Fairfax 2020

[Xerxes]

With all due respect, i think the Blackberry purchase was a disaster. After Fairfax’s first purchase they had 6 months to learn how challenged the business was amd how poorly managed it was; it was pretty obvious (all you had to do was listen to the quarterly calls to understand the management team was not up to the challenge.).

 

PS: i actually bought RIM shares back when Fairfax initiated their position. It took me 3 conference calls to figure out the RIM management team was in way over their head (the company was no longer a start up and the industry was morphing fast with strong competitors). I took a small hit when i sold my position. But investing in RIM became one of my best investment decisions ever because it taught me about the cell phone industry. 18 months later Apple got wickedly cheap (the narrative then was Samsung was going to take over the world) and i was able to take my learnings from my time in Blackberry and buy a truckload of Apple over a 4 month period (the stock just kept going lower), which ended up being by largest gain ever :-) Learn...

 

Looks like I have a short memory.

I forgot BB was a phone company competing with Apple at the time when FFH got in. LOL.

I was thinking cybersecurity and its IP portfolio.

 

On the positive side, if I forgot about that, that means the 100 year turn around is turning around just fine.

[Cigarbutt]

...I hadn't seen the article from Insurance Journal, so that is interesting in particular.  A couple of the more elaborate industry level loss estimates gives a bound for Zenith.  It looks like perhaps 16 loss points, before reinsurance and government funding, might be the reasonable estimate, with a bound of perhaps 50 loss points.  So, for an outfit like Zenith that writes $750m of premium, that would be maybe ~$120m before reinsurance and government funding, but possibly as much as $375m .  As you said, it's probably not an existential question, but it's curious that no provision was taken in the first quarter.

SJ

Relevant follow-up about potential costs (workers comp in California) which is important for Zenith. The ongoing development (not in the sense of recognized reserve development but in the sense of the social inflation threat) is definitely positive. Absent future adverse legislation, costs appear more and more manageable. Even if there is unusual flexibility to submit claims, Zenith will have to opportunity to rebut the claims and influence case law. It appears that Zenith will be able to report reasonable estimates in the coming quarters.

https://www.wcirb.com/sites/default/files/documents/rb-covid19-cost_impact_of_governor_executive_order_0.pdf

...

The document was a nice walk through on how the costs can rapidly accumulate.  So in California, they are estimating a mid-point of 7 loss points and a bound of 10 or 11 points, and that's before any government programming or reinsurance.  If that applied across the US, that would be no problem at all for Zenith.

Beyond that, on a personal level, I am surprised at how small the indemnity is for a health care worker fatality.  Only $400k each and that includes medical costs as well as 5 or 10 years of economic support to surviving spouses and children?  The bulk of the workers dying must be personal support workers who don't earn so much?  I think I trotted out an assumption of about 5X as large, but admittedly, I just pulled that out of my ass because I know so little about WC.

SJ

Perhaps the saturation point has been reached for this topic but the California workers comp Bureau just came out with an interesting report:

https://www.wcirb.com/sites/default/files/documents/rb-impact_of_economic_downturn-audienceready_0.pdf

TL;DR version: with the economy slowing, on a net basis (more 'cumulative' injuries more than compensated by lower 'traumatic' injuries), there will be less claims per hours worked, if history is any guide. The challenge may mean much lower written premiums but Zenith has been there before and they could always send excess capital upstream until they can grow their book of business again.

 

[petec]

...I hadn't seen the article from Insurance Journal, so that is interesting in particular.  A couple of the more elaborate industry level loss estimates gives a bound for Zenith.  It looks like perhaps 16 loss points, before reinsurance and government funding, might be the reasonable estimate, with a bound of perhaps 50 loss points.  So, for an outfit like Zenith that writes $750m of premium, that would be maybe ~$120m before reinsurance and government funding, but possibly as much as $375m .  As you said, it's probably not an existential question, but it's curious that no provision was taken in the first quarter.

SJ

Relevant follow-up about potential costs (workers comp in California) which is important for Zenith. The ongoing development (not in the sense of recognized reserve development but in the sense of the social inflation threat) is definitely positive. Absent future adverse legislation, costs appear more and more manageable. Even if there is unusual flexibility to submit claims, Zenith will have to opportunity to rebut the claims and influence case law. It appears that Zenith will be able to report reasonable estimates in the coming quarters.

https://www.wcirb.com/sites/default/files/documents/rb-covid19-cost_impact_of_governor_executive_order_0.pdf

...

The document was a nice walk through on how the costs can rapidly accumulate.  So in California, they are estimating a mid-point of 7 loss points and a bound of 10 or 11 points, and that's before any government programming or reinsurance.  If that applied across the US, that would be no problem at all for Zenith.

Beyond that, on a personal level, I am surprised at how small the indemnity is for a health care worker fatality.  Only $400k each and that includes medical costs as well as 5 or 10 years of economic support to surviving spouses and children?  The bulk of the workers dying must be personal support workers who don't earn so much?  I think I trotted out an assumption of about 5X as large, but admittedly, I just pulled that out of my ass because I know so little about WC.

SJ

Perhaps the saturation point has been reached for this topic but the California workers comp Bureau just came out with an interesting report:

https://www.wcirb.com/sites/default/files/documents/rb-impact_of_economic_downturn-audienceready_0.pdf

TL;DR version: with the economy slowing, on a net basis (more 'cumulative' injuries more than compensated by lower 'traumatic' injuries), there will be less claims per hours worked, if history is any guide. The challenge may mean much lower written premiums but Zenith has been there before and they could always send excess capital upstream until they can grow their book of business again.

 

Thanks!

[OliverSung]

Hi everyone,

 

Jumping in here with my first post on this forum. Incredibly excited to have joined.

 

I'm the author behind the Fairfax analysis at Junto Investments that Bryggen referred to earlier in this thread.

 

As for Fairfax, I'm all for thinking about the long game and bigger picture. It's pretty much only at times of uncertainty one is able to buy stuff below intrinsic value.

 

I think dwelling on individual investments tells us that the market cares more about the short-term stuff. I find very little reason to believe that management will not be able to live up to the baseline scenario that the current price reflects. Even after the last few weeks' share price gains.

 

Why wouldn't Hamblin Watsa learn from past investment blunders and look forward? Torstar is an exemplification of that. And why wouldn't there be great opportunity for Fairfax to compound invested capital well over the cost of capital going forward from here now that insurance operations are doing so well? The current price-to-book makes very little sense in this regard.

 

The level of uncertainty doesn't match the level of risk.

 

Cheers.

[StubbleJumper]

Hi everyone,

 

Jumping in here with my first post on this forum. Incredibly excited to have joined.

 

I'm the author behind the Fairfax analysis at Junto Investments that Bryggen referred to earlier in this thread.

 

As for Fairfax, I'm all for thinking about the long game and bigger picture. It's pretty much only at times of uncertainty one is able to buy stuff below intrinsic value.

 

I think dwelling on individual investments tells us that the market cares more about the short-term stuff. I find very little reason to believe that management will not be able to live up to the baseline scenario that the current price reflects. Even after the last few weeks' share price gains.

 

Why wouldn't Hamblin Watsa learn from past investment blunders and look forward? Torstar is an exemplification of that. And why wouldn't there be great opportunity for Fairfax to compound invested capital well over the cost of capital going forward from here now that insurance operations are doing so well? The current price-to-book makes very little sense in this regard.

 

The level of uncertainty doesn't match the level of risk.

 

Cheers.

 

 

Welcome to the discussion.  Share everything that you want to share, and ask any question that you want to ask.  The most insightful threads are triggered by questions, comments and nuggets of information.

 

FFH has been obviously cheap for the past month.  The company has done an admirable job to ensure its holdco liquidity for the next 18 or so months, it has improved its underwriting, and it is in a more favourable investment environment for corporate bonds and equities.  Meanwhile the stock price tanked to ~US$250.  As TwoCities and others have pointed out, at that price it doesn't require much of an investment return to get a earnings-yield of 15% (ie, only US$37.50 EPS).  Despite the warts, FFH for the past month has been a compelling opportunity for people who have room in their asset allocation for more...

 

 

SJ

[Xerxes]

Depends when you want to start the clock I guess.

 

Just like it is not Prem's fault that covid-19 bended the market, the bounce back from here is not Prem's gain ... unless he TAKES advantage of it.

Beefing up core liquidity is not taking advantage. That is just being a good swimmer in a storm. That is as far as giving credit goes.

 

He is going to say it in Q2 results, "see guys I told you it will bounce back"; hell, Blackberry shares shooting up from oblivion should provided enough mark to market juice to help things out. As long as market doesn't think FFH will eat Blackberry whole, then down it goes. 

 

To have a 15% on book value over the long term, he needs to have a massive lumpy return on the upside to undo the Lost Decade.

Or we could just take the clock based on the year the company was founded, to let the earlier years great gains average up the total compounded long term rate of return.

 

I am ok with 5-10 return on book value per annum.

What I like is the optionality.

 

[StubbleJumper]

Depends when you want to start the clock I guess.

 

Just like it is not Prem's fault that covid-19 bended the market, the bounce back from here is not Prem's gain ... unless he TAKES advantage of it.

Beefing up core liquidity is not taking advantage. That is just being a good swimmer in a storm. That is as far as giving credit goes.

 

He is going to say it in Q2 results, "see guys I told you it will bounce back"; hell, Blackberry shares shooting up from oblivion should provided enough mark to market juice to help things out. As long as market doesn't think FFH will eat Blackberry whole, then down it goes. 

 

To have a 15% on book value over the long term, he needs to have a massive lumpy return on the upside to undo the Lost Decade.

Or we could just take the clock based on the year the company was founded, to let the earlier years great gains average up the total compounded long term rate of return.

 

I am ok with 5-10 return on book value per annum.

What I like is the optionality.

 

 

That's precisely it.  It absolutely depends on when you start the clock.  People who are anchored in a US$500 stock price from two years ago look at FFH and wonder when they will see US$75/sh of EPS which would give an earnings yield of 15%.  But, the decision to buy at $500 (or fail to sell at $500) was already made, so the $500 number and the $75 number are completely irrelevant.  The most relevant thing today is the current stock price and FFH's prospective earnings...and US$250 was pretty cheap.  Even today at US$316, it would likely work out well over a 5 year horizon.

 

I would like to also take the opportunity to make a couple of comments about the management of the past few months.  I am first person to bitch and moan about poor management decisions, and I am possibly amongst Prem's loudest critics.  But, so far in 2020, FFH management has pretty much done exactly what was needed:

 

-they proactively pre-released the direction and general magnitude of Q1 earnings

-they managed to float a debt issuance in a situation where credit markets were spooked and an equity issuance would have been highly dilutive

-they fully drew the revolver to proactively prevent the banker from screwing FFH by finding a reason to pull it

-they exploited widening credit spreads to bolster interest/dividend income

-they have continued to grow their book at seemingly profitable prices

-they have communicated their understanding of the pandemic impact on both underwriting and claims (they might ultimately be incorrect in their assessment, but at least they have been clear)

-so far there has been no sign of pulling from the "too hard pile," which is exactly what you want to see when securities valuations broadly declined.

 

 

Despite the many and varied mistakes that FFH management has made over the years (I have spilled much ink moaning about many of them), there is not really much that I can bitch about over the past 3 months.

 

 

SJ

 

 

[petec]

 

-so far there has been no sign of pulling from the "too hard pile," which is exactly what you want to see when securities valuations broadly declined.

 

 

Must you tempt fate?

 

::)

[StubbleJumper]

He is going to say it in Q2 results, "see guys I told you it will bounce back"; hell, Blackberry shares shooting up from oblivion should provided enough mark to market juice to help things out. As long as market doesn't think FFH will eat Blackberry whole, then down it goes.

 

 

With the market going nuts this morning, I was thinking a bit about Xerxes' comment about FFH's Q2 mark.  Taking a quick gander at some of the major holdings (Recipe, BB, K-W, Resolute, Eurobank, Stelco, etc), almost all of them are showing considerable improvement over March 31.  There's still three weeks to go before June 30, and heaven knows what kind of gyrations we'll see between now and then, but has anyone taken the time to actually estimate the mark for Q2 to date?  Is it a 10-digit number, or just in the high 9-digits?

 

 

SJ

[Xerxes]

SJ, I think of the names that are marked to market, there is only BB and K-W of consequence + Stelco. The first two are up about 32-33% from March 31 to date. Stelco is up 75% in CAD terms.

 

BB and K-W have a combined unrealized gain of USD $118 million.

Add to Stelco's ~$55 USD gain, it comes to $173 million unrealized gain.

Divided by 26.8 million outstanding shares that is very small number.

 

Blackberry Ltd

46,724,700 FFH ownership

 

Kennedy-Wilson Holdings Inc.

13,322,009 FFH ownership

 

Stelco

12,200,000 FFH ownership

 

The rest of the ones you named are equity accounted, but perhaps that there is a pickup in their earning vis a vis Q1.

 

[Xerxes]

This is from Q1 report:

 

"Portfolio investments comprise investments carried at fair value and equity accounted investments, the aggregate carrying value of which was $37,867.5 ($37,435.3 net of subsidiary short sale and derivative obligations) at March 31, 2020 compared to $38,235.0 ($38,029.4 net of subsidiary short sale and derivative obligations) at December 31, 2019. The decrease of $594.1 principally reflected net unrealized losses on common stocks, total return swaps, equity warrants and U.S. treasury bond forward contracts, in addition to the specific factors which caused movements in portfolio investments as discussed in the paragraphs that follow.

 

Subsidiary cash and short term investments (including cash and short term investments pledged for short sale and derivative obligations) decreased by $630.2, primarily reflecting proceeds from sales and maturities of short-dated U.S. treasury bonds principally reinvested into U.S. corporate bonds, partially offset by the reinvestment of U.S. treasury bond proceeds into corporate and other short term investments.

 

Bonds (including bonds pledged for short sale and derivative obligations) decreased by $808.2 primarily reflecting sales and maturities of short-dated U.S. treasury bonds, partially offset by the reinvestment of proceeds into U.S. corporate bonds.

Common stocks decreased by $772.8 primarily reflecting net unrealized losses as a result of the global economic and social disruption caused by the COVID-19 pandemic."

 

I am not sure what companies are included in the $772 figure for common stock decrease. But it cannot include Resolute/Atlas/Recipe. Of that $772 figure, I calculate $380 million due to BB, K-W and Stelco losing value from Dec 31 to March 31.

 

Now, $173 million of that $772 is reversed by the bounce back on BB, K-W and Stelco from March 31 to date. Not including BB converts as I am not sure how those are accounted quarter to quarter.

[StubbleJumper]

SJ, I think of the names that are marked to market, there is only BB and K-W of consequence + Stelco. The first two are up about 32-33% from March 31 to date. Stelco is up 75% in CAD terms.

 

BB and K-W have a combined unrealized gain of USD $118 million.

Add to Stelco's ~$55 USD gain, it comes to $173 million unrealized gain.

Divided by 26.8 million outstanding shares that is very small number.

 

Blackberry Ltd

46,724,700 FFH ownership

 

Kennedy-Wilson Holdings Inc.

13,322,009 FFH ownership

 

Stelco

12,200,000 FFH ownership

 

The rest of the ones you named are equity accounted, but perhaps that there is a pickup in their earning vis a vis Q1.

 

 

Good point on the equity accounting.  I don't generally spend much time thinking about mark-to-market gains, but that doesn't excuse my being brain-dead and asking about companies that are consolidated or equity accounted!  So, it looks like maybe a couple hundred million from the major equity holdings, plus likely a considerable chunk from the total return swaps and possibly something considerable for the miscellaneous equities....so it's likely low-to-mid 9-digits.  Quarterly financial reporting is going to look bizarre for a great many companies!

 

Thanks for setting me straight,

 

SJ

[petec]

On this topic, it seems to me that Fairfax may have been deliberately reconstructing their equity portfolio to reduce M2M volatility. Does anyone else have this sense?

[Thrifty3000]

On this topic, it seems to me that Fairfax may have been deliberately reconstructing their equity portfolio to reduce M2M volatility. Does anyone else have this sense?

 

I 100% get that sense. Their marks to model in India are super aggressive. And, they’re trying to go the same route with Africa. But, you just have to look at the compensation system to see the benefits to them, and why their judgment probably gets clouded. Of course, now they’re in the same boat as Biglari, where it could be years before their next performance fee payout.

[Thrifty3000]

They were carrying Quess at something like 70 times trailing look through earnings, until they impaired it last quarter to a humble 50 times. I think Bangalore is carried at around 100 times look through earnings. Geez. But, they excused these sky high marks because arms length transactions were done with suckers willing to pay those prices.

 

(I have no doubt Bangalore will eventually be worth it’s carrying value, as more capacity is added and real estate is developed. But, Fairfax was able to fast track years of performance fees thanks to the high marks.)

[petec]

On this topic, it seems to me that Fairfax may have been deliberately reconstructing their equity portfolio to reduce M2M volatility. Does anyone else have this sense?

 

I 100% get that sense. Their marks to model in India are super aggressive. And, they’re trying to go the same route with Africa. But, you just have to look at the compensation system to see the benefits to them, and why their judgment probably gets clouded. Of course, now they’re in the same boat as Biglari, where it could be years before their next performance fee payout.

 

It's not the scale/aggressiveness of the marks. It's the accounting structure. More and more of the equities seem to be consolidated or equity accounted, so that stock market moves don't affect BV. I can't decide whether I think this is a great way of enabling them to focus on the long term or a naughty way of disguising losses.

[Thrifty3000]

I think it mostly provides stability and allows better long term focus. Berkshire enjoys the same benefits. I’m sure, for example, it was nice not having to mark BNSF down to fair market value on March 31.

[petec]

I think it mostly provides stability and allows better long term focus. Berkshire enjoys the same benefits. I’m sure, for example, it was nice not having to mark BNSF down to fair market value on March 31.

 

Sure. But they own BNSF, and control its cash flows, and there isn't a market price.

 

Not so Eurobank and Seaspan.

[Xerxes]

Pete

FFH is definitely using the full extent of accounting when it suits them, but two things:

 

- I really doubt that they are going to overinvest hundreds of  millions so that is passes the threshold above 20% ownership to be equity accounted

 

- equity accounting also has a huge impact on book value. Ex When impairment was done on recipe and resolute that also pass through income statement hitting book value. Worse it doesn’t bounce back quarter to quarter. My view is that Equity method is a better way to account for large strategic holdings that are below 50%. 

 

On BRK side, there is no shortages of interviews where Buffet actually tells people to ignore mark to market accounting.

[petec]

Pete

FFH is definitely using the full extent of accounting when it suits them, but two things:

 

- I really doubt that they are going to overinvest hundreds of  millions so that is passes the threshold above 20% ownership to be equity accounted

 

- equity accounting also has a huge impact on book value. Ex When impairment was done on recipe and resolute that also pass through income statement hitting book value. Worse it doesn’t bounce back quarter to quarter. My view is that Equity method is a better way to account for large strategic holdings that are below 50%. 

 

On BRK side, there is no shortages of interviews where Buffet actually tells people to ignore mark to market accounting.

 

Yes - I am not saying M2M is particularly worthwhile. My main concern is whether FFH are being a little manipulative, seeming to find ways to lock in relatively high equity accounting values and then being slow to impair. I don't really have an issue with it frankly because no accounting system is perfect but it's something to be aware of.

[StubbleJumper]

Pete

FFH is definitely using the full extent of accounting when it suits them, but two things:

 

- I really doubt that they are going to overinvest hundreds of  millions so that is passes the threshold above 20% ownership to be equity accounted

 

- equity accounting also has a huge impact on book value. Ex When impairment was done on recipe and resolute that also pass through income statement hitting book value. Worse it doesn’t bounce back quarter to quarter. My view is that Equity method is a better way to account for large strategic holdings that are below 50%. 

 

On BRK side, there is no shortages of interviews where Buffet actually tells people to ignore mark to market accounting.

 

Yes - I am not saying M2M is particularly worthwhile. My main concern is whether FFH are being a little manipulative, seeming to find ways to lock in relatively high equity accounting values and then being slow to impair. I don't really have an issue with it frankly because no accounting system is perfect but it's something to be aware of.

 

 

Hard to know whether they are being manipulative, but it does argue for squinting a bit when looking at the EPS number (there was BV growth of 14.8% in 2019, right?!).  Usually EPS is one of the metrics used to measure how well a company has performed in a particular year, but the paper gains triggered by periodic marks, or the failure to write down assets that are not marked can conceal true economic performance for the year.  Usually when FFH triggers paper gains, they are the result of good decisions made 4 or 5 years ago -- these decisions are still to the credit of management, but they are not really indicative of performance in the current year.

 

Maybe Ben Graham was a pretty smart guy when he advocated the use of a E10?

 

 

SJ

[Xerxes]

For BRK, there are three different valuations:  book value, intrinsic value (a range) and market value. The first one has been dropped as a yardstick.

 

For FFH, there are only two different valuations they look at : book value and market value.

On annual letters, if I recall, Prem W. equals book value with intrinsic value.

 

It is safe to say that BRK looks more at economic reality as oppose to FFH that sees accounting  book value as a significant yardstick in representing economic reality.

[Xerxes]

I think it mostly provides stability and allows better long term focus. Berkshire enjoys the same benefits. I’m sure, for example, it was nice not having to mark BNSF down to fair market value on March 31.

 

I may be wrong, but I think the value of BNSF and mid-American energy are their historical purchase cost without any upward adjustment to account for all the value created since their purchase.. So an adjustment would be a boost to BRK book value.

 

I think your comment assumes BNSF was being carried out fair market value, in which case a mark to market drop would bring it down.

[Thrifty3000]

Pete

FFH is definitely using the full extent of accounting when it suits them, but two things:

 

- I really doubt that they are going to overinvest hundreds of  millions so that is passes the threshold above 20% ownership to be equity accounted

 

- equity accounting also has a huge impact on book value. Ex When impairment was done on recipe and resolute that also pass through income statement hitting book value. Worse it doesn’t bounce back quarter to quarter. My view is that Equity method is a better way to account for large strategic holdings that are below 50%. 

 

On BRK side, there is no shortages of interviews where Buffet actually tells people to ignore mark to market accounting.

 

Yes - I am not saying M2M is particularly worthwhile. My main concern is whether FFH are being a little manipulative, seeming to find ways to lock in relatively high equity accounting values and then being slow to impair. I don't really have an issue with it frankly because no accounting system is perfect but it's something to be aware of.

 

 

Hard to know whether they are being manipulative, but it does argue for squinting a bit when looking at the EPS number (there was BV growth of 14.8% in 2019, right?!).  Usually EPS is one of the metrics used to measure how well a company has performed in a particular year, but the paper gains triggered by periodic marks, or the failure to write down assets that are not marked can conceal true economic performance for the year.  Usually when FFH triggers paper gains, they are the result of good decisions made 4 or 5 years ago -- these decisions are still to the credit of management, but they are not really indicative of performance in the current year.

 

Maybe Ben Graham was a pretty smart guy when he advocated the use of a E10?

 

 

SJ

 

I agree with watching look through earnings over time. It would be nice if we could have any sense of what "normalized" non-insurance earnings looks like now, or what non-insurance earnings might look like 10 years from now. I predict non-insurance earnings in 2030 will be somewhere between $0 and $2 billion. How's that for precision?

[Thrifty3000]

I think it mostly provides stability and allows better long term focus. Berkshire enjoys the same benefits. I’m sure, for example, it was nice not having to mark BNSF down to fair market value on March 31.

 

I may be wrong, but I think the value of BNSF and mid-American energy are their historical purchase cost without any upward adjustment to account for all the value created since their purchase.. So an adjustment would be a boost to BRK book value.

 

I think your comment assumes BNSF was being carried out fair market value, in which case a mark to market drop would bring it down.

 

Yeah, I used BNSF as an example because it was the first holding that popped into my mind that BRK had to mark to market during the prior crisis, but had the luxury of not needing to do that for BNSF this time around.