canadian dollar has steadily trended down from US75.5¢ to US69¢ currently – we would
    have been smart not to have hedged any of our exposures!!

 

And from the 2002 AR:

  • We listed on the NYSE on December 18, 2002 as we suggested we might. We were warmly
    welcomed and on January 14, 2003, the NYSE reported that there were almost 2 million shares
    shorted! Soon after, there was a spate of negative articles and reports on Fairfax, including a
    report containing seriously misleading commentary on Fairfax’s reserves.
    We have always tried to give very full disclosure in our annual reports, and we expand that
    disclosure if we discover that there are areas where enhanced disclosure would be useful (this
    year, for instance, our MD&A includes significantly expanded disclosure on our ORC Re
    subsidiary and our asbestos and pollution reserves). Because we are always concerned for our
    long term investors, we have decided to have conference calls after our earnings releases. There
    will continue to be no earnings guidance – quarterly or annually – but we will be open to
    answering any questions that shareholders or others may have. Although we are very much
    against quarterly conference calls because of their short term focus and promotional nature, we
    were guided by the greater concern that our investors not suffer from misleading information.
    We also plan to continue to have an annual investor meeting in New York, likely in the fall.

 

 

For FFH nothing (I mean nothing) good came out of the NYSE listing. I get the distinct sense that Prem is simply firing the NYSE

 

If one connects the dots between what Patrick Byrne has been saying for years, the whole NYSE stock trading business is a severely goosed situation. This was not how it was before the 80's, probably all the way back to the period just befoe 1929 when we are told by WEB that there was much hanky panky then as there is now. There are simply too many worms under the rock today.

 

Also, Prem is clearly focused on growing his insurance biz in other parts of the world, Poland, India, Brazil, Singapore etc. What a distraction it has been for Prem, not to mention untold millions of unrealized return potential for the long termers.

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Apologies to US board members but I am now thinking this is a good move.

 

NYSEs handling of the whole affair has been dismal.  They forgot who the customer was.  So they lose a rapidly growing company with 8 billion market cap.

 

If Thursday and Friday this week are any indication the trade volumes going forward are going to be very low 20 -30 k per day maximum.  This may create a desirability situation. 

 

It would be really nice to get the hand of this company of the likes of this board's members into the hands of someone willing to pay more for the stock.  I am thinking the NYSE listing has been a drag on the stock price.  This drag may disappear now.  We shall see.  A few months should bear out whether my hypothesis is correct, or not. 

 

It also removes the effect of the currency fluctuations on the stock price which lately have been indecipherable from the actual stock movement. 

 

 

 

 

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I don't believe a TSX-only listing is going to solve the valuation problem because I remember NB trading cheap.  There will still be times when it will trade at book value, even below book value, same as NB.  NB mostly traded above book but only during good times... once the markets blew up it went down to book and even below that.  Fairfax was broken during the good times and enjoyed a premium in late 2006 and early in 2007 only to see the premium disappear once the markets blew up.

 

So having a "fixed" Fairfax we only really have late 2006 and 2007 data to go on -- sort of a small sample.

 

The markets I think won't pay a premium until it senses that the next hard market is here.  There's no telling how much smaller the insurance operations will be once the soft market is over (it keeps shrinking), and it's these insurance operations that the market pays a premium for (that's my understanding). 

 

Personally, I am willing to be patient because we are making excellent money as we wait.  Sure, the markets might crash and pull down book value again, but if I sell out and buy something else that isn't going to help me at all with that risk.

 

I hope they boost the dividend again.  I feel more comfortable knowing what my actually income is (as opposed to look-through), especially given the turmoil (my other alternative is to use my margin as a pay-day lender, but the dividend is clearly a safer strategy).

 

 

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Guest longinvestor

I don't believe a TSX-only listing is going to solve the valuation problem because I remember NB trading cheap.  There will still be times when it will trade at book value, even below book value, same as NB.  NB mostly traded above book but only during good times... once the markets blew up it went down to book and even below that.  Fairfax was broken during the good times and enjoyed a premium in late 2006 and early in 2007 only to see the premium disappear once the markets blew up.

So having a "fixed" Fairfax we only really have late 2006 and 2007 data to go on -- sort of a small sample.

The markets I think won't pay a premium until it senses that the next hard market is here.  There's no telling how much smaller the insurance operations will be once the soft market is over (it keeps shrinking), and it's these insurance operations that the market pays a premium for (that's my understanding). 

Personally, I am willing to be patient because we are making excellent money as we wait.  Sure, the markets might crash and pull down book value again, but if I sell out and buy something else that isn't going to help me at all with that risk.

I hope they boost the dividend again.  I feel more comfortable knowing what my actually income is (as opposed to look-through), especially given the turmoil (my other alternative is to use my margin as a pay-day lender, but the dividend is clearly a safer strategy).

 

Here are Prem's words from a prior AR....

Before discussing 2000 (easier to discuss the past than the present!), let me reiterate Fairfax’s

excellent long term track record which has been achieved during the longest and toughest

down-cycle in the history of the property and casualty business. Book value per share has

compounded at 37% annually, while our stock price, even after the recent declines in 1999

and 2000, has compounded at 33% annually. In Canada, there are only two companies, and in

the U.S., eight companies, whose stock price has compounded at a rate faster than ours over

the past 15 years. Our company has earned an average 18.2% on shareholders’ equity since we

began 15 years ago (below our objective of 20%, because of our low profits in the past two

years) versus 9.4% for the 25 leading U.S. property and casualty insurers. There is only one

property and casualty company in the U.S. and Canada that has had a higher return on equity

than Fairfax in the past 15 years and none has compounded book value or stock price as fast.

You can see why we are so grateful for this long term record.

 

That is more than two years worth of data where the stock price reflected the biz. Stock price in 1999 had a high of $610.

Prem's experiment with the NYSE is over. Sometimes when you want to win, you change the playing field. The TSX is an old playing field for FFH.

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That is more than two years worth of data where the stock price reflected the biz.

 

Those are prior to the seven lean years.

 

My point is that, sure, the stock sucked on the NYSE up until late 2006 but these were all lean years (runoff sucked up all profits).  Then there was a big restatement in July 2006 that just made people so happy to run out and buy the stock!  But then people collected their heads and realized that runoff really was fixed, there was some short covering, and it traded between 1.75x -1.2x book up until August 2007.  Then it went downhill but things were no better over on the TSX for NB. 

 

Would a TSX-only FFH have fared any better than NB late last year?

 

I just question the theory that FFH is only cheap due to it's NYSE listing.  I think if they generate more underwriting profit people will bid the price up.  I think MKL's premium is really just due to the generally better underwriting profit -- the market capitalizes that as extra income and it shows up as a premium to book... or so I believe.

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"Good points, Ericopoly. The members of this board trust that Watsa and Co. will generate alpha from the float. Unfortunately, that's a story that takes more time to digest than underwriting strength simply because good investors produce more volatility than good underwriters."

 

We don't think they will generate profit from the float we know they will!

 

Ericopoly, you make a good point about the seven lean years...but no one else in the investing community does knows what you are talking about. The Northbridge argument is a good one which I think is worth exploring...Canadian mutuals bought it because it had yeild and a piece of Fairfax with great underwriting.  It was a stock you could buy for your mother...That is what Fairfax would like to be and should be. The world is going to start looking at yield and Fairfax could become a core Canadian holding with lower volatility...So we shall see how it goes but we have made substantial bets that it was the right move.

 

Dazel.

 

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I would be surprised if the dividend does not increase from last year. I believe Prem has stated on numerous occasions that the dividend payout will be tied to results and the results this year should be stellar again. Having said that, given that FFH pays it in one shot, my read is this will attract short term buyers looking to get the one time payment.

 

It is difficult to use NB as the model that should lead to higher FFH valuation. NB underwriting has been quite ugly (in aggregate) the past few years. This demonstrates to me the variability that is possible in even the most conservatively managed insurer. Until the hard market arrives, I do not expect insurer multiples to improve in a meaningful way.

 

I have not read a great deal lately, but it looks to me that we need something big and ugly to happen to insurers to bring on the hard market. Like a big catastrophe or for global financial markets to sieze up. Not something you would want to bet the farm on right now.

 

Near term regarding FFH, I wonder if the delisting in the US will have more of an impact on the share price than underwriting, interest & dividend income or realized investment gains. Hard to make a meaningful investment with so much noise going on.

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Viking,

 

I am not convinced that it takes a disaster to bring about a hard market.  I think it is more likely the cumulative effect of bad underwriting that will come home to roost at a whole lot of companies all at once.  A disaster certainly would speed things up though and create a buying opportunity of a lifetime in Fairfax (again  :P).

 

Suddenly at some point the collective group will start to report really bad results in a benign environment.  With no yields to offset it it could be very signficant.  A couple of hundred million each across 30 companies adds up to a disaster of epic proportions. 

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I am sorry guys, but if you are waiting for the next hard market to make money with Fairfax or any other insurer, then you are due for disappointment.

 

During the last 40 years, insurance has been in a soft market for something like 75% of the time. The soft cycle is extremely long relative to the hard market. It took the disaster of September 11 combined with massive losses in the stock market and years and years of underwriting losses to bring about a short lived hard market. The insurance business may get a bit better in a few years, but I would not hold on for a repeat of the 2001-2005 hard market.

 

For Fairfax, expanding in Brazil, China and other emerging markets is the way to go to gain policies and make underwriting profits right away. Tuck-in acquisitions in NA and Europe could also make sense. The industry is depressed and valuations are low. That is why they could afford to buy back Northbridge and Odyssey Re.

 

As I have mentioned before, I am not a big fan of insurance especially for Fairfax. Regulations, ratings, cash flows force them to keep a very low ratio of equities in their overall portfolio. You end up with a very leveraged structure, exposed to the risks of insurance combined with a terrible industry cycle to have no more equities than you would if you were not involved at all in the business. At times, they may have a bit more exposure to great assets vs their equity, but these periods seem rare and not really worth the risks and constraints.

 

If you think this is crazy, then I encourage you to do the math. Check the ratio of equities in their portfolio vs book value over time. Then check the cost (underwriting losses) over time and add to it the interest cost on the debt that they took to maintain this level of underwriting. You should come to the conclusion that whatever they earn on what is not equities in their portfolio is used up to pay for insurance and debt costs.

 

Cardboard

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