Fairfax 2021

[petec]

^The 516.0 in matches exactly the 516.0 out. With this and other transactions with OMERS, one gets the impression that OMERS is a debt financing partner, ie they look to get their principal back and to get a reasonable return along the way.

 

OMERS' returns (as reported end-yr 2019):

1-year    11.9%

3-year      8.5%

5-year      8.5%

10-year    8.2%

Their stated goal is 7-11%.

 

I think the 516/516 might be the result of a tax structure. Could the deal have been designed to provide a return via dividends instead of capital gains?

 

But yes, in principle I agree OMERS is basically providing debt finance albeit I think they do take equity risk:

- I am not sure FFH have to buy back the stake if they don't want to.

- The valuation of Brit came down from 2018 ($251.8m for 11.2%) to 2020 ($206.6m for 10.5%).

 

Looking at it another way, by my maths FFH has paid a total of $1.85bn for 100% of Brit (before then selling 14% back to OMERS). I think that's a good chunk more than they originally wanted to pay, for a lower BV since Brit BV has barely grown.

 

[Cigarbutt]

...

I think the 516/516 might be the result of a tax structure. Could the deal have been designed to provide a return via dividends instead of capital gains?

But yes, in principle I agree OMERS is basically providing debt finance albeit I think they do take equity risk:

- I am not sure FFH have to buy back the stake if they don't want to.

- The valuation of Brit came down from 2018 ($251.8m for 11.2%) to 2020 ($206.6m for 10.5%).

Looking at it another way, by my maths FFH has paid a total of $1.85bn for 100% of Brit (before then selling 14% back to OMERS). I think that's a good chunk more than they originally wanted to pay, for a lower BV since Brit BV has barely grown.

i just spend 5-10 minutes on both Brit and FFH reporting and cross-checked a few things.

Summary (it's easier to take OMERS' perspective as FFH contributed capital and assigned its own dividends to Brit) (all numbers in USD)

Summer 2015: OMERS pay 4.30 per share for 120M shares (29.92% interest), with a shareholders' agreement stipulating an annual dividend at 0.43 per share. Total 516.0M

In 2016: OMERS gets 4.30 per share for 13.449M shares, 57.8M

In 2018: OMERS gets 4.30 per share for 58.551M shares, 251.8M

In 2020: OMERS gets 4.30 per share for the remaining 48.000M shares, 206.4M

i think the cumulative dividend has been paid effectively at 0.43 per share per year during the minority ownership. FFH had permission to buy back, on an annual basis and possibly with certain restrictions, the minority interest.

So, this type of partnership could be a win-win and has been a reliable source of funds for FFH so far but, so far, the win-win has been met 100% on OMERS' side and remains to be defined on FFH's side and is based on a 10% (+/-) hurdle rate.

[petec]

That’s really interesting, thanks. Probably a dumb question but where did you find the Brit filings?

 

It’s pretty eye-opening to think the Allied World deal probably looks like this too. Works for FFH if they can grow BV >10%, but they didn’t. I suspect Eurolife is the only OMERS deal that was truly a win-win.

[petec]

The other key part of the economics that we don’t know is OMERS’ anti-dilution clauses. The prices at which FFH injected equity were sometimes sky-high.

[Cigarbutt]

...question but where did you find the Brit filings?

https://www.britinsurance.com/financials-and-governance/financials

[bluedevil]

Fairfax has not done well on these deals with OMERS.  Paying 7-9% interest when their investment portfolio has earned far less than that is not ideal.  I believe the idea was to pay these off sooner and it hasn't worked out because lack of cash.  If you go through and add up all the costs of these acquisitions, they have been pricey in many ways (share issuances, poor underwriting performance at times; issuing preferred shares; OMERS deals), as doing Brit and Allied back to back was a stretch.

 

So it has not all gone according to plan.  BUT the good news is that Fairfax has built out a global insurance empire that can service all manner of companies and risks all across the world and it does not need more acquisitions going forward.  In the past two years alone, GWP have gone from 15.5 billion to 19.1 billion -- an increase of $3.6 billion!  Brit wrote significantly less premiums than that when we paid almost $2billion to acquire it in 2015.  With tentacles all over the world, there's room to run over the years ahead.

 

   

[Viking]

It is crazy the number of significant tailwinds that are benefitting Fairfax today; what a difference a year makes! In all the years i have followed Fairfax i do not think i have ever seen a better broad based positive set up for the company and the stock price. The set up pre-Great Financial Crisis with the CDS positions was better but it was a one hit wonder versus today where we have so many significant things working in Fairfax’s favour. Shares are trading at US $403 and BV = $478; P/BV = 0.85.

 

Insurance operations are in ongoing hard market:

1.) this is driving top line revenue growth in excess of 10%. Importantly, the growth is skewed to the more profitable insurance operations.

2.) At the same time, the hard market is well over a year old and we are now seeing an improving underlying CR as written premiums become earned. I wonder if we do not see Fairfax post a quarterly CR of 95% or better (across all its insurance businesses) at some point in 2021. And a 95% CR on a full year basis after catastrophes now looks attainable.

- importantly, were are not seeing any red flags with their reserving.

 

Their equity investment have been on fire in Q4 and the first 6 weeks of Q1.

3.) in aggregate, my math says their equity investments are up $1.5 billion the first 6 weeks of 2021 ($59/share pre-tax). Based on what we saw in Q4 this number is likely understated and perhaps meaningfully.

4.) we also should see the non-insurance companies also deliver improving operating results (increased profitability) and this will drive improved financial results for Fairfax; i expect this to accelerate each quarter in 2021 as the economy opens up and GDP growth jumps.

 

5.) Atlas is their largest single equity holding (at about $1.35 billion, including warrants). The container shipping market is seeing crazy high pricing. Atlas has announced significant growth plans for Seaspan. Atlas shares hardly look expensive at $13.14 (where they closed Feb 8). Every $1 increase in Atlas is about a $110-120 million benefit for Fairfax. It would not surprise me to see Atlas shares trade over $15 in Q2.

6.) Blackberry is Fairfax’s second largest equity position at about $1.3 billion. Will Fairfax monetize all or a part of their position? We may not find out definitively until when they report Q1 results in early May. If they do this will be a game changer as the gains will significantly boost BV and  provide the company with a significant amount of cash.

7.) Fairfax Investments in India are on fire: Fairfax India, Quess, IIFL Finance, IIFL Wealth. One of the big macro trades for 2021 is weak US$ and strong emerging markets. This trend may run for years.

- US$ weakness should also result in a current benefit for Fairfax given its sizeable holdings outside of the US.

8.) Fairfax commodity investments are on fire: Resolute, Stelco and Astarta. A second big macro trade tied to US$ weakness is strength in commodity pricing. Rising commodity prices may play out for years. We are also seeing merger and aquisitions market heat up and this may benefit Resolute.

9.) Fairfax investments disproportionately hit by pandemic: Eurobank, CIB, Recipe, Dexterra, Thomas Cook India, Kennedy Wilson, John Keells. As the year progresses and vaccinations happen and economies open up these companies will slowly come to benefit.

 

Frothy equity markets are driving hot IPO market, especially technology names.

10.) Fairfax controlled companies with IPO news:

- Farmers Edge: early March

- Boat Rocker just announced

- Prem mentioned on Q4 to watch Fairfax India; this likely references Anchorage (Bangalore airport) which would be a significant development.

11.) More monetizations. Fairfax has many more companies it may chose to monetize as 2021 unfolds: AGT, Performance Sports (Bauer), Toys ‘R Us (real estate).

 

12.) Digit Insurance (India): it appears another round of financing was completed in January and valuation carried on books is likely low and perhaps meaningfully low. Fairfax will be increasing stake from 49% to 74%. This looks like a gem of a company. Cost? Financed how? Bottom line the value of this business will be increasing materially in 2021.

 

13.) Investment in associates/consolidated equities and BV: A big part of BV calculation for Fairfax is how the associates and consolidated equities are valued on the balance sheet. In past years it was normal to discount Fairfax reported BV to account for high marks given to consolidated equities. This no longer appears to be necessary. And we may now be in a situation where BV is actually understated with consolidated equities fair value in excess of carrying value. This point deserves a deeper dive given its complexity and importance to understanding Fairfax. Fairfax is also understanding this issue and said they will be providing disclosure in AR to be released in March to help investors.

 

14.) Total Return Swap on Fairfax shares (communicated with Q4 results): giving Fairfax exposure to 1.4 million of their own shares. Cost base is US$345. With Fairfax shares trading at $403 the TRS are up $88 million since Dec 31. Every US$10 move in Fairfax shares will provide a $14 million benefit to Fairfax.

[Xerxes]

Viking,

We need to give an award to you and the rest of the team here for the very detailed analysis you guys provide.

 

Some years in the future, I think we can move away from BV as the measure of Fairfax's intrinsic value. I think BV has a purpose as a proxy when looking as a floor, but when it comes to growth potential of FFH' many franchises, I think that proxy understates its potential.

 

For instance how is India' massive growth potential to the entire Fairfax operations captured in the backward looking book value or for that matter how is the growth in the insurance businesses (the upswing due to hardening cycle) captured in the book value and of course the associates are captured in the BV only when FFH' portion of the associates' earning (net of dividends) flows through its income statement (i.e. you don't register the upswing in the stock price that is discounting future growth). I think these are the elements that makes FFH an interesting holding, cheap compared to its growth potential and disguised as a mere insurance name and valued as such via antiquated accounting book value.

 

On a different note, let me throw a question to the team here:

 

You all know what i think about RFP and Stelco from a position sizing and timing point of view when FFH first got in. The pandemic gave a front-loaded energy bar to the technology sector and rear-loaded energy bar to the commodity, financials, energy, insurance etc. The word commodity super-cycle is now being uttered. I am not surprised at all. It all goes hand in hand with low US Dollar, the rise of emerging market, the CAPEX holiday O&G sector had, and the mother of all pent up demand (synchronized at that) etc etc. People are going to LIVE and spend like there is no tomorrow.

 

We know that Fairfax did not add to its existing RFP and Stelco positions because they were already large enough and they didnt have the dollars. But I bet they are savvy enough to see the same trend that might be in fact powering these two dormant positions. Knowing what we know about their use of Total Return Swap on their shares, is it not inconceivable that they also entered TRS positions on these two commodity related names, using minimal outlay by getting extra juice ?

 

 

 

 

 

 

 

 

 

[Viking]

Xerxes, Fairfax is my largest position and i find writing helps to crystallize what is rattling around in my head. There is also much that i do not understand (as i do not have an accounting background) and i appreciate the opportunity to communicate with and learn from other members of this board (there are lots, like yourself :-). I especially like when posters push back/disagree (with rationale/logic) as it provides food for thought.

 

In terms of your question as to how Fairfax may be taking advantage of the current environment (commodities etc), based on the investment results they posted in Q4, i agree they may be active doing something. I was surprised by the very large investment gains in Q4 and do not understand what drove a lot of it (not that i am complaining). When the annual report is released March 5 we will get more information :-)

[petec]

Viking I largely agree with you although it’s worth remembering some of these tailwinds could vanish as fast as they appeared. I also think 95% CR is a probability, not a possibility. Excluding COVID they were at 93% in 2020.

 

Can’t remember if this has been posted before: https://moiglobal.com/jeffrey-stacey-202101/

 

I particularly like his speculation on $100 in EPS ;)

 

 

[Viking]

Petec, the key assumption i am making is that we see an economic recovery beginning in Q2 (driven by vaccines). If the virus mutates and a more serious variant emerges which throws the recovery into question then i would reduce my expectations for Fairfax accordingly (likely quite a bit).

 

And of course, we could get a big correction in the stock market (20% or more), regardless of what is going on in the larger economy, and this would hit Fairfax hard (as their equity holdings would likely fall by more than 20%).

 

In terms of near term headwinds for Fairfax, interest and dividend income will be weak especially in 1H 2021. And this is usually a key driver for insurance stock valuations (analysts like predictability).

 

Another headwind is legacy run off business. Selling off the good part (Riverstone) is exposing the remaining runoff business and the big reserve additions in Q4 the past 2 years is not encouraging. The good news is problems will likely not show up until Q4, 2021.

 

And the very large cash/short term investment balance, with rates so low, could be problematic if rates stay low for years and Fairfax has problems redeploying. I do not expect this to be a problem in 2021 given all the tailwinds. But this could become a bigger issue in 2022. (On the other hand, if rates rise in 2021 Fairfax will be in good position to benefit.).

 

And Fairfax could shock me and decide to put $500 million of fresh money into some crazy, swing for the fence equity investment that i hate (and call in a deep value investment). I think this is low probability but i need more time to assess what they will do in the future when investing new money.

 

Probably the biggest near term headwind for Fairfax is sentiment. Past investors in Fairfax are very scarred after so many bad years. The ‘narrative’ is not good (the fact it does not accurately reflect the current reality of the company will only be overcome over time).

 

It reminds me of the big US banks in the US after the Great Financial Crisis. So many people lost so much money with the big US banks after the GFC they completely missed the reality of investing in the big US banks in 2016. They were unable to see all the changes that had happened (regulatory and at the banks) for years that made the big US banks solid investment by 2016. My view is Fairfax has been undergoing a similar metamorphosis for a couple of years now. But investors are so stuck in the past they are unable to see what Fairfax is today. The investor who was complaining to Prem on the Q4 conference call is a perfect example of this backwards looking thinking.

 

Shareholders establishing a position today do not carry this baggage. And the good news is future returns for Fairfax with shares trading at US$403 (BV=$478) should be solid to outstanding.

[Viking]

Viking I largely agree with you although it’s worth remembering some of these tailwinds could vanish as fast as they appeared. I also think 95% CR is a probability, not a possibility. Excluding COVID they were at 93% in 2020.

 

Can’t remember if this has been posted before: https://moiglobal.com/jeffrey-stacey-202101/

 

I particularly like his speculation on $100 in EPS ;)

 

Thanks for posting the presentation; i had not seen it before. The $100 in EPS is not a crazy number if you look at it as a rolling number from Q4 2020 (from when the presentation was made). Q4 came in at $36. We could easily see another $64 from Q1-Q3 2021 = $100 EPS.

[petec]

Viking I largely agree with you although it’s worth remembering some of these tailwinds could vanish as fast as they appeared. I also think 95% CR is a probability, not a possibility. Excluding COVID they were at 93% in 2020.

 

Can’t remember if this has been posted before: https://moiglobal.com/jeffrey-stacey-202101/

 

I particularly like his speculation on $100 in EPS ;)

 

Thanks for posting the presentation; i had not seen it before. The $100 in EPS is not a crazy number if you look at it as a rolling number from Q4 2020 (from when the presentation was made). Q4 came in at $36. We could easily see another $64 from Q1-Q3 2021 = $100 EPS.

 

Agreed, although I think he meant ongoing. $20bn NPW, 90% CR, $500m in interest and dividends, and enough investment gains to offset holdco costs, and you're there. Unlikely, but not impossible, that they can sustain this for a couple of years.

[StubbleJumper]

Viking I largely agree with you although it’s worth remembering some of these tailwinds could vanish as fast as they appeared. I also think 95% CR is a probability, not a possibility. Excluding COVID they were at 93% in 2020.

 

Can’t remember if this has been posted before: https://moiglobal.com/jeffrey-stacey-202101/

 

I particularly like his speculation on $100 in EPS ;)

 

Thanks for posting the presentation; i had not seen it before. The $100 in EPS is not a crazy number if you look at it as a rolling number from Q4 2020 (from when the presentation was made). Q4 came in at $36. We could easily see another $64 from Q1-Q3 2021 = $100 EPS.

 

Agreed, although I think he meant ongoing. $20bn NPW, 90% CR, $500m in interest and dividends, and enough investment gains to offset holdco costs, and you're there. Unlikely, but not impossible, that they can sustain this for a couple of years.

 

 

 

Yeah, you don't get a sustainable CR of 90, because the industry would be flooded with capital which would put pressure on prices.  Even a longer term CR of 93 will be tough to maintain.  In the particular case of a 90, we know that it would be a no-brainer to add capital to the subs because every dollar of new capital allows the FFH subs to write $1.5 to $2 of new business.  So, at a 90 CR, the return on that incremental dollar of capital is 15+% in underwriting profits plus maybe 1% in bond returns.  The prospect of that kind of return would cause a rapid inflow of capital into the industry.  As I said, even a long-term 93 results in a very attractive place for new capital.  At 94 or 95, maybe it wouldn't result in a tsunami of new money.

 

EPS of US$100/sh in the short-term is definitely conceivable, but it would require some pretty large gains on the equity positions and some large gains on the equity accounted positions (eg, trigger a paper gain by selling 10% of the airport to your buddy).  The arithmetic on the gains makes it a bit challenging to get $100/sh on a regular basis.  The investment portfolio is $40B, so you'd need a weighted-average after-tax return of approximately 6% to generate US$2.4B in after-tax investment income, which, when added to the UW profit, could get you to $2.6B in net income, which would be $100/sh.  With such a large portion of the portfolio held in bonds, we should not expect anywhere near a 6% weighted average after-tax return on a recurring basis from that portfolio.

 

There are lots of good things going on right now for FFH, but the challenge for them will be to take advantage of the temporary craziness in the tech market while it lasts and exploit the underwriting cycle while they can.  If they can do a good job of that for the next 0-24 months, they might earn us a hell of a lot of money for a couple of years and hopefully FFH comes out the other side on a more solid, sustainable financial footing.

 

 

SJ

[Santayana]

And if they can take advantage of the current conditions to keep buying back shares, the earnings needed to hit that $100 EPS number will keep falling.  But honestly just consistently getting $50/share would do wonders for sentiment.

[Saluki]

The conference call was wonderful, but there was some unintentional comedy gold.  Did you guys catch the guy who said that Prem is not doing deep analysis in these holdings anymore, and that he doesn't understand tech, and that he should give up the reigns and that people on the board probably think the same thing about him but are too polite to say it to him...because they are Canadians. 

 

Prem's response reminded me of the Big Lebowski "well, that's just, like, an opinion, man."

 

I've been a shareholder for a few years and have been down about 50% at some points so I'm glad to see it firing on all cylinders again with Prem and company focused solely on the businesses instead of making huge bets on calling market tops.

[Parsad]

The conference call was wonderful, but there was some unintentional comedy gold.  Did you guys catch the guy who said that Prem is not doing deep analysis in these holdings anymore, and that he doesn't understand tech, and that he should give up the reigns and that people on the board probably think the same thing about him but are too polite to say it to him...because they are Canadians. 

 

Prem's response reminded me of the Big Lebowski "well, that's just, like, an opinion, man."

 

I've been a shareholder for a few years and have been down about 50% at some points so I'm glad to see it firing on all cylinders again with Prem and company focused solely on the businesses instead of making huge bets on calling market tops.

 

No one could have done that role other than Jeff Bridges...maybe Matthew McConaughey...but that's it!  Cheers!

[StubbleJumper]

I am also curious to see how the market responds - historically it pops like 2-3 days AFTER earnings are announced.

 

Will be interesting to see if it's flat tomorrow and up big in Monday or Tuesday.

 

 

Yep, looks like you called this one right!  It was up like US$5/sh on Friday (the day after the earnings release), and then another US$15/sh on the second trading day after earnings.

 

It's funny, but predictable.

 

 

SJ

[Xerxes]

Seeing FFH is shooting up on the same day that BB plunges, i think, in some weird way indicative that the market is looking past all these little noise about movement of equity holdings quarter to quarter and looking at the whole picture.

[TwoCitiesCapital]

I am also curious to see how the market responds - historically it pops like 2-3 days AFTER earnings are announced.

 

Will be interesting to see if it's flat tomorrow and up big in Monday or Tuesday.

 

 

Yep, looks like you called this one right!  It was up like US$5/sh on Friday (the day after the earnings release), and then another US$15/sh on the second trading day after earnings.

 

It's funny, but predictable.

 

 

SJ

 

That's efficient markets for you

[drzola]

Jeffries has turned positive on Reinsurance it appears

 

https://www.printfriendly.com/p/g/grCmkN.

 

 

[SharperDingaan]

Re disclosure. We have reduced our position in FFH, and moved our gain to date (29%) elsewhere.

If ever there was a time to be in FFH it is 2021, and at a time when the world is coming out of Covid. Hopefully by late Fall; o/g is solidly recovering, GBP is weakening, and we will get an FX boost on repatriation as well.

 

If you have the risk tolerance, look at the CVE warrants  ;)

The nearest thing to a leap, and a lot more liquid.

 

SD

 

 

 

 

[Viking]

Sharper i have also decided to reduce my position in Fairfax to lock in some very nice gains from the past three months. Fairfax is still my largest position. I did redeploy some of the proceeds into starter positions in Atlas, Fairfax India and Stelco - all look cheapish to me with nice tailwinds.

[Xerxes]

Allow Xerxes to reveal to you an new way to measure FFH's rising intrinsic value. In this very forum, there were:

 

- 50 pages in the 2021 FFH Thread; and we are not even in March

- 88 pages in the 2020 FFH Thread

- 14 pages in the 2019 FFH Thread

- 51 pages in the 2018 FFH Thread

- 16 pages in the 2017 FFH Thread

 

If this is not a technical bullish signal from the Faithful populating this forum, then i don't know what is.

[no_free_lunch]

How many pages are there in the Valeant thread. :)