Fairfax 2018

[StubbleJumper]

 

 

For those holding the FFH shares...USD and the Euro have risen about 5% in FEb...I am not certain of Fairfax hedges but I believe they are unhedged other than most liabilities? All numbers and most importantly book value are stated in USD as we know...it is a trend to watch and another reason for Prem to be picking off FFH shares.

5% is a lot to Fairfax these days as it has become very large.

 

 

I don't recall seeing anything about meaningful currency hedging.  In principle, it shouldn't be required.  All of the subs have presumably matched off their assets against their liabilities in local currency, and each is regulated by a national regulator and must keep adequate capital for the specific country in which they operate.  The only thing where currency hedging might be helpful would be for the holdco to hedge enough to ensure that it can meet its interest and debt repayment obligations, as well as its annual dividend.  However, given that most of the interest and debt, and the common dividend are denominated in US dollars and FFH's largest subs are US based, one would think that they would have plenty of capacity to meet their US dollar obligations using dividends from their US subs. 

 

Other than that, currency hedging would serve the purpose of managing consolidated income?  I'd say that FFH has traditionally not worried much about income lumpiness, so managing EPS movements triggered by currency fluctuations doesn't seem like something that they'd do.

 

 

SJ

[Dazel]

 

 

I know in the past they did not hedge in a meaningful way....it is possible they hedge on their European and Asian investments.  But apples to apples FFH should have had a 5% boost in Feb relative to book value because it is priced in CAD. This is short term stuff of course but like I said if it is trend then it should be paid attention too and a buy back at a 5% to 10% discount on the FFH shares added  to the discount I think is already there...well that is just smart business to buy more shares back until the market figures it out.

[StubbleJumper]

 

 

I know in the past they did not hedge in a meaningful way....it is possible they hedge on their European and Asian investments.  But apples to apples FFH should have had a 5% boost in Feb relative to book value because it is priced in CAD. This is short term stuff of course but like I said if it is trend then it should be paid attention too and a buy back at a 5% to 10% discount on the FFH shares added  to the discount I think is already there...well that is just smart business to buy more shares back until the market figures it out.

 

 

In your mind you price FFH in Canadian dollars?  I mentally gravitate to the US dollar price because their financial reporting is all in US dollars and the only Canadian sub is NB, which is pretty small in the grand scheme of things.  If you think of FFH in US dollar terms, then the past month hasn't been so great because there are many small subs that report in non-US and non-Euro currencies which have generally not done well over the past month.

 

 

SJ

[Dazel]

 

 

SJ,

 

The market may be reading these post for (f......k) sakes....reluctant to reply!

Fairfax is a USD company....my point is we are being priced and buying back in CAD which is FFH. So if Book Value remains constant...and CAD drops 5% then the FFH shares are 5% cheaper because in CAD they should be priced 5% higher....if it is just short term fluctauation which is possible no big deal because we will not buy enough shares back to be meaningful....but if it is a trend and CAD continues lower and the market does not price it in we get a 5% plus discount to the Book value which is priced in USD.

[Spekulatius]

FFH is an US Business quoted in CAD for all practical purposes, IMO.

[StevieV]

I joined you jokers by initiating a small position this morning.  Looking forward to some good returns, and continued interesting posts on this board.

[Dazel]

http://xlcatlin.com/insurance/news/axa-to-acquire-xl-group

 

 

This transaction values XL at 1.5 times book value....XL has a $32b bond portfolio which would have dropped in value 2018...very little cash.

 

Under theses metrics with the unrealized value added into Fairfax book value...FFH would be trading for $870.

 

FFH

Bond exposure is limited (XL full earning power in play for interest income but unrealized losses this quarter from bond drop)

Massive cash position (XL has very little cash a little over $800m)

India growth exposure (XL investment portfolio is smaller and over 85% in fixed income)

 

This is why FFH best investment opportunity lies in share buy backs it’s cheap relative to its peers.

 

[petec]

 

This transaction values XL at 1.5 times book value....

 

True, although the market clearly doesn't. AXA's market cap fell by about the market cap of XL when the deal was announced!

[rohitc99]

https://www.bseindia.com/corporates/anndet_new.aspx?newsid=0f84fd68-9a81-4d73-bdc5-7e1ec0a5e9bc

 

The Board of Directors (“Board”) of Thomas Cook (India) Limited (“Company”) at its meeting held today have  given  their  consent  to  the  management  to  explore  the  possibility  of  an  internal  corporate  restructuring exercise that would (i) enable the Company to focus on travel related business, (ii) give the shareholders direct exposure and shareholding in the business of Quess Corp Limited; and (iii) enhance the stakeholders’ value (“Proposed Restructuring”). 

[Dazel]

 

 

Petec I think AXA shareholders and those following the stock were expecting a one time dividend from the sale of their U.S operations....they will not only not get this dividend now they are using the proceeds of the IPO and leverage for the purchase to make it a cash deal.

 

 

[Dazel]

 

 

Fairfax reorg of Thomas Cook and it’s position in the company makes sense as Fairfax India is now their investment vehicle for new investment. The market likes the decision...Thomas Cook shares are up sharply...

[wondering]

presumably a small investment

 

https://privatecapitaljournal.com/fairfax-torstar-backed-blue-ant-media-acquires-australian-geographic-magazine/

 

 

[Dazel]

 

Looks like Fairfax has a approx $850m pretax gain in Thomas Cook India...not bad for a group that has lost their touch. LOL

[rohitc99]

 

Looks like Fairfax has a approx $850m pretax gain in Thomas Cook India...not bad for a group that has lost their touch. LOL

 

https://timesofindia.indiatimes.com/business/india-business/thomas-cook-to-sell-5-42-in-quess-corp-to-raise-rs-600-crore/articleshow/61754756.cms.

 

Thomas cook recently sold around 5.5% of quess and booked a gain of close to 100 Mn on the sale. The company plans to use it to pay down debt at the thomas cook level.

 

Thomas cook in itself is an interesting company operating on float via the forex and travel business. Except for recent quarters, it has run the travel and forex business on close to zero capital due to this float. as it grows, this float should allow it to make further accquisitions

[Dazel]

 

 

The letter was Pure Class.

Watch out Fairfax is back!

 

Cheers,

 

Dazel

[petec]

 

 

The letter was Pure Class.

Watch out Fairfax is back!

 

Cheers,

 

Dazel

 

+1

 

Very impressive.

[Dazel]

http://www.business-standard.com/article/companies/thomas-cook-to-spin-off-quess-within-a-year-to-simplify-business-structure-118031301063_1.html

 

 

The stock price continues to rise as does FFH unrealized (not in book value) gain. I would expect Prem to discuss this at the annual meeting...they will have realized (if Thomas Cook is de consolidated  and sold)....almost $3b after tax gains from consolidated companies in a little over a year without losing any cash flow at all. Impressive!

[petec]

http://www.business-standard.com/article/companies/thomas-cook-to-spin-off-quess-within-a-year-to-simplify-business-structure-118031301063_1.html

 

 

The stock price continues to rise as does FFH unrealized (not in book value) gain. I would expect Prem to discuss this at the annual meeting...they will have realized (if Thomas Cook is de consolidated  and sold)....almost $3b after tax gains from consolidated companies in a little over a year without losing any cash flow at all. Impressive!

 

Is there any evidence that they will sell it? I see this as a move to simplify and make the value obvious, but I don't see why they'd sell. It's a good business with a huge growth runway and they've been doing a lot of tuck-ins. I think this is a long term holding. Might be wrong.

[ourkid8]

http://www.seaspancorp.com/press-release-post/press-release-122843/  (A second round of $250m investment by Fairfax to be funded next January on the same terms as first debenture/warrant deal)

 

If we exercise all the warrants @ $6.50 on the 5th anniversary, Fairfax has a potential ownership in SSW of 44.8% and we will be enjoying a coupon of $27.5M a year waiting... I love it!   

[petec]

Yes - extraordinary - and cheap!

[dartmonkey]

http://www.seaspancorp.com/press-release-post/press-release-122843/  (A second round of $250m investment by Fairfax to be funded next January on the same terms as first debenture/warrant deal)

 

If we exercise all the warrants @ $6.50 on the 5th anniversary, Fairfax has a potential ownership in SSW of 44.8% and we will be enjoying a coupon of $27.5M a year waiting... I love it! 

 

 

Interesting that this is another deal with David Sokol, of Berkshire renown. "Prem Watsa, Chairman and Chief Executive Officer of Fairfax, said:

 

"We are delighted to grow our partnership with the Seaspan team. Building an even greater relationship with a company guided by proven leaders like David Sokol and Bing Chen, ..."

 

And this, in the 2017 AR:

 

"In addition to our restaurant businesses, our investment in the Davos craft spirit brands, in partnership with our good friend David Sokol and the management team led by Andrew Chrisomalis, continues to do exceptionally well. Davos’ brands include TYKU Sake, Aviation American Gin, Sombra Mezcal and Astral Tequila. Davos recently partnered with Ryan Reynolds (star of the blockbuster movie Deadpool) in Aviation American Gin."

 

and this:

 

"Late in 2017, we had the good fortune to be a partner with David Sokol and Dennis Washington, two outstanding businessmen with great track records, by investing in Seaspan. Dennis is the largest shareholder of Seaspan while David became its Executive Chairman in July 2017. David has one of the most outstanding records I have come across, as he built Mid American Energy from revenue of $116 million in 1991 to revenue of $11 billion in 2010, while net income increased from $27 million to $1.2 billion over the same period, representing a compound growth rate of 22.4% per year."

 

Sokol, as many will remember, had a falling out with Buffett and Berkshire when he pitched a deal for the takeover of Lubrizol, without making it clear that he had taken a small stake already.

 

 

 

[ourkid8]

Fairfax has deployed a bit over $1B in debt/warrant deals so far in the last year. I was wondering are they using float or cash at the Holdco for these deals?  If it is using float and we average a CRs of 100, there is no further built in leverage, correct?  Or is the leverage derived from the differential between government rates and CR written?  Sorry for these noob questions, I am trying to better understand the company and cash deployment opportunities.

[petec]

Fairfax has deployed a bit over $1B in debt/warrant deals so far in the last year. I was wondering are they using float or cash at the Holdco for these deals?  If it is using float and we average a CRs of 100, there is no further built in leverage, correct?  Or is the leverage derived from the differential between government rates and CR written?  Sorry for these noob questions, I am trying to better understand the company and cash deployment opportunities.

 

They are using float. The holdco cash is probably going to be used to buy the OMERS stakes in Brit and Eurolife when those agreements come due. But I wouldn't necessarily differentiate between float and holdco cash. The point is that float levers your equity - you get to keep the investment returns on a far greater amount of money that what you invested in the business. Here's how I understand it:

 

The leverage is derived from the fact that when you sell an insurance contract, the buyer effectively lends you money (premiums come in now, claims go out later, and you get to sit on the money in the meantime).

 

The cost of the leverage is derived from the CR.

 

The amount of the leverage is derived from the value of the premiums you write and the duration of the contracts.

 

So for example, if you write $1bn in premiums every year on contracts that expire after a year (e.g. a typical house insurance contract) you'll have about $1bn in float, because you get to sit on one year's worth of premiums before the claims go out the door. If your CR is 100, then that leverage is cost free. Bit if you write $1bn in premiums every year on contracts that expire after 10 years, then (once the business is mature) you'll have about $10bn in float, because you get to sit on 10 years' worth of premiums. If the CR is 98%, then you're being paid to borrow that money. Of course, long tail is riskier than short tail - you can't predict the exposures so well and something you didn't foresee, like asbestos causing cancer, can come back to bite you - so you have to be very careful with underwriting.

 

So, let's say you have $1bn in equity and you write $1bn in premiums every year on 3 year contracts. You'd have $4bn in investable assets ($1bn equity and $3bn float).

 

If you can underwrite at 102% you're going to lose 2% of premiums a year in underwriting profit: $20m.

 

If you can invest $4bn in a 7-year Seaspan debenture at 5.5% you're going to earn $220m in interest for a total of $200m in annual income, before holdco costs and tax.

 

If you've also got warrants exercising at $6.50, and the Seaspan share price goes to $13, then towards the end of the debenture you're going to exercise the warrants for $8bn(!!), paying by forgiving the debenture. Not a bad return on your $1bn of equity. That's the impact of levering equity upside using float.

 

A few points to note:

 

- I have oversimplified the relationship between contract duration and float, but I think the basic principle holds.

 

- Fairfax currently lever their equity about 2:1 using float, not 3:1. But they could probably double premiums in a hard insurance market. If you double premiums across the board it would take time for float to double, but logically you'd get there if the hard market lasted long enough. Unfortunately I suspect the regulator or the ratings agencies would panic long before they got to 4:1 levered, but there's scope for some growth.

 

- underwriting profit in any given year  is calculated off the $ of premiums, not float. That said, you can look at the float and know, if the average CR over all those contracts is 98%, that you're getting paid 2% to borrow.

 

- float gives you huge investing leverage whether or not the CR is over 100% - it's just that the cost of that leverage is lower with a lower CR. That's why this model is so powerful for compounding if you can get both underwriting and investing right.

 

- the debenture + warrant deals are great in theory because the downside is bondlike, so the regulator looks at these as bonds, but in most cases the warrant strike price is quite close to the share price at inception, and the shares look reasonably cheap, so there is near-full equity upside. That's powerful, if they can do it with a significant proportion of that big bond portfolio. If they can do $1bn a year on 5-7 year terms then they can basically convert $5-7bn of that bond portfolio into securities that have bond downside but equity upside. That more or less doubles their equity exposure but only on the upside. Get that right and lever it with float and the impact on shareholder's equity could be spectacular.

 

I hope this helps but sorry if I am teaching grandma to suck eggs.

 

 

[StevieV]

Fairfax has deployed a bit over $1B in debt/warrant deals so far in the last year. I was wondering are they using float or cash at the Holdco for these deals?  If it is using float and we average a CRs of 100, there is no further built in leverage, correct?  Or is the leverage derived from the differential between government rates and CR written?  Sorry for these noob questions, I am trying to better understand the company and cash deployment opportunities.

 

They are using float. The holdco cash is probably going to be used to buy the OMERS stakes in Brit and Eurolife when those agreements come due. But I wouldn't necessarily differentiate between float and holdco cash. The point is that float levers your equity - you get to keep the investment returns on a far greater amount of money that what you invested in the business. Here's how I understand it:

 

The leverage is derived from the fact that when you sell an insurance contract, the buyer effectively lends you money (premiums come in now, claims go out later, and you get to sit on the money in the meantime).

 

The cost of the leverage is derived from the CR.

 

The amount of the leverage is derived from the value of the premiums you write and the duration of the contracts.

 

So for example, if you write $1bn in premiums every year on contracts that expire after a year (e.g. a typical house insurance contract) you'll have about $1bn in float, because you get to sit on one year's worth of premiums before the claims go out the door. If your CR is 100, then that leverage is cost free. Bit if you write $1bn in premiums every year on contracts that expire after 10 years, then (once the business is mature) you'll have about $10bn in float, because you get to sit on 10 years' worth of premiums. If the CR is 98%, then you're being paid to borrow that money. Of course, long tail is riskier than short tail - you can't predict the exposures so well and something you didn't foresee, like asbestos causing cancer, can come back to bite you - so you have to be very careful with underwriting.

 

So, let's say you have $1bn in equity and you write $1bn in premiums every year on 3 year contracts. You'd have $4bn in investable assets ($1bn equity and $3bn float).

 

If you can underwrite at 102% you're going to lose 2% of premiums a year in underwriting profit: $20m.

 

If you can invest $4bn in a 7-year Seaspan debenture at 5.5% you're going to earn $220m in interest for a total of $200m in annual income, before holdco costs and tax.

 

If you've also got warrants exercising at $6.50, and the Seaspan share price goes to $13, then towards the end of the debenture you're going to exercise the warrants for $8bn(!!), paying by forgiving the debenture. Not a bad return on your $1bn of equity. That's the impact of levering equity upside using float.

 

A few points to note:

 

- I have oversimplified the relationship between contract duration and float, but I think the basic principle holds.

 

- Fairfax currently lever their equity about 2:1 using float, not 3:1. But they could probably double premiums in a hard insurance market. If you double premiums across the board it would take time for float to double, but logically you'd get there if the hard market lasted long enough. Unfortunately I suspect the regulator or the ratings agencies would panic long before they got to 4:1 levered, but there's scope for some growth.

 

- underwriting profit in any given year  is calculated off the $ of premiums, not float. That said, you can look at the float and know, if the average CR over all those contracts is 98%, that you're getting paid 2% to borrow.

 

- float gives you huge investing leverage whether or not the CR is over 100% - it's just that the cost of that leverage is lower with a lower CR. That's why this model is so powerful for compounding if you can get both underwriting and investing right.

 

- the debenture + warrant deals are great in theory because the downside is bondlike, so the regulator looks at these as bonds, but in most cases the warrant strike price is quite close to the share price at inception, and the shares look reasonably cheap, so there is near-full equity upside. That's powerful, if they can do it with a significant proportion of that big bond portfolio. If they can do $1bn a year on 5-7 year terms then they can basically convert $5-7bn of that bond portfolio into securities that have bond downside but equity upside. That more or less doubles their equity exposure but only on the upside. Get that right and lever it with float and the impact on shareholder's equity could be spectacular.

 

I hope this helps but sorry if I am teaching grandma to suck eggs.

 

petec,

 

My only quibble is that I don't believe it is as easy to increase the leverage as your post may imply.  They need to find profitable insurance to write (100% or less CR) or acquire.

 

If Fairfax does increase book value by 15% (straight book value, not per share), it seems to me as though it will be a challenge to maintain the current leverage.  If they grow 15%/share/year, and some of that is through share buybacks, that should be a little less difficult.  That is one of the reasons why I like opportunistic buybacks. It helps alleviate some size/growth problems.

 

I think I have that right.  Any reason you think maintaining the leverage won't be an issue?

 

StevieV

 

[Cigarbutt]

The big multi-variable equation question about Fairfax capacity to grow profitably is one I am wrestling with.

Historically, FFH has shown an incredible capacity to grow float and more recently to grow it profitably.

Isolating the residual room to grow variable going forward, here's an excerpt from Berkshire Hathaway 2017 edition:

 

Here’s the record:

(in $ millions)

Volume Float

1970 39    1980 237    1990 1,632    2000 27,871    2010 65,832    2017 114,500

 

Fairfax year-end float (2017): 22,700

 

If you go back in time for Berkshire Hathaway, in 1998, year-end float was 22,800

Question:

From the perspective of 1998, did BH have an opportunity to grow float?

Float has grown at 8.9% (CAGR).

 

FFH is not BH but even if the rate of potential growth in float has come down, IMO, the variable, in itself, is not a major limiting factor in terms of the return objective that they describe going forward.

And indeed, opportunistic buybacks, given the right environment, could help with float per share.