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[WhoIsWarren]

Regarding Toys R Us Paul Rivett said: "we got a business that was making over 10 years $100m of EBITDA year after year....the company continues to generate EBITDA...."  Unless I missed a clarification somewhere else, I took that to mean $100m was a 10 year average.  Isn't it likely that more recent years have been tougher?  $100m might not be a good benchmark for the future at all.  I am also very wary of the idea that they got valuable real estate with a toy business thrown in for free - if the liabilities from one can transfer over to the other, then it's just wrong to talk about them as two parts.  They know this too and when they make such statements I feel violated.

 

I'm also interested in what you guys think about the last question on the earnings call, which was about the level of equity securities on the balance sheet and whether a mark-to-market of their securities in a -50% stock market environment could wipe out 50% of Fairfax's equity capital.  He was giving rough numbers here of course, but it's a point worthy of serious consideration.  Not just a question for Fairfax mind you, but compare and contrast with Berkshire (a lot of wholly-owned businesses).

 

Paul's answer was pathetic -- this is "a stock picker's market", "we've got value stocks", we are "conservatively positioned", "we think there is....a potential for a trade deal that will extend the runway in the US..." -- but I will give him the benefit of the doubt for being caught on the hop.  Even if they are right that their equity investments are cheap long-term, mark-to-market can have real business implications in the short term.  Perhaps a hedge or, more simply, perhaps less equities is the answer?

 

A separate but related point is why insurance companies are run with debt.  I think there's enough risk in the business without it.  Bundled up in there is a question about how much insurance underwriting risk is being taken on, how much risk has been laid off to reinsurers etc., so it's a complicated topic.  It's not a free lunch though and I would personally prefer less than more.  Perhaps this topic has been discussed somewhere else, if so apologies.

 

[StubbleJumper]

Regarding Toys R Us Paul Rivett said: "we got a business that was making over 10 years $100m of EBITDA year after year....the company continues to generate EBITDA...."  Unless I missed a clarification somewhere else, I took that to mean $100m was a 10 year average.  Isn't it likely that more recent years have been tougher?  $100m might not be a good benchmark for the future at all.  I am also very wary of the idea that they got valuable real estate with a toy business thrown in for free - if the liabilities from one can transfer over to the other, then it's just wrong to talk about them as two parts.  They know this too and when they make such statements I feel violated.

 

I'm also interested in what you guys think about the last question on the earnings call, which was about the level of equity securities on the balance sheet and whether a mark-to-market of their securities in a -50% stock market environment could wipe out 50% of Fairfax's equity capital.  He was giving rough numbers here of course, but it's a point worthy of serious consideration.  Not just a question for Fairfax mind you, but compare and contrast with Berkshire (a lot of wholly-owned businesses).

 

Paul's answer was pathetic -- this is "a stock picker's market", "we've got value stocks", we are "conservatively positioned", "we think there is....a potential for a trade deal that will extend the runway in the US..." -- but I will give him the benefit of the doubt for being caught on the hop.  Even if they are right that their equity investments are cheap long-term, mark-to-market can have real business implications in the short term.  Perhaps a hedge or, more simply, perhaps less equities is the answer?

 

A separate but related point is why insurance companies are run with debt.  I think there's enough risk in the business without it.  Bundled up in there is a question about how much insurance underwriting risk is being taken on, how much risk has been laid off to reinsurers etc., so it's a complicated topic.  It's not a free lunch though and I would personally prefer less than more.  Perhaps this topic has been discussed somewhere else, if so apologies.

 

 

Paul's answer was definitely poor, and it effectively argued that cheap stocks can't get cheaper.  Blackberry is currently cheap, but in a market drawdown, it's impossible that the investment community will hate Blackberry even more than they hate it today!  It was not a great response, but he might have been a bit of a deer in the headlights on the subject of potential equity hedging.  ;D

 

The better answer would be, who cares?  If equity is cut in half temporarily, it's cut in half temporarily.  As long as the regulators don't get their panties in a twist and as long as it doesn't violate some obscure bond covenant, everything is fine.  And, when you look at their premiums to surplus ratio, there's lots of room to haircut capital without constraining underwriting.  I don't doubt that a 50% haircut would cause a fair bit of dancing at FFH to move capital around the subs, they might need to make a few decisions about not renewing some business, and they'd probably need to issue a couple million more shares -- but it's probably not an existential question.

 

 

SJ

[sdev]

While I won't argue that the business will not grow / contract in the future, because it likely will - what is concerning is the equity investment strategy over the past 10 years has been a disaster, select large portfolio holdings are homerun swings without a clear strategy, and the forward equity strategy is a mixed bag of investments without any clear investor advantage other than, it's cheap.

 

The age old strategy is to be the best at your part of the world. I personally am guilty (perhaps very guilty) of thinking that my investable universe is larger than it should be. In my opinion Fairfax could do with an overhaul (read: narrowing) of how they deploy equity capital - as it's possible to buy "cheap" assets in any market, in any vertical - with patience and best in class platform / skills for the niche.

 

As my underwriting box thankfully narrows over time - Fairfax falls outside my criteria, and I'll be peeling off my 10+ year holdings over time, with remorse.

[WhoIsWarren]

 

The better answer would be, who cares?  If equity is cut in half temporarily, it's cut in half temporarily.  As long as the regulators don't get their panties in a twist and as long as it doesn't violate some obscure bond covenant, everything is fine.  And, when you look at their premiums to surplus ratio, there's lots of room to haircut capital without constraining underwriting.  I don't doubt that a 50% haircut would cause a fair bit of dancing at FFH to move capital around the subs, they might need to make a few decisions about not renewing some business, and they'd probably need to issue a couple million more shares -- but it's probably not an existential question.

 

 

SJ

 

Maybe you're right that it's not a big deal, but it's not a theoretical risk.  If the capital situation got bad enough they might have to raise capital (or at least have the threat of it hanging over them).  They could cut back on underwriting / increasing inwards reinsurance, but it might be precisely when insurance pricing is really attractive.  Mark-to-market can have a detrimental effect.  If I'm not mistaken, a whole host of insurers (Europeans?) got into trouble in the early 2000s as a result of having too much equity exposure.

 

I just hope management has run the scenarios and carefully considered the possible consequences.

[StubbleJumper]

 

The better answer would be, who cares?  If equity is cut in half temporarily, it's cut in half temporarily.  As long as the regulators don't get their panties in a twist and as long as it doesn't violate some obscure bond covenant, everything is fine.  And, when you look at their premiums to surplus ratio, there's lots of room to haircut capital without constraining underwriting.  I don't doubt that a 50% haircut would cause a fair bit of dancing at FFH to move capital around the subs, they might need to make a few decisions about not renewing some business, and they'd probably need to issue a couple million more shares -- but it's probably not an existential question.

 

 

SJ

 

Maybe you're right that it's not a big deal, but it's not a theoretical risk.  If the capital situation got bad enough they might have to raise capital (or at least have the threat of it hanging over them).  They could cut back on underwriting / increasing inwards reinsurance, but it might be precisely when insurance pricing is really attractive.  Mark-to-market can have a detrimental effect.  If I'm not mistaken, a whole host of insurers (Europeans?) got into trouble in the early 2000s as a result of having too much equity exposure.

 

I just hope management has run the scenarios and carefully considered the possible consequences.

 

 

No, don't get me wrong.  Seeing half of FFH's equity disappear temporarily would cause most of us to have a shit-fit.  But, the question on the conference call seemed to be driving at the notion that it was an existential issue, and I do not believe that to be the case.  It would certainly be bad, it would almost certainly result in an equity issuance that disadvantages existing shareholders, and it would certainly come at the cost of future growth. But, the countervailing factor is that FFH would probably make a pile of money on the investment side in those circumstances.

 

 

SJ

[WhoIsWarren]

....the countervailing factor is that FFH would probably make a pile of money on the investment side in those circumstances.

 

SJ

 

I hope you're right there.  I know they haven't become stupid of a sudden, but my confidence in their investment decision-making is wavering.  Oh, me of little faith!!  :o

 

Thanks for your comments.

[Santayana]

After all the grief they got over the hedges, I'm sure the last thing they expected to hear on the call was somebody complaining that they weren't hedged enough!

[petec]

Eurobank up by about a third year to date.