Fairfax stock positions

[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.

—————-

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.

 

===========

 

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

[TwoCitiesCapital]

9 minutes ago, Viking said:

 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.

 

I'm not sure this is a fair comparison - had Kestenbaum purchased CLF for an 87% premium, the tides would likely be different.

 

Ultimately, Kestenbaum set up Stelco to be sold and Goncalves is setting up CLF to consolidate the industry and be the long-term beneficiary of that activity. 

 

One is a shorter game. One is a longer game. Both are likely to result in great returns to shareholders (one already has).

 

There is more risk to CLF and it's execution, but also the optionality of greater reward IMO - especially if Goncalves continues to take advantage of weak macro conditions to be opportunistic capital allocation across debt purchases, share repurchases, and further industry consolidation. 

Edited November 7, 2024 by TwoCitiesCapital

[nwoodman]

Tidy set of results for Eurobank and importantly some partial resolution to the outstanding shares in Hellenic

 

Eurobank announces that it has entered into an agreement to acquire 12.848% in Hellenic Bank and 8.58% in Demetra Holdings

 

www.eurobankholdings.gr/-/media/holding/omilos/grafeio-tupou/etairikes-anakoinoseis/2024/3q2024/3q2024-results-presentation.pdf

[Hoodlum]

I wonder what the investment in Demetra Holding provides to Eurobank.  Do they get to account on their book somehow for the 21.3% shares that Demetra owns of Hellenic bank?   Also, am I understand correctly that they paid €4.58 per share for the other Hellenic shares.  That is quite the premium over the currently share price.   

 

It looks like they will now do a tender offer for whatever share ares remaining for I presume €4.58 per share.

 

Quote

In accordance with the provisions of the Takeover Bids Law of 2007 in Cyprus, Eurobank will proceed, following the completion of the Transaction, to a tender offer for all the outstanding shares of Hellenic Bank that it will not already hold at the time.

 

Edited November 9, 2024 by Hoodlum

[Hoodlum]

I found some further details regarding the Demetra Holding acquisition.  77% of Demetra Holding's net equity comes from their Hellenic bank holding.  So taking Eurobank's 8.58% stake in Demetra Holdings times the 77% Hellenic equity portion and then multiply by the 21.3% Demetra Holdings stake in Hellenic Equity.  That provides Eurobank a tiny 1.4% indirect stake in Hellenic Bank through Demetra Holding, but it does take them to just over 70% total ownership in Hellenic Bank.  Maybe that provides Eurobank with some additional reporting benefits.

 

https://www.fxleaders.com/news/2024/11/08/eurobank-posts-15-8-profit-growth-in-first-nine-months-boosted-by-net-interest-and-fee-income/

[gfp]

On 11/4/2024 at 2:48 PM, gfp said:

 

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)

 

Just to update on this - I heard back from Fairfax tonight and any gains on the total return swaps on Fairfax's own share are taxable in Canada and it is incorporated into the tax provision in the financials.

 

 

[Haryana]

On 11/5/2024 at 12:00 PM, dartmonkey said:

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.) 

 

Your return could be infinite if the cost of your OPM is zero. 

 

Fairfax underlying earning 5% can turn 15% on equity due to float leverage => 15% Not 5%. 

 

So, the return on Trs would be in thousands of percentages. 

[nwoodman]

Eurobank Q3 transcript and MS analyst note attached.  All very positive especially the likely move to 50% payout.  The mix of divs /buyback  to be finalised early next year.  Some good color on the expected synergies with Hellenic.  This has to be worth more than tangible book (€2.27)!

 

Summary

 

Macroeconomic Context and Bank Growth

• CEO Fokion Karavias opened by noting strong regional economic performance in Cyprus (3.3% GDP growth), Greece (2.3%), and Bulgaria (2.1%). He remarked on Greece’s fiscal discipline, tourism’s boost to the economy, and an uptick in investment contributing to credit growth of 6.6% in 2024.

• Eurobank’s loan growth almost reached its annual target of €2.1 billion, with potential to hit €3.5 billion by year-end, driven by organic growth and the Hellenic Bank acquisition.

 

Hellenic Bank Acquisition and Synergies

• The acquisition of Hellenic Bank has expanded Eurobank’s assets, and the bank plans to leverage synergies amounting to €120 million, expected over three years (2025-2027), with a third realized in 2025.

• “The envelope of synergies of €120 million… will be fully deployed over a period of roughly three years.” - Fokion Karavias

 

Financial Performance

• Eurobank achieved €1.14 billion in net profit, with a return on tangible book value (RoTE) of 19% for the nine-month period.

• Karavias stated, “We may consider increasing the payout ratio from 40% previously up to 50% payable in 2025 of the 2024 profits,” with potential for both dividends and buybacks.

 

Strategic Plans and Challenges

• CFO Kokologiannis explained their approach to managing Deferred Tax Credits (DTC) by accelerating amortization, which would reduce DTC by 2033.

• They announced the intention to merge Eurobank Holdings and Eurobank S.A. to reduce administrative costs, a decision unrelated to DTC discussions with regulators.

 

Future Outlook and Loan Growth

• Karavias emphasized that, despite a projected slowdown in transactions in 2025, the bank expects solid loan demand due to a lower interest rate environment and ongoing Recovery and Resilience Facility (RRF) project disbursements, forecasting 7% growth in 2025.

 

Key Quotes

 

1. Macroeconomic Growth: “The positive economic sentiment is supported by a number of factors, including tourism, which had another strong year… and residential real estate prices remaining strong at 9.2% year-on-year growth.” - Fokion Karavias

2. Hellenic Bank Synergies: “We see an envelope of synergies of about €120 million… we should be able to realize at least one-third of this envelope [in 2025].” - Fokion Karavias

3. Dividend and Buyback Strategy: “We may consider increasing the payout ratio from 40% previously up to 50% payable in 2025 of the 2024 profits.” - Fokion Karavias

4. Deferred Tax Credits: “As of 2025, we will accelerate prudential amortization… DTC amortization is expected to accelerate materially and be eliminated circa eight years earlier than the current trajectory.” - Harris Kokologiannis

5. 2025 Loan Growth: “In 2024, we may achieve a credit growth of around 9%… in 2025, let’s say in the area of 7%, which is still a very solid number.” - Fokion Karavias

 

Demetra Specifically

 

1. Current Stake in Demetra: Eurobank recently acquired an 8.5% stake in Demetra, a holding company whose assets are predominantly in Hellenic Bank shares. This acquisition was part of a package deal with the Union of Bank Employees in Cyprus.

“Eurobank acquired the 8.5% of Demetra, that was a package deal with the Union of Bank employees in Cyprus.” - Fokion Karavias

 

2. Indirect Ownership in Hellenic Bank: This stake in Demetra gives Eurobank an additional indirect economic interest in Hellenic Bank. When calculated, it roughly adds 2% to Eurobank’s ownership in Hellenic Bank, supplementing its direct ownership, which will soon total 69% (56% current stake plus 13% additional shares subject to regulatory approval).

“The ticket for Demetra was around €32 million consideration… almost 2% on top of the 69% that we own directly.” - Fokion Karavias

 

3. Consideration for Further Stake: While Eurobank has not committed to further increasing its holdings in Demetra, the company noted that Demetra is an illiquid stock on the Cyprus Stock Exchange, which poses challenges for acquiring a significant additional stake in the open market.

“Whether we increase further our stake to Demetra or not, this is something that has not been considered yet. Take into account that Demetra is a very illiquid stock in the Cyprus Stock Exchange and through the market someone cannot really buy any material amount.” - Fokion Karavias

 

4. Strategic Value: Eurobank considers Demetra to act as a derivative of Hellenic Bank shares due to its significant holdings in Hellenic, thus enhancing Eurobank’s overall economic interest and control in Hellenic Bank.

“Demetra could be viewed as a derivative of Hellenic Bank shares.” - Fokion Karavias

EUROBANK_20241107_1846.pdf Eurobank Ergasias Services and Holdings S.A. (EGFEY) Q3 2024 Earnings….pdf

Edited November 10, 2024 by nwoodman