Fairfax stock positions

[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 11 hours ago 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 4 hours ago 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 1 hour ago by TwoCitiesCapital