Fairfax stock positions

[Viking]

Estimate of change in value of Fairfax’s equity portfolio in Q3 - 2024

 

Fairfax’s equity portfolio (that I track) increased in value in Q3, 2024 by about $800 million (pre-tax) or 4.0%, which is a solid result. It had a total value of about $20.7 billion at September 30, 2024. After being a headwind in 1H 2024 (on US$ strength), currency flipped to being a tailwind in Q3 (on US$ weakness).

 

 

Notes:

• I include the FFH-TRS position in the mark to market bucket and at its notional value. I also include warrants and debentures that Fairfax holds in the mark to market bucket.

My tracker portfolio is not an exact match to Fairfax’s actual holdings. It is useful only as a tool to understand the rough change in Fairfax’s equity portfolio (and not the precise change).

 

My equities tracker does not include the change in value of Digit, Fairfax's P/C insurance company in India that is now publicly traded. The total value of Digit increased about $400 million in Q3. This amount needs to be adjusted to reflect Fairfax's ownership stake.

 

Split of total holdings by accounting treatment

 

About 47% of Fairfax’s equity holdings are mark to market - and will fluctuate each quarter with changes in equity markets. The other 53% are Associates and Consolidated holdings. The Sleep Country and Peak Achievement (Bauer) acquisitions (which are expected to close in Q4) will significantly increase the consolidated bucket of holdings.

 

Over the past couple of years, the share of the mark to market holdings has been shrinking. This means Fairfax's quarterly reported results will be less impacted by volatility in equity markets.

 

 

Split of total gains by accounting treatment

 

• The total change is an increase of about $800 million = $36/share (pre-tax)
• The mark to market change is an increase of about $315 million = $14/share. This does not include the gain on the sale of Stelco when it closes (expected in Q4). The change in this bucket of holdings will show up in ‘net gains (losses) on investments’ (along with changes in the value of the fixed income portfolio) when Fairfax reports each quarter.

 

 

What were the big movers in the equity portfolio Q1-YTD?

• Stelco is up $288 million. Fairfax is expected to book an estimated pre-tax gain of $390 million on the sale of its 13 million shares in Stelco. The sale is expected to close in Q4 2024.
• The FFH-TRS is up $241 million and is now Fairfax’s second largest holding at $2.5 billion.
• Eurobank is up $161 million. Currency has been a tailwind in Q3 (strong Euro).
• Quess continues its big move higher, and is up another $104 million. Market value of $473 million now exceeds carrying value of $434 million.
• Thomas Cook India, down $144 million, gave back some of its recent gains. Market value of $726 million significantly exceeds carrying value of $218 million.

 

Excess of fair value over carrying value (not captured in book value)

 

For Associate and Consolidated holdings, the excess of fair value to carrying value is about $2.0 billion pre-tax ($89/share). The 'excess' of FV to CV has been materially increasing in recent years. This is a good example of how book value at Fairfax is understated.

 

Excess of FV over CV:

• Associates:           $1.3 billion = $59/share
• Consolidated:       $661 million = $30/share

Equity Tracker Spreadsheet explained

 

We have separated holdings by accounting treatment: 

• Mark to market
• Associates – equity accounted 
• Consolidated
• Other Holdings – total return swaps and warrants and debentures

The value of each holding is calculated by multiplying the share price by the number of shares. All holdings are tracked in US$, so non-US holdings have their values adjusted for currency.

 

This spreadsheet contains errors. It is updated as new and better information becomes available.

 

 

 

 

Fairfax Oct 1 2024.xlsx

Edited October 2, 2024 by Viking

[dartmonkey]

Thanks Viking, very helpful to see these changes, even if the consolidated holdings are harder to guess at.

 

Some additional excess to fair value in the associates, with FIH, hopefully, too. 

 

In the mark to market bucket, I'm curious, you have smaller holdings going down from $65m (Ensign) to Johnson & Johnson ($13m), and then 'Remaining Smaller Holdings' worth $2145m (unchanged from June 30). It's hard to believe there are enough tiny holdings to get up to the equivalent of 200+ stakes worth $10m or smaller, or is it? Where do you get this figure?

 

 

[Viking]

3 hours ago, dartmonkey said:

In the mark to market bucket, I'm curious, you have smaller holdings going down from $65m (Ensign) to Johnson & Johnson ($13m), and then 'Remaining Smaller Holdings' worth $2145m (unchanged from June 30). It's hard to believe there are enough tiny holdings to get up to the equivalent of 200+ stakes worth $10m or smaller, or is it?

 

Where do you get this figure?

 

@dartmonkey, when putting together my summary of Fairfax's equity holdings:

1.) I start with the summary Fairfax provides in their annual report each year. This provides a great deal of information (all the different buckets and sub-buckets).

2.) Then layer in holdings that we know about but that Fairfax did not have in the annual report (these amounts will be subtracted from the sub totals so they do not get counted twice).

3.) Then incorporate new news each quarter: 13F, Fairfax announcements etc.

 

When each annual report comes out I start at the beginning again. 

----------

As you rightfully note, there are holdings worth billions in value that we know little about (what the holdings are and how they are doing over the year).

---------

As a result, my estimate (tracking spreadsheet) is usually light when it comes to estimating actual reported gains and losses from investments.

 

Edited October 2, 2024 by Viking

[Viking]

A question for board members. When Fairfax takes Peak Achievement private (expected in Q4) will they mark up their 43% stake to reflect the purchase price? If so, this should drive a meaningful realized investment gain in Q4. 

 

Fairfax's carrying value for its 43% position in Peak Achievement is $129 million. At June 30, it had a fair value of $226 million.

 

The sale price for 100% of Peak has not been disclosed. Some reports suggested Peak was being shopped for $800 million. A post on Twitter suggests the final sale price (likely including debt) values the company at $1 billion.

-----------

Fairfax is 'sitting' on about $2 billion in unrealized investment gains today. This figure has been growing rapidly over the past 4 years. As Fairfax harvests this value in the coming years it will be incremental to analysts EPS earnings forecasts.

 

How Fairfax harvest this value will vary. Sometimes it will be an outright sale like Stelco. Other times it will be change in their ownership stake, like Peak Achievement (if I am understanding things correctly).

Edited October 3, 2024 by Viking

[glider3834]

50 minutes ago, Viking said:

When Fairfax takes Peak Achievement private (expected in Q4) will they mark up their 43% stake to reflect the purchase price?

viking yes I would expect so - a gain on consolidation - similar to Gulf Insurance transaction in the sense we are moving from equity associate to controlled sub, but we will need to wait for official confirmation from Fairfax to determine the amount of any potential consolidation gain here with Peak deal.

 

 

 

Edited October 2, 2024 by glider3834

[TwoCitiesCapital]

2 hours ago, glider3834 said:

viking yes I would expect so - a gain on consolidation - similar to Gulf Insurance transaction in the sense we are moving from equity associate to controlled sub, but we will need to wait for official confirmation from Fairfax to determine the amount of any potential consolidation gain here with Peak deal.

 

 

 

 

 This is what I'd expect as well. 

 

A mark up to the value of their offer, the consolidation of gains/losses through the income statement going forward, and a static carrying value on the balance sheet. 

 

[Viking]

Fairfax's total return swap investment (giving it exposure to 1.96m $FFH.TO shares) is up $841m 2024YTD. And up $1.9b (before carrying costs) in 3.75 years. Outstanding capital allocation. Opportunistic. Creative. Concentrated position - a needle mover.

 

How does one calculate the internal rate of return that Fairfax has generated from this investment? Any suggestions?

 

The total return of $1.9 billion in 3.75 years is amazing. But when you compare the return to what it has cost Fairfax to put this position on and keep it on... the internal rate of return from this investment has to be astronomical. 

 

Fairfax's shares are trading at about $1,350/share. If they return 15% over then next 12 months (likely a mildly conservative assumption) that would result in a $200 increase in the share price. That would translate into a $400 million increase (pre-tax) in the value of the FFH-TRS position. A 20% return would result in a gain in the FFH-TRS of $540 million. These are big numbers (larger than the notional value when the position was put on originally). Compounding and time is working its magic.

 

With the shares trading at $1,350, it will be interesting to see if Fairfax continues to be aggressive on the share buyback front. 

 

My guess is holding the FFH-TRS and share buybacks might be linked strategically from a Fairfax perspective. But I am not sure. If Fairfax is confident they will be able to deliver an average ROE of 15% per year over the next 3 or 4 years, perhaps they continue to hold the FFH-TRS position, regardless of what they decide to do with buybacks.

 

This single investment is so instructive about Fairfax on so many different levels. Why it is so different from not only traditional P&C insurance companies, but also how different it is from Markel and Berkshire Hathaway. Unconstrained capital allocation (Fairfax's business model) can be a wonderful compounding machine when executed by the right management team. The FFH-TRS is one of many examples of where the senior team at Fairfax has been executing exceptionally well over the past 6 years or so. 

 

Mr. Market is starting to wake up to the fact that Fairfax has once again become a compounding machine - with its glide path for the next 4 years largely set.  

 

“We think this will be a great investment for Fairfax, perhaps our best yet!” Prem Watsa 2020AR

 

Edited November 4, 2024 by Viking

[Crip1]

37 minutes ago, Viking said:

Fairfax's total return swap investment (giving it exposure to 1.96m $FFH.TO shares) is up $841m 2024YTD. And up $1.9b (before carrying costs) in 3.75 years. Outstanding capital allocation. Opportunistic. Creative. Concentrated position - a needle mover.

 

How does one calculate the internal rate of return that Fairfax has generated from this investment? Any suggestions?

 

The total return of $1.9 billion in 3.75 years is amazing. But when you compare the return to what it has cost Fairfax to put this position on and keep it on... the internal rate of return from this investment has to be astronomical. 

 

Fairfax's shares are trading at about $1,350/share. If they return 15% over then next 12 months (likely a mildly conservative assumption) that would result in a $200 increase in the share price. That would translate into a $400 million increase (pre-tax) in the value of the FFH-TRS position. A 20% return would result in a gain in the FFH-TRS of $540 million. These are big numbers (larger than the notional value when the position was put on originally). Compounding and time is working its magic.

 

With the shares trading at $1,350, it will be interesting to see if Fairfax continues to be aggressive on the share buyback front. 

 

My guess is holding the FFH-TRS and share buybacks might be linked strategically from a Fairfax perspective. But I am not sure. If Fairfax is confident they will be able to deliver an average ROE of 15% per year over the next 3 or 4 years, perhaps they continue to hold the FFH-TRS position, regardless of what they decide to do with buybacks.

 

This single investment is so instructive about Fairfax on so many different levels. Why it is so different from not only traditional P&C insurance companies, but also how different it is from Markel and Berkshire Hathaway. Unconstrained capital allocation (Fairfax's business model) can be a wonderful compounding machine when executed by the right management team. The FFH-TRS is one of many examples of where the senior team at Fairfax has been executing exceptionally well over the past 6 years or so. 

 

Mr. Market is starting to wake up to the fact that Fairfax has once again become a compounding machine - with its glide path for the next 4 years largely set.  

 

“We think this will be a great investment for Fairfax, perhaps our best yet!” Prem Watsa 2020AR

 

The one aspect of Prem that I’ve not cared for is the “cheerleader” aspect of the Annual Letters to Shareholders, always felt it was in stark contrast to Buffett’s candor. The use of exclamation points only added to that. 

But, at the same time, one must give credit where it’s due, and this investment has to be one of the best, if not THE best, they’ve ever done from an ROI perspective. It’s important to admit when one is wrong, and I’d have suggested that they take the money and run on this investment a long time ago…I was dead wrong.

-Crip
 

[73 Reds]

54 minutes ago, Crip1 said:

The one aspect of Prem that I’ve not cared for is the “cheerleader” aspect of the Annual Letters to Shareholders, always felt it was in stark contrast to Buffett’s candor. The use of exclamation points only added to that. 

But, at the same time, one must give credit where it’s due, and this investment has to be one of the best, if not THE best, they’ve ever done from an ROI perspective. It’s important to admit when one is wrong, and I’d have suggested that they take the money and run on this investment a long time ago…I was dead wrong.

-Crip
 

Seems like the time to cash out of the TRS is when the stock gets too expensive to repurchase.  Otherwise, they can continue to support the TRS through share repurchases.

[dartmonkey]

4 hours ago, Viking said:

My guess is holding the FFH-TRS and share buybacks might be linked strategically from a Fairfax perspective. But I am not sure. If Fairfax is confident they will be able to deliver an average ROE of 15% per year over the next 3 or 4 years, perhaps they continue to hold the FFH-TRS position, regardless of what they decide to do with buybacks.

 

My guess is that it's exactly the same, as far as the return goes, as if Fairfax had just repurchased the equivalent number of shares.

 

Obviously there are other differences. Liquidity, for one thing, and availability of FRFHF shares that are being traded, and, perhaps, tax consequences. For instance, I wonder whether Fairfax has not discovered an innovative way of avoiding the recent repurchase tax of 2%, although that was not the reason to set up the trade, as the TRS's were purchased before the tax came into effect (Jan 1st, 2024.) 

 

Think about it this way: they put on the TRS trade with exposure to 1.964m shares when shares were trading at $344 (all number $US). If they had had the liquidity then, they might also have just bought that many shares for 1.964m*$344 = $677m. With shares now at $1350 (ignoring today's $50 plunge), they have gains of 1.964*(1350-344) = $1.976b.

 

Now that they have lots of liquidity, they could use that cash to buy back shares - if they wanted to buy back 1.964m shares, it would cost them a lot more now, in fact that would be 1.964*1350= $2.652b. To do that, they could use their $1.976b in TRS gains, plus another $677m. It is no coincidence that that $677m happens to be exactly how much it would have cost them to buy back the same number of shares back at the end of 2020 when they put on the TRS trade. 

 

In other words, at the end of 2020, Fairfax locked in the price of almost 2m shares, at $344. Using the gains from the TRS's, they could now buy back those same 2m shares by paying the cash they have received from the swaps, plus another $344 per share. So economically, they have the effect of a 2m buyback, but with there will be all sorts of differences, tax on the gains from the TRS's maybe being the worst. If I am correct, they may never close the TRS deal - why would they want to pay all that tax on the capital gain? And then pay another 2% tax on further repurchases? It might make more sense just to hold them indefinitely.

 

Edited November 4, 2024 by dartmonkey

[MMM20]

 

4 hours ago, Viking said:

How does one calculate the internal rate of return that Fairfax has generated from this investment? Any suggestions?

Why not treat it like a full outlay (ie buyback) at t0 and just incorporate some borrowing cost? 

[gfp]

27 minutes ago, dartmonkey said:

If I am correct, they may never close the TRS deal - why would they want to pay all that tax on the capital gain?

 

My hunch is that the gains on the TRS on Fairfax's own shares are not taxable but I have asked Jenn Allen for clarification and hope she gets back to me.  If profits are taxed, they would be taxed as the profit or loss flowed back and forth each quarter or each year and not realized at the end like a regular stock investment that defers tax until sold.

 

I'll post here if I get more clarification.  I don't know what tax law applies to these derivatives at Fairfax and I don't know how this type of trade would be taxed in the United States.  But in the United States, an issuer's trading in its own common stock does not produce a taxable gain or loss.  Does that extend to TRS on own shares?  I dunno.  But maybe.

 

(and obviously Fairfax is a Canadian corporation with several US subsidiaries and the US / IRS treatment might be nothing like the Canadian)

Edited November 4, 2024 by gfp

[TwoCitiesCapital]

44 minutes ago, dartmonkey said:

My guess is that it's exactly the same, as far as the return goes, as if Fairfax had just repurchased the equivalent number of shares.

 

It isn't though. To buy the shares required a cash outlay of hundreds of millions of dollars. The TRS probably required outlays of 10-15% as initial margin meaning the trade was nearly 7-10x levered versus buying the shares outright. 

 

It's not exactly that though because there was a financing rate paid the whole time which would reduce the amount gained and then there were a handful of quarters with slightly negative performance requiring small additional cash outlays for that 3 month period that would have been return in the following quarter, but still impact the ROI calculation. 

 

29 minutes ago, MMM20 said:

 

Why not treat it like a full outlay (ie buyback) at t0 and just incorporate some borrowing cost? 

 

Because they didn't have a full outlay upfront. They saved hundreds of millions which stayed invested in other parts of the company generating returns too. 

 

It's like buying a house with 100% cash or buying it with a 30-year mortgage. The return profiles and ROIC are different even if the $ gain on the home price is equivalent. 

[dartmonkey]

53 minutes ago, TwoCitiesCapital said:

1 hour ago, dartmonkey said:

My guess is that it's exactly the same, as far as the return goes, as if Fairfax had just repurchased the equivalent number of shares.

 

It isn't though. To buy the shares required a cash outlay of hundreds of millions of dollars. The TRS probably required outlays of 10-15% as initial margin meaning the trade was nearly 7-10x levered versus buying the shares outright. 

 

 

54 minutes ago, TwoCitiesCapital said:

It's like buying a house with 100% cash or buying it with a 30-year mortgage. The return profiles and ROIC are different even if the $ gain on the home price is equivalent. 

 Yes - all I am saying is that the pre-tax $ gain is the same (and maybe the post-tax $ gain, if the gains are exempt from tax - that will be interesting to see). As I acknowledged, the effect on liquidity and the tax implications are quite different, but the economic gain is equivalent to a share repurchase at the price that prevailed when the trade was put on.

 

The value of the TRS goes up by $1 if the share price goes up by $1, and down by $1 if the share price goes down by $1, so it is like buying a share, from a gain perspective. It makes sense to have done the trade as a swap, given the liquidity position Fairfax had at the end of 2020, but economically, it's like buying 2m shares, so I would calculate the return that way. If it quacks like a duck...

[MMM20]

4 hours ago, TwoCitiesCapital said:

Because they didn't have a full outlay upfront. They saved hundreds of millions which stayed invested in other parts of the company generating returns too.

I mean, sure, but there’s no free lunch. Wasn’t the whole point that it was economically equivalent to buying their own stock? They didn’t have enough free cash on hand at the time so they found a way around it. Seems like the best way to think about the ROIC is to use the full notional amount in the denominator. And then account for the extra costs like the borrowing costs. Maybe I’m missing something?

[Haryana]

9 hours ago, Viking said:

...

How does one calculate the internal rate of return that Fairfax has generated from this investment? Any suggestions?

 

The total return of $1.9 billion in 3.75 years is amazing. But when you compare the return to what it has cost Fairfax to put this position on and keep it on... the internal rate of return from this investment has to be astronomical. 

...

 

While it is easier to use the notional amount for understanding and presentation,

this position is very much different from plain buyback because of the amount of actual cash used.

 

The usused cash had a lot of alternatives which would have added a very large amount of return.

For example, either by use on the insurance business at the right time or on any investment.

 

The main item used for this position is a contract and its inherent risk.

Not cash.

 

Throwing a wild guess, the leverage might be of 5 to 10 times.

Return on the cash used could be of the order of over 1000%.

[TwoCitiesCapital]

2 hours ago, MMM20 said:

I mean, sure, but there’s no free lunch. Wasn’t the whole point that it was economically equivalent to buying their own stock? They didn’t have enough free cash on hand at the time so they found a way around it. Seems like the best way to think about the ROIC is to use the full notional amount in the denominator. And then account for the extra costs like the borrowing costs. Maybe I’m missing something?

 

This is akin to saying the ROIC of buying a call option is the same as buying the underlying stock/shares. It's not the same. 

 

The shares have a ton more invested capital than the option does. The $ return may be similar, but the Return on Invested Capital is different by nature of being a ratio and the denominator of "invested capital" being dramatically different. 

Edited November 5, 2024 by TwoCitiesCapital

[MMM20]

7 hours ago, TwoCitiesCapital said:

 

This is akin to saying the ROIC of buying a call option is the same as buying the underlying stock/shares. It's not the same. 

 

The shares have a ton more invested capital than the option does. The $ return may be similar, but the Return on Invested Capital is different by nature of being a ratio and the denominator of "invested capital" being dramatically different. 

 

I'll have to think harder about this. I just don't see it as functionally equivalent to a call option... maybe a call option with an open-ended duration where you're on the hook for the full amount of the underlying change if the stock goes -100% against you. In other words, just like buying the stock, but if a bank lent you almost 100% of the capital and needed to be paid back either way. If you calculate the IRR off FFH's initial outlay, you basically get an infinite IRR - that can't be right in general. It only looks like that in this case b/c the stock basically went straight up. Were they not truly risking the full notional amount of the swaps? Maybe I'm missing something. Thanks!

 

Edited November 5, 2024 by MMM20

[TwoCitiesCapital]

3 hours ago, MMM20 said:

 

I'll have to think harder about this. I just don't see it as functionally equivalent to a call option... maybe a call option with an open-ended duration where you're on the hook for the full amount of the underlying change if the stock goes -100% against you.

 

The mechanics are slightly different than an option. With an option you can only lose the premium. With the TRS, you can lose 100% of the notional (or more with financing payments included). But they are similar in that both provide leveraged exposure to the underlying for a fraction of the cash for an implied, or explicit, financing rate. 

 

3 hours ago, MMM20 said:

 

 

In other words, just like buying the stock, but if a bank lent you almost 100% of the capital and needed to be paid back either way. If you calculate the IRR off FFH's initial outlay, you basically get an infinite IRR - that can't be right in general. It only looks like that in this case b/c the stock basically went straight up. Were they not truly risking the full notional amount of the swaps? Maybe I'm missing something. Thanks!

 

 

Very similar - yes. 

 

But instead of the bank lending you 100%, you're putting down 10-15% initial margin, any daily margin for moves against you (while also collecting it for moves in your favor), less any financing rate. So instead of being infinite with no money down, you're in the ballpark of 7-10x leverage.  The actual ROIC will be determined mostly by where the stock ends, but also somewhat by the path of how it got there since you're daily on the hook for potential cash margin which each day adds to, or deducts from, the ROIC. 

 

We would basically need to recalculate daily to get an accurate ROIC figure, but taking 7-10x the underlying cash return should get us in the right ballpark. 

 

We may just be arguing semantics - the $ return will be very similar, but since ROIC is a ratio and the denominator of the ratio is changing dramatically, the ROIC between the is dramatically different. 

Edited November 5, 2024 by TwoCitiesCapital

[dartmonkey]

14 hours ago, MMM20 said:

I mean, sure, but there’s no free lunch. Wasn’t the whole point that it was economically equivalent to buying their own stock? They didn’t have enough free cash on hand at the time so they found a way around it. Seems like the best way to think about the ROIC is to use the full notional amount in the denominator. And then account for the extra costs like the borrowing costs.

I think this is exactly right. Fairfax bought swaps on 1.964m shares, let's say 2m, at $344 a share, so they had $677m at risk, and they are now sitting on unrealized gains of 1.964m*($1350-$344) = $2651m - $677m = $1976m, roughly a 290% gain. Just because they didn't have to lay out cash at the time the swaps were set up doesn't mean that that $677m of capital was not at risk. 

 

Any investor who invests $677 and gets back $2651 has a ROIC of 292% - the cost of financing doesn't enter into it. If the ROIC is less than the weighted average cost of capital (WACC), then that return is not enough to make it a good investment, but the ROIC is what it is.

[TwoCitiesCapital]

12 minutes ago, dartmonkey said:

I think this is exactly right. Fairfax bought swaps on 1.964m shares, let's say 2m, at $344 a share, so they had $677m at risk, and they are now sitting on unrealized gains of 1.964m*($1350-$344) = $2651m - $677m = $1976m, roughly a 290% gain. Just because they didn't have to lay out cash at the time the swaps were set up doesn't mean that that $677m of capital was not at risk. 

 

Any investor who invests $677 and gets back $2651 has a ROIC of 292% - the cost of financing doesn't enter into it. If the ROIC is less than the weighted average cost of capital (WACC), then that return is not enough to make it a good investment, but the ROIC is what it is.

 

If I buy $500,000 home for 3% down, and it doubles in value next year to $1 million - is my ROIC 100% or is it 3300%? 

Edited November 5, 2024 by TwoCitiesCapital

[MMM20]

3 minutes ago, TwoCitiesCapital said:

 

If I buy $500,000 home for 3% down, and it doubles in value next year to $1 million - is my ROIC 100% or is it 3300%? 

 

In your example, if home values are -50%, you can hand the keys to the bank and only lose your 3% down payment. Fairfax has always been on the hook for the full notional amount of the swaps, right? I think you're technically correct but if we're trying to evaluate the capital allocation decision across scenarios it's conceptually/economically a different story.

 

Edited November 5, 2024 by MMM20

[Santayana]

1 hour ago, dartmonkey said:

I think this is exactly right. Fairfax bought swaps on 1.964m shares, let's say 2m, at $344 a share, so they had $677m at risk,

Saying that full amount is at risk suggests the possibility of the stock going to $0. 

[dartmonkey]

35 minutes ago, TwoCitiesCapital said:

If I buy $500,000 home for 3% down, and it doubles in value next year to $1 million - is my ROIC 100% or is it 3300%? 

You can do it both ways.

 

Hell, how about just borrowing that 3% down payment from your parents, and now you have an infinite return, using the second method, right?

 

But in most circumstances, I think it makes more sense to use the first method, so the answer would be 100% (and 292% for the Fairfax's total return swaps.) 

[Viking]

Stelco – Rock Star Alan Kestenbaum / Reaping the Rewards of ‘New Fairfax’

 

With the closing of the sale of Stelco to Cleveland Cliffs in November 1, 2024, it is time to do a final long form post on this investment. Let's evaluate the performance of the management team at Fairfax. And see what else can we learn about Fairfax from this investment.

----------

On July 15, 2024, Stelco announced that the company had been sold to Cleveland-Cliffs for about C$70/share (consisting of C$60.00 in cash and 0.454 of a share of Cliffs common stock). Fairfax owned 13 million shares of Stelco. Total proceeds to Fairfax will be about US$639 million ($561 million in cash + $78 million in CLF shares). With the deal closing on November 1, 2024, Fairfax is expected to book an investment gain of $366 million (pre-tax) when it reports Q4, 2024 results.

 

How has Fairfax’s investment in Stelco performed? (All amounts are in US$)

 

I know… I know… Show me the money!

 

In November 2018, Fairfax paid $193 million for 14.7% of Stelco (13 million shares at C$20.50/share). When Fairfax announced their Stelco purchase I hated it. At the time, it screamed ‘old Fairfax’ to me. Boy was I wrong.

 

Fairfax’s return on its investment in Stelco has come from 3 sources:

• Gain on the increase in the value of Stelco shares …..…..……  $368 million
• Regular and special dividends paid by Stelco …………………….  $115 million
• Value of Cleveland Cliffs shares received as part of sale …….   $78 million

Over its 6-year holding period, Fairfax earned a total return of about US$568 million (+294%) on its $193 million investment in Stelco. The 6-year CAGR is 25.5%. That is an outstanding return. Bottom line, the team at Fairfax/Hamblin Watsa absolutely crushed their investment in Stelco.

 

 

What made Stelco such a good investment for Fairfax?

 

The CEO of Stelco, Alan Kestenbaum.

 

Since buying Stelco out of bankruptcy in 2017 (via Bedrock Industries) Kestenbaum's capital allocation decisions have been exceptional. Some examples:

• What did Stelco do with the earnings windfall from the historic bull market in steel in 2021 and 2022?
  • They bought back 38% of shares outstanding. And they did not overpay. That was freaking brilliant.
    • As a result of the significant buybacks Fairfax’s ownership in Stelco increased from 14.7% to 23.6% - with no new money invested.
  • A significant amount was paid out to shareholders over the past 6 years in dividends (regular and special dividends).
• Two other brilliant moves by Kestenbaum:
  • April 2020 - Minntac deal: at a cost of $100 million, Stelco got an 8-year supply agreement with US Steel with option to purchase 25% of Minntac (the largest iron ore mine in the US). Stelco struck this deal  when Covid was raging - other CEO’s were in capital preservation mode and Kestenbaum was thinking long term value creation. At Fairfax’s annual general meeting in April 2023, Kestenbaum re-told the story of the incredible support he received from Prem/Fairfax in 2020 that allowed him to pull the trigger on this deal.
  • June 2022: Stelco sold their real estate holdings in Hamilton (the Stelco Lands) for C$518 million. The timing of this sale was brilliant - at what might be close to the peak of Canada’s real estate bubble. And remember, Kestenbaum paid a total of about C$500 million for all of Stelco in 2017.
• And the final act? Selling the entire company for C$70.00 in July 2024.

Kestenbaum has been schooling the North American steel industry on capital allocation and building shareholder value for the past 7 years. In short, Kestenbaum has been a rock star - even Billy Idol would agree.

 

The incredible power of share buybacks (when done well)

 

Over a 2 year period Stelco reduced shares outstanding by 38%. What is interesting is Fairfax has also been very aggressive, reducing their shares outstanding by 20.1% over the past 6.75 years. As a result, Fairfax shareholders got a double benefit - and they saw their per share ownership interest in Stelco increase substantially over the past 6 years as a result of two large buybacks. Importantly, both Stelco and Fairfax bought back their shares at very low prices. The result is incredible value creation for long term shareholders of Fairfax.

 

 

How does Kestenbaum’s performance compare with Goncalves, CEO of Cleveland-Cliffs?

 

Many investors hold Lourenco Goncalves, CEO of Cleveland Cliffs, in high regard for his capital allocation skills. In November 2018, Cleveland Cliffs shares traded at about $10/share. Today CLF trades at about $13/share. Since 2018, CLF has paid dividends of $0.38/share. Over the past 6 years, a shareholder in CLF has earned a total CAGR of 5% per year.

 

Over the past 6 years, Kestenbaum has delivered to Stelco shareholders a CAGR of 25.5%. Kestenbaum’s strategic vision, execution, results and timing have been exceptional. Much better than Goncalves (and that is an understatement). As a result, over the past 6 years, shareholders of Stelco have done much, much better than shareholders of Cleveland-Cliffs.

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Reaping the rewards of the 'new Fairfax'

 

Stelco is a great example of what I like to call ‘new Fairfax.’ In about 2018, Fairfax (and the team at Hamblin Watsa) appeared to ‘tweak’ their value investing framework when it came to new equity purchases. As a result of these changes, Fairfax’s new equity purchases made since 2018 have performed very well.

 

One of the important changes Fairfax made to their value investing framework was putting a much higher premium on partnering with great CEO/founders/owners. Stelco/Kestenbaum is a wonderful example of the incredible value creation that the changes made by Fairfax 6 years ago are now delivering to Fairfax shareholders. Importantly, Fairfax, via their many investments, is now partnered with many outstanding CEO’s/leaders/founders and the quality (in terms of earnings power) and prospects of their $20 billion equity portfolio has never looked better.

 

Capital Allocation - Asset Sales

 

Asset sales are a very important and underappreciated part of Fairfax’s capital allocation framework. It is something that separates Fairfax from both Berkshire Hathaway and Markel.

 

Why sell an asset?

 

Because someone values it much more than you do - and they are willing to pay you far more than it is worth.

 

Selling Assets at Nosebleed High Prices

 

Cleveland Cliffs paid consideration of C$70/share (cash and CLF shares) that was an 87% premium to Stelco’s closing share price of C$37.36 on July 12, 2024, and a 37% premium to Stelco’s 52-week high. In selling the company, Stelco (and Fairfax) were being highly opportunistic - they were able to take advantage of the consolidation fever that has gripped the North American steel industry in recent years.

 

Fairfax did something similar twice in 2022:

• Insurance: Sold their pet insurance business for $1.3 billion, booking a surprising $1 billion gain after-tax. Pet assets were in a bubble (driven by a race to consolidate). At the time, no one even knew Fairfax had a pet insurance business.
• Non-insurance: Sold Resolute Forest Products at the top of the lumber cycle for a premium price of $626 million (plus $183 in million contingent value rights). At the same time, the sale resulted in the disposal of a chronically underperforming asset - which improved the overall quality of their remaining equity portfolio.

As these three recent examples demonstrate, selling assets (insurance and non-insurance) can create significant value for long term shareholders. And improve the quality of the company.

 

Fairfax detractors

 

But talk to Fairfax detractors… my guess is they still view Fairfax’s purchase of Stelco as a shitty investment. They explain it away with ‘Fairfax got lucky.’ After all, Stelco is a commodity producer! It cracks me up when I hear the detractors talk about Fairfax’s equity holdings. They usually have no idea what they are talking about. But boy, do they ever have a lot of conviction when they express their views.

 

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For those board members who are interested in going on a trip down memory lane, below are links to some of the important events in Stelco's life since Kestenbaum purchased the company out of bankruptcy in 2017. 

 

A short history of Fairfax’s investment in Stelco

 

In November of 2018, Fairfax invested US$193 million in Stelco, buying 13 million shares at C$20.50. At the time, it was a deeply contrarian purchase.

  

News release from Stelco announcing the company’s sale to Cleveland-Cliffs

 

Cleveland-Cliffs to Acquire Stelco for C$70 per Share - July 15, 2024

 

https://investors.stelco.com/news/news-details/2024/Cleveland-Cliffs-to-Acquire-Stelco-for-C70-per-Share/default.aspx

 

HAMILTON, Ontario--(BUSINESS WIRE)-- Stelco Holdings Inc. (TSX: STLC) (“Stelco” or the “Company”) is pleased to announce that it has entered into a definitive agreement (the “Arrangement Agreement”) with Cleveland-Cliffs Inc. (NYSE: CLF) (“Cliffs”), pursuant to which Cliffs has agreed to acquire all of the issued and outstanding common shares of Stelco (the “Transaction”) at a price of C$70.00 per share (the “Consideration”), consisting of C$60.00 in cash and 0.454 of a share of Cliffs common stock (equivalent to C$10.00 based on the closing price of Cliffs common stock on July 12, 2024) per Stelco share.

 

The total enterprise value pursuant to the Transaction is approximately C$3.4 billion. The Consideration represents an 87% premium to Stelco’s closing share price of C$37.36 on July 12, 2024, and a 37% premium to Stelco’s 52-week high.

 

Fairfax Financial Holdings, an affiliate of Lindsay Goldberg LLC, Alan Kestenbaum, and each of the other directors and executive officers of Stelco collectively holding approximately 45% of the current outstanding Stelco common shares have entered into support agreements to vote in favour of the Transaction, subject to customary exceptions.

 

Comments from Prem about Stelco from Fairfax's 2023AR and 2022AR. 

 

2023: "In a year of volatile steel prices, Stelco performed well, highlighting its competitive cost structure. Stelco’s talented team – led by Alan Kestenbaum, Sujit Sanyal, and Paul Scherzer – continues to be excellent stewards of the business with a keen focus on creating shareholder value. We believe that Stelco owns the best-in-class blast furnace assets in North America, which is highlighted by its industry leading margins. The company’s Lake Erie Works facility has had recent upgrades to its blast furnace, coke battery, a newly constructed co-generation facility and a new pig iron caster. Nippon recently announced an agreement to acquire US Steel at a multiple of 7.8x 2024 EBITDA, a significant premium to Stelco’s trading multiple. We believe the US Steel acquisition highlights the value of blast furnace operations. Stelco continues to have significant net cash on its balance sheet, providing management with flexibility to take advantage of both organic and inorganic growth opportunities. The company rewarded shareholders with a Cdn$3 per share special dividend in addition to its Cdn$1.68 per share regular dividend in 2023. Stelco has raised its regular dividend for 2024 to Cdn$2.00 per share. We believe Stelco has a bright future under Alan Kestenbaum’s leadership. Stelco is carried on our books at $22.44 per share versus a market price of $37.84 per share." Prem Watsa - Fairfax 2023AR

 

2022: “2022 was an active and successful year for Alan Kestenbaum and the talented team at Stelco. The company ended the year with its second-best fiscal result since going public despite an approximately 50% decline in steel prices over the summer. Stelco is benefiting from the Cdn$900 million it has invested in its Lake Erie Works mill since 2017, which has made the mill one of the lowest-cost operators in North America. Stelco entered 2022 with an extremely strong balance sheet and put its capital to good use, completing three substantial issuer bids during the year, thereby repurchasing approximately 29% of its outstanding shares. These repurchases have resulted in Fairfax’s ownership increasing to 24% from 17% at the beginning of the year. In addition to share repurchases, Stelco paid a Cdn$3 per share special dividend and increased its regular dividend to Cdn$1.68 per share from Cdn$1.20 per share. Stelco maintains over Cdn$700 million of net cash on its balance sheet and we anticipate that it will continue to be active both investing in its operations and efficiently returning excess capital to shareholders. We are excited to continue as a significant investor in Alan Kestenbaum’s leadership at Stelco.” Prem Watsa – Fairfax 2022AR

 

Details of Stelco’s Hamilton land sale in 2022, for proceeds of $518 million.

 

“Stelco Holdings Inc. (TSX: STLC) (“Stelco” or the “Company”) announced today that its wholly-owned subsidiary, Stelco Inc., has successfully closed a sale-leaseback transaction with an affiliate of Slate Asset Management (“Slate”). Stelco Inc. has sold the entirety of its interest in the approximately 800-acre parcel of land it occupies on the shores of Hamilton Harbour in Hamilton, Ontario to Slate for gross consideration of $518 million. In conjunction with the sale, Stelco Inc. has entered into a long-term lease arrangement for certain portions of the lands to continue its cokemaking and value-added steel finishing operations at its Hamilton Works site in Hamilton, Ontario.”

 

https://www.thespec.com/news/hamilton-region/all-of-stelco-s-hamilton-land-sold-in-deal-that-would-see-it-transformed-into/article_17a333af-8198-5f97-9866-8c61ed8f799f.html?

 

Details of Stelco’s agreement with US Steel in 2020 to securing long term supply for iron ore pellets.

 

Stelco Announces Option To Acquire 25% Interest In Minntac, The Largest Iron Ore Mine In The United States, And Entry Into Long-Term Extension Of Pellet Supply Agreement With U.S. Steel

 

“Stelco will pay US$100 million, in cash, to U.S. Steel in consideration for the Option (the "Initial Consideration"). The Initial Consideration is payable in five US$20 million installments, with the first installment paid upon closing of the Option Agreement and the remaining four installments payable every two months thereafter. Upon the exercise of the Option, Stelco would pay a net exercise price of US$500 million.”

 

Transaction Highlights:

• Secures long-term future of Stelco's steel production and solidifies Stelco's low-cost advantage
• Provides supply of high-quality iron ore pellets from a well-understood and consistent source for the next eight years, or longer if the Option is exercised
• Increases annual pellet supply to level required for Stelco's higher production capacity following this year's blast furnace upgrade project
• Supports Stelco's tactical flexibility model to deliver highest margin outcomes based on prevailing market conditions
• Creates a secure pathway for Stelco to become a vertically integrated player in the future through ownership in a low-cost iron ore source which is the largest producing iron ore mine in the Mesabi iron range
• Structured in stages that will preserve Stelco's strong balance sheet and financial flexibility

https://investors.stelco.com/news/news-details/2020/Stelco-Announces-Option-to-Acquire-25-Interest-in-Minntac-the-Largest-Iron-Ore-Mine-in-the-United-States-and-Entry-into-Long-Term-Extension-of-Pellet-Supply-Agreement-with-U.S.-Steel-04-20-2020/default.aspx

 

Here is a little more information of Kestenbaum’s initial investment in Stelco in 2017.

 

Purchase of Stelco out of bankruptcy: Bedrock gets steelmaker for less than $500 million

 

https://www.thespec.com/business/stelco-deal-bedrock-gets-steelmaker-for-less-than-500-million/article_da943b70-1a93-5a35-acb4-92a6da05946a.html?

 

Edited November 7, 2024 by Viking