Fairfax 2023

[glider3834]

22 hours ago, Xerxes said:

"... I can tell you, this is 2023, 24, 25 ... we have extended our term by buying treasury bonds in the last 2-3 months ... so we are confident that we will have $1.5B in interest & dividend income in 23, 24 and 25, by buying about 80% of our fixed-income portfolio in government bonds etc."

 

Above is the statement from Prem W. during AGM. 

 

So if the size of the fixed-income portfolio is $38 billion based on Dec 2022 data, of that $9B was in cash and short-term treasury bills and $29B in bonds. So 76% of that portfolio in treasury bonds.

 

Today, based on the comment from the AGM, about 80% of that is now in bonds. So $30B vs. $7B in in cash and short-term treasury bills (assuming $38B as constant). 

 

@TwoCitiesCapital

 

If you measure $1.5B as yield against the $38 fixed-income portfolio (as oppose to $52B), the yield looks better at 3.94%

 

my sense is Fairfax has taken a full pivot by moving to lock in a lot more duration at the beginning of 1Q'23 suggesting inflation has peaked and rates to come down. 

If you look at chart below their timing has been driven by data - a very large cash position at beginning of 2022 with 1.2 yrs duration & hedges to protect from further increases in rates, and then with inflation peaking July 2022, they continued pushing out to 1.6 years by end of 2022 & substantially reducing their interest rate hedges & then pushing to 2 yrs and over in 1 Q 2023.

 

 

 

[Thrifty3000]

 

^ @Parsad What’s the beef with Robert Gunn? 42% of subordinate shares voted against him is pretty aggressive.

[MMM20]

13 hours ago, Thrifty3000 said:

 

^ @Parsad What’s the beef with Robert Gunn? 42% of subordinate shares voted against him is pretty aggressive.

Same question. I would’ve thought Prem’s kids would get the most pushback. 
 

Edited April 22, 2023 by MMM20

[Viking]

16 hours ago, glider3834 said:

my sense is Fairfax has taken a full pivot by moving to lock in a lot more duration at the beginning of 1Q'23 suggesting inflation has peaked and rates to come down. 

If you look at chart below their timing has been driven by data - a very large cash position at beginning of 2022 with 1.2 yrs duration & hedges to protect from further increases in rates, and then with inflation peaking July 2022, they continued pushing out to 1.6 years by end of 2022 & substantially reducing their interest rate hedges & then pushing to 2 yrs and over in 1 Q 2023.

 

 

 

@glider3834  It is looking more and more to me like what Fairfax has done with their $38 billion fixed income portfolio over the past 18 months is perhaps going to be recognized, in time, as one of their best tactical moves ever.

•  in Q4 - 2021 going to 1.2 years average duration on Dec 31, 2021 with hedges as interest rates bottom
• and now pushing average duration over 2years (let’s hope) and removing the hedges as interest rates peak out.

They are going to make close to $900 million per year in incremental interest income in the coming years (from what they earned in 2021) from these moves.

• 2021 = $568 million
• 2022= $874 Million
• 2023E = $1.43 billion

That is a material improvement in the company’s prospects. This is just another in the long line of examples of what an exceptional team Fairfax has managing their fixed income portfolio. They are wicked smart.

—————

We all know book value is everything when it comes to properly valuing P&C insurers… so how did this crazy good move impact book value? The fixed income portfolio had an pre-tax unrealized loss of $1.1 billion in 2022 = $47/share. So if an investor felt Fairfax stock should trade at 1 x BV at Dec 31, 2021 and the same 1 x BV at Dec 31, 2022 (it is the same company after all) then they would correctly assume the stock is now worth $47/share LESS year over year - just looking at the fixed income portfolio.

 

The problem with book value as a metric is it is not forward looking. The fact the $1.1 billion in unrealized losses will largely reverse in the near term is ignored. The fact that future interest income has exploded to more than $1.5 billion in 2023, and is likely to remain at these levels for at least the next 3 years, is ignored.

 

With the move in interest rates in 2022, book value tells you Fairfax is worth less as a company. Of course this is completely wrong. The reversal of the unrealized losses combined with the steady, predictable stream of $1.5 billion in cash from interest income makes Fairfax a much, much more valuable company at the end of 2022 than it was at the end of 2021.

 

Of course, people who closely follow the company know this. But most people don’t follow the company (yet). So they blindly use book value as their primary valuation tool. Which in turn causes them to misunderstand and undervalue the company.

—————

From the AGM, it sounds like Fairfax has extended the duration of the bond portfolio in Q1. It also sounds like the run rate for interest and dividends is higher than the $1.5 billion guide they provided when they released Q4 results.

Edited April 22, 2023 by Viking

[Viking]

Is Fairfax a growth company? I realize that sounds like a dumb thing to ask. I mean this is Fairfax after all. But hey, just for fun, what do the numbers say? Fairfax has compounded net written premiums from $6.3 billion in 2014 to $22.3 billion in 2022, which is a compound growth rate of 17% each year for the past 8 years. And my guess is we will get around 10% growth for each of the next two years, which would give us compound growth over 10 years of +15%. Really? That performance is pretty impressive.

 

Guess how many large cap Canadian companies have grown their top line by +15% per year for 10 years? Not many. Apparently not many P&C insurance companies either. Like a goat going up a mountain, Fairfax has been nimbly and quickly climbing the rankings of the largest global P&C insurers… last year they were top 25 and this year they quietly moved into the top 20 list. 

 

So let’s ask that question again… is Fairfax a growth company? Yup. 

 

WOW! A Canadian company that is competing against the best the world has to offer… and not just playing the game (that participation award thing we love here in Canada) but actually winning? That is crazy. Canada must be so proud! Like invite Prem to Ottawa. And hold a parade and celebrate! 

 

Except… ummm… no one in Canada seems to know that Fairfax exists let alone that it has been growing like a weed. It looks like most investors are also in the same boat. Because how does Mr. Market reward a fast grower’s stock price?

 

 

Fairfax’s stock price price is dirt cheap. Makes no sense to me. But, hey, we all know Mr. Market is always right. Right? Except of course… when Mr. Market is completely wrong. (That is called a fat pitch by some country bumpkin who lives in Omaha). But hey, that is a story for another day. 

 

Today, let’s dig into what happened at Fairfax over the past 8 years to drive all that top line growth. And why I am optimistic over the near term (even thought the hard market looks like it is slowing).

————

The 17% growth in net written premiums that Fairfax has delivered over the past 8 years has happened in two pretty distinct phases. Then i will take a stab at what might come next:

• phase 1: Acquisitions (2015-2017)
• phase 2: Organic - hard market (2019-2023)
• phase 3: Take-out of minority partners (2022-2025)

As one would expect, there is some overlap with these phases. So let’s peel back the onion a little bit and review what happened in each phase. What did Fairfax do? What was the cost? Was it good for shareholders? By digging a little deeper, we can learn more about Fairfax. And better evaluate the performance of the management team.

 

Phase 1: Acquisitions (2015 to 2017)

 

Fairfax has used acquisitions to help fuel its growth through its entire existence. And unlike many P&C insurers, Fairfax has long had an international presence. Over a three year period, from 2015-2017 Fairfax made 6 separate acquisitions that cost a total of $7.5 billion.

 

 

How did Fairfax pay for the acquisitions? At the time, Fairfax was short on cash as the investment side of the business was underperforming (losses from equity hedges… yes, sorry to keep picking that scab). Fairfax funded the purchases though:

• stock issuance = $3.34 billion (7.225 million shares at $462/share)
• minority partners = $2.256 billion (see above) 
• asset monetizations = Bank of Ireland, Ridley, ICICI Lombard, First Capital

The deal with the minority partners is interesting: From 2015AR: “In the case of both Brit and Eurolife, we expect to be able to acquire the interests back within the five years after closing, after providing OMERS with an acceptable return. The team at OMERS has been a pleasure to deal with.” Allied World is structured similarly. Finding a temporary partner was a very creative funding solution. I think the partners make an annual rate of return (of around 8% per year?) and Fairfax is able to buy the stakes back when they have the cash and at an acceptable price (negotiated when the deal is struck, I think).

 

Timing? In hindsight, 2015-2017 was a good time to buy insurance companies. Reasonable prices. Right before the start of the hard market. The timing was likely not a fluke. Fairfax was being opportunistic. 

 

How much did Fairfax grow? Net premiums written increased from $6.3 billion in 2014 to $12.4 billion in 2018, for total growth of 97% over 4 years (see the table at the bottom of this post). Yes, the share count did increase quite a bit so growth per share was lower at 54% (more on this later).

 

Growth by acquisition can be good but it carries risks. Do you overpay? Are there hidden issues (such as poor reserving)? Are there integration/culture issues? What is the best way for an insurance company to grow? A hard market. And that is what started in the second half of 2019.

 

Phase 2: Organic - hard market (2019-2023)

 

Hard markets for P&C insurers are exceptionally rare. The last one was in 2001-2004. What makes a hard market so good? The opportunity to charge higher premiums. And to apply more stringent underwriting (more favourable terms and conditions). For well run insurers like Fairfax a hard market is like a gift from the insurance gods.

 

Fairfax was positioned perfectly for the hard market that started in 2H 2019. And they have been taking full advantage of it for close to 4 years now. 

 

How much did Fairfax grow? Net premiums increased from $12.4 billion in 2018 to $22.3 billion in 2022, for total growth of 79% over 4 years. However, during this period the share count decreased quite a bit so growth per share was higher at 109%. That is rocket ship emoji type organic growth in 4 years time.

 

The hard market is the best way for an insurance company to grow but they do not last forever. And it certainly looks like the current hard market is slowing. My guess is Fairfax will post mid to high single digit growth in net premiums written in 2023. Does that mean the growth story is over? No. Because Fairfax has set the table nicely for what will drive the next big phase of growth for the company: the buying out their minority partners. 

 

Phase 3: Take-out of minority partners (2022-2025)

 

Fairfax started executing this strategy over the past couple of years. But it picked up steam in 2022 with the Allied World transaction.

• 2021 Singapore Re: paid $103 million to increase ownership from 28.1% to 96% (now 100%)
• 2018 & 2021 Eurolife: increased ownership from 40% to 50% and then to 80%. The last 30% was purchased from OMERS for $143 million.
• 2022 Allied World: cost $733 million to increase ownership from 70.9% to 82.9%

Why is this strategy picking up steam? Fairfax is now generating around $2.5 billion in free cash flow per year. It started in 2022 but was masked in the reported results by the large unrealized losses in the bond portfolio. As we begin 2023, we are going to see reported earnings spike higher. My conservative estimate is Fairfax is going to earn $120/share in 2023 = $2.8 billion. The biggest chunk of this is interest and dividends at $1.5 billion. The next biggest chunk is underwriting profit of $1.1 billion. The quality of the earnings are the best in Fairfax’s history.

 

So what will Fairfax do with this Smaug like mountain of gold that is rolling in every quarter? Let’s quickly review capital allocation:

1. strong financial condition: while debt levels are a little elevated, shareholders equity will be spiking over the next couple of years. So no need to pay down debt.
2. support growth of subsidiaries in hard market? As the hard market slows, this will not be needed.
3. buy out minority partners - bingo, we have a winner
4. share buybacks - well, we actually have two winners

And what just got announced? Fairfax is buying out Kipco and increasing its ownership in GIG from 43.7% to 90%. It is interesting how the deal will be financed: $200 million at closing and $165 million each year for the next 4 years. GIG’s earnings will likely come close to covering each of the annual payments due to Kipco. So the total cost of $860 million is being spread over 4 years. Very creative.
 

In GIG’s case, yes i realize Fairfax bought out the majority partner. Same with Singapore Re. Both deals fit the theme perfectly.

 

Moving forward i expect Fairfax to continue buying out their minority partners in the insurance businesses. These transactions are very low risk (Fairfax knows the assets) and they offer a solid rate of return (what ever was being paid to minority partners; likely around 8%?). Taking out the minority partners also simplifies Fairfax’s structure and makes the company easier to understand.

 

Some on this board have stated buying out minority partners is kind of like doing a share buyback. Because shareholders get an even bigger piece of Fairfax’s growing earnings. 

 

Share buybacks: With all the free cash flow Fairfax is generating we should also see more significant share buybacks moving forward. If Fairfax repurchases 600,000 shares per year (about $420 million/year at the current price) we could see total shares count drop to 22 million by the end of 2024. This would return the share count to where it was in 2015. In turn, this will boost net written premiums per share. 

 

Conclusion: So after all this, what did we learn? The management team at Fairfax has been masterful at taking advantage of the changing environment - both the external (in the insurance market) and internal (at Fairfax). Their planning, creativity and execution over the last 8 years has built Fairfax into a global insurance giant that is exceptionally well positioned in the current environment.
 

What does this mean for investors? Growth investing is identifying and investing in companies with above average growth prospects compared to the industry/peers. Over time higher growth - leads to higher earnings - leads to a higher stock price. For growth investing to work the company needs to be successful; does the growth and higher profitability actually happen?
 

What does this have to do with Fairfax? Well the growth has already happened at Fairfax. And profitability is spiking. And yet little of this is reflected in the stock price - yet.
 

Investors in Fairfax today are getting years of growth that has already happened (top and bottom line) for free. That, of course, sounds preposterous. But it is true. 
 

How can that happen? Its not that complicated. The current narrative around the company is completely wrong. Fairfax is a great example of how dumb the ‘smart money’ can be at times. 

 

“One more thing”: Fairfax owns a significant amount of Digit Insurance. Who is Digit? Digit is one of the fastest growing general insurance companies in India. We may see an IPO in 2023. But that is a story for another day. 

—————

• Allied World (17.1% = @ $1 billion?): “The company has the option to purchase the remaining interests of the minority shareholders in Allied World at certain dates until September 2024.” 
• Odyssey ($900 million): “The company has the option to purchase the interests of CPPIB and OMERS in Odyssey Group at certain dates commencing in January 2025.”
• Brit ($375 million): “The company has the option to purchase OMERS’ interest in Brit at certain dates commencing in October 2023.”

—————

Let’s quickly review share count. Fairfax issued a total of 7.2 million shares in 2015, 2016 and 2017 to help fund its aggressive international insurance expansion. The new shares were issued at an average price of $462/share. At December 31 2022, the ‘effective shares outstanding’ at Fairfax has fallen to 23.3 million shares. Over the last 5 years (2018-2022), Fairfax has reduced its share count by approximately 4.4 million shares or 15.9%.  The average price paid to buy back shares was $464/share. The average price paid for the shares repurchased by Fairfax over the past 5 years is the same price that the shares were issued at from 2015-2017. Fairfax’s book value at Dec 31, 2022 was $658/share (old BV). Bottom line, Fairfax was extremely opportunistic and was able to repurchase a significant quantity of shares at a very low price - and offset most of the dilution that happened from 2015-2017.

 

Of interest, in 2021 Fairfax sold 10% of Odyssey Re for $900 million to help fund a buy back of 2 million shares of Fairfax at $500/share. Fairfax knew their shares were crazy cheap at $500. But they did not have the cash at the time. So they put together another deal with OMERS structured the same as the Brit and Allied deals. Creative. Opportunistic.

—————

A Fairfax company did make one large insurance acquisition in 2021. Gulf Insurance Group (GIG) practically stole AXA’s gulf insurance business. AXA was kind of a forced seller and GIG got a great price (who in their right mind would buy an insurance business in the middle of covid… yes, a company affiliated with Fairfax). The acquisition increased GIG’s size by about 80% and gives them considerable scale in MENA - they are now one of the largest P&C insurers in the region.

—————

Edited April 23, 2023 by Viking

[Santayana]

As easy as it is to point to the equity hedges as a cause of underperformance, I have to wonder if they would have been as comfortable with the aggressive acquisitions if those hedges hadn't been in place.

[Xerxes]

On 4/21/2023 at 9:01 AM, TwoCitiesCapital said:

 

But it's not against the fixed income portfolio. It's interest AND dividends. It's the whole $52B portfolio. 

In the 2022 letter this year, Prem actually adds interest + dividend AND retained earning. And gets to +3% yield on the whole portfolio. 
 

so to be fair, if we are looking at interest AND dividend (as oppose to just interest) and comparing with the market bond yield, we do need to include the whole of earning on common stocks. (distributed or not). 

[Viking]

18 hours ago, Viking said:

Is Fairfax a growth company? I realize that sounds like a dumb thing to ask. I mean this is Fairfax after all. But hey, just for fun, what do the numbers say? Fairfax has compounded net written premiums from $6.3 billion in 2014 to $22.3 billion in 2022, which is a compound growth rate of 17% each year for the past 8 years. And my guess is we will get around 10% growth for each of the next two years, which would give us compound growth over 10 years of +15%. Really? That performance is pretty impressive.

 

Guess how many large cap Canadian companies have grown their top line by +15% per year for 10 years? Not many. Apparently not many P&C insurance companies either. Like a goat going up a mountain, Fairfax has been nimbly and quickly climbing the rankings of the largest global P&C insurers… last year they were top 25 and this year they quietly moved into the top 20 list. 

 

So let’s ask that question again… is Fairfax a growth company? Yup. 

 

WOW! A Canadian company that is competing against the best the world has to offer… and not just playing the game (that participation award thing we love here in Canada) but actually winning? That is crazy. Canada must be so proud! Like invite Prem to Ottawa. And hold a parade and celebrate! 

 

Except… ummm… no one in Canada seems to know that Fairfax exists let alone that it has been growing like a weed. It looks like most investors are also in the same boat. Because how does Mr. Market reward a fast grower’s stock price?

 

 

Fairfax’s stock price price is dirt cheap. Makes no sense to me. But, hey, we all know Mr. Market is always right. Right? Except of course… when Mr. Market is completely wrong. (That is called a fat pitch by some country bumpkin who lives in Omaha). But hey, that is a story for another day. 

 

Today, let’s dig into what happened at Fairfax over the past 8 years to drive all that top line growth. And why I am optimistic over the near term (even thought the hard market looks like it is slowing).

————

The 17% growth in net written premiums that Fairfax has delivered over the past 8 years has happened in two pretty distinct phases. Then i will take a stab at what might come next:

• phase 1: Acquisitions (2015-2017)
• phase 2: Organic - hard market (2019-2023)
• phase 3: Take-out of minority partners (2022-2025)

As one would expect, there is some overlap with these phases. So let’s peel back the onion a little bit and review what happened in each phase. What did Fairfax do? What was the cost? Was it good for shareholders? By digging a little deeper, we can learn more about Fairfax. And better evaluate the performance of the management team.

 

Phase 1: Acquisitions (2015 to 2017)

 

Fairfax has used acquisitions to help fuel its growth through its entire existence. And unlike many P&C insurers, Fairfax has long had an international presence. Over a three year period, from 2015-2017 Fairfax made 6 separate acquisitions that cost a total of $7.5 billion.

 

 

How did Fairfax pay for the acquisitions? At the time, Fairfax was short on cash as the investment side of the business was underperforming (losses from equity hedges… yes, sorry to keep picking that scab). Fairfax funded the purchases though:

• stock issuance = $3.34 billion (7.225 million shares at $462/share)
• minority partners = $2.256 billion (see above) 
• asset monetizations = Bank of Ireland, Ridley, ICICI Lombard, First Capital

The deal with the minority partners is interesting: From 2015AR: “In the case of both Brit and Eurolife, we expect to be able to acquire the interests back within the five years after closing, after providing OMERS with an acceptable return. The team at OMERS has been a pleasure to deal with.” Allied World is structured similarly. Finding a temporary partner was a very creative funding solution. I think the partners make an annual rate of return (of around 8% per year?) and Fairfax is able to buy the stakes back when they have the cash and at an acceptable price (negotiated when the deal is struck, I think).

 

Timing? In hindsight, 2015-2017 was a good time to buy insurance companies. Reasonable prices. Right before the start of the hard market. The timing was likely not a fluke. Fairfax was being opportunistic. 

 

How much did Fairfax grow? Net premiums written increased from $6.3 billion in 2014 to $12.4 billion in 2018, for total growth of 97% over 4 years (see the table at the bottom of this post). Yes, the share count did increase quite a bit so growth per share was lower at 54% (more on this later).

 

Growth by acquisition can be good but it carries risks. Do you overpay? Are there hidden issues (such as poor reserving)? Are there integration/culture issues? What is the best way for an insurance company to grow? A hard market. And that is what started in the second half of 2019.

 

Phase 2: Organic - hard market (2019-2023)

 

Hard markets for P&C insurers are exceptionally rare. The last one was in 2001-2004. What makes a hard market so good? The opportunity to charge higher premiums. And to apply more stringent underwriting (more favourable terms and conditions). For well run insurers like Fairfax a hard market is like a gift from the insurance gods.

 

Fairfax was positioned perfectly for the hard market that started in 2H 2019. And they have been taking full advantage of it for close to 4 years now. 

 

How much did Fairfax grow? Net premiums increased from $12.4 billion in 2018 to $22.3 billion in 2022, for total growth of 79% over 4 years. However, during this period the share count decreased quite a bit so growth per share was higher at 109%. That is rocket ship emoji type organic growth in 4 years time.

 

The hard market is the best way for an insurance company to grow but they do not last forever. And it certainly looks like the current hard market is slowing. My guess is Fairfax will post mid to high single digit growth in net premiums written in 2023. Does that mean the growth story is over? No. Because Fairfax has set the table nicely for what will drive the next big phase of growth for the company: the buying out their minority partners. 

 

Phase 3: Take-out of minority partners (2022-2025)

 

Fairfax started executing this strategy over the past couple of years. But it picked up steam in 2022 with the Allied World transaction.

• 2021 Singapore Re: paid $103 million to increase ownership from 28.1% to 96% (now 100%)
• 2018 & 2021 Eurolife: increased ownership from 40% to 50% and then to 80%. The last 30% was purchased from OMERS for $143 million.
• 2022 Allied World: cost $733 million to increase ownership from 70.9% to 82.9%

Why is this strategy picking up steam? Fairfax is now generating around $2.5 billion in free cash flow per year. It started in 2022 but was masked in the reported results by the large unrealized losses in the bond portfolio. As we begin 2023, we are going to see reported earnings spike higher. My conservative estimate is Fairfax is going to earn $120/share in 2023 = $2.8 billion. The biggest chunk of this is interest and dividends at $1.5 billion. The next biggest chunk is underwriting profit of $1.1 billion. The quality of the earnings are the best in Fairfax’s history.

 

So what will Fairfax do with this Smaug like mountain of gold that is rolling in every quarter? Let’s quickly review capital allocation:

1. strong financial condition: while debt levels are a little elevated, shareholders equity will be spiking over the next couple of years. So no need to pay down debt.
2. support growth of subsidiaries in hard market? As the hard market slows, this will not be needed.
3. buy out minority partners - bingo, we have a winner
4. share buybacks - well, we actually have two winners

And what just got announced? Fairfax is buying out Kipco and increasing its ownership in GIG from 43.7% to 90%. It is interesting how the deal will be financed: $200 million at closing and $165 million each year for the next 4 years. GIG’s earnings will likely come close to covering each of the annual payments due to Kipco. So the total cost of $860 million is being spread over 4 years. Very creative.
 

In GIG’s case, yes i realize Fairfax bought out the majority partner. Same with Singapore Re. Both deals fit the theme perfectly.

 

Moving forward i expect Fairfax to continue buying out their minority partners in the insurance businesses. These transactions are very low risk (Fairfax knows the assets) and they offer a solid rate of return (what ever was being paid to minority partners; likely around 8%?). Taking out the minority partners also simplifies Fairfax’s structure and makes the company easier to understand.

 

Some on this board have stated buying out minority partners is kind of like doing a share buyback. Because shareholders get an even bigger piece of Fairfax’s growing earnings. 

 

Share buybacks: With all the free cash flow Fairfax is generating we should also see more significant share buybacks moving forward. If Fairfax repurchases 600,000 shares per year (about $420 million/year at the current price) we could see total shares count drop to 22 million by the end of 2024. This would return the share count to where it was in 2015. In turn, this will boost net written premiums per share. 

 

Conclusion: So after all this, what did we learn? The management team at Fairfax has been masterful at taking advantage of the changing environment - both the external (in the insurance market) and internal (at Fairfax). Their planning, creativity and execution over the last 8 years has built Fairfax into a global insurance giant that is exceptionally well positioned in the current environment.
 

What does this mean for investors? Growth investing is identifying and investing in companies with above average growth prospects compared to the industry/peers. Over time higher growth - leads to higher earnings - leads to a higher stock price. For growth investing to work the company needs to be successful; does the growth and higher profitability actually happen?
 

What does this have to do with Fairfax? Well the growth has already happened at Fairfax. And profitability is spiking. And yet little of this is reflected in the stock price - yet.
 

Investors in Fairfax today are getting years of growth that has already happened (top and bottom line) for free. That, of course, sounds preposterous. But it is true. 
 

How can that happen? Its not that complicated. The current narrative around the company is completely wrong. Fairfax is a great example of how dumb the ‘smart money’ can be at times. 

 

“One more thing”: Fairfax owns a significant amount of Digit Insurance. Who is Digit? Digit is one of the fastest growing general insurance companies in India. We may see an IPO in 2023. But that is a story for another day. 

—————

• Allied World (17.1% = @ $1 billion?): “The company has the option to purchase the remaining interests of the minority shareholders in Allied World at certain dates until September 2024.” 
• Odyssey ($900 million): “The company has the option to purchase the interests of CPPIB and OMERS in Odyssey Group at certain dates commencing in January 2025.”
• Brit ($375 million): “The company has the option to purchase OMERS’ interest in Brit at certain dates commencing in October 2023.”

—————

Let’s quickly review share count. Fairfax issued a total of 7.2 million shares in 2015, 2016 and 2017 to help fund its aggressive international insurance expansion. The new shares were issued at an average price of $462/share. At December 31 2022, the ‘effective shares outstanding’ at Fairfax has fallen to 23.3 million shares. Over the last 5 years (2018-2022), Fairfax has reduced its share count by approximately 4.4 million shares or 15.9%.  The average price paid to buy back shares was $464/share. The average price paid for the shares repurchased by Fairfax over the past 5 years is the same price that the shares were issued at from 2015-2017. Fairfax’s book value at Dec 31, 2022 was $658/share (old BV). Bottom line, Fairfax was extremely opportunistic and was able to repurchase a significant quantity of shares at a very low price - and offset most of the dilution that happened from 2015-2017.

 

Of interest, in 2021 Fairfax sold 10% of Odyssey Re for $900 million to help fund a buy back of 2 million shares of Fairfax at $500/share. Fairfax knew their shares were crazy cheap at $500. But they did not have the cash at the time. So they put together another deal with OMERS structured the same as the Brit and Allied deals. Creative. Opportunistic.

—————

A Fairfax company did make one large insurance acquisition in 2021. Gulf Insurance Group (GIG) practically stole AXA’s gulf insurance business. AXA was kind of a forced seller and GIG got a great price (who in their right mind would buy an insurance business in the middle of covid… yes, a company affiliated with Fairfax). The acquisition increased GIG’s size by about 80% and gives them considerable scale in MENA - they are now one of the largest P&C insurers in the region.

—————

I re-wrote my conclusion to the article i posted yesterday. This is more on-point.

 

Conclusion: So after all this, what did we learn? The management team at Fairfax has been masterful at taking advantage of the changing environment - both the external (in the insurance market) and internal (at Fairfax). Their planning, creativity and execution over the last 8 years has built Fairfax into a global insurance giant that is exceptionally well positioned in the current environment.
 

What does this mean for investors? Growth investing is identifying and investing in companies with above average growth prospects compared to the industry/peers. Over time higher growth - leads to higher earnings - leads to a higher stock price. For growth investing to work the company needs to be successful; does the growth and higher profitability actually happen?
 

What does this have to do with Fairfax? Well the growth has already happened at Fairfax. And profitability is spiking. And yet little of this is reflected in the stock price - yet.
 

Investors in Fairfax today are getting years of growth that has already happened (top and bottom line) for free. That, of course, sounds preposterous. But it is true. 
 

How can that happen? Its not that complicated. The current narrative around the company is completely wrong. Fairfax is a great example of how dumb the ‘smart money’ can be at times.

[Viking]

Fairfax has grown their excess and surplus lines insurance in the US by about 80% over the past 2 years. They were the 4th largest player in 2022, up from 7th in 2020. 

 

What is excess and surplus lines insurance (E&S)? Progressive explains it well:

• Excess and surplus lines (E&S) insurance is a market that protects high-risk businesses that standard insurers won’t cover. This market is also known as surplus lines or non-admitted insurance.
• Companies with unusual or elevated risks often need E&S insurance because the admitted market considers them too risky to cover. These businesses could get a policy through a qualified E&S carrier.
• https://www.progressivecommercial.com/business-insurance/excess-and-surplus-insurance/

----------

Excess & Specialty - US Top 25 – 2022

 

Top US excess and surplus carriers see premiums surge, market share slip in 2022

• https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/top-us-excess-and-surplus-carriers-see-premiums-surge-market-share-slip-in-2022-75096783
• “Fairfax Financial was the lone company among the top 10 that picked up market share in 2022, rising to 5.0% from 4.8%. The company also experienced a 26.6% surge in premiums.”

-----------

Excess & Specialty - US Top 25 – 2021

 

Most top E&S insurers see market shares decline in 2021; premiums rise YOY

• https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/most-top-e-s-insurers-see-market-shares-decline-in-2021-premiums-rise-yoy-70287307
• “Fairfax Financial Holdings Limited, the fourth-largest insurer in the rankings, was the only company among top 10 players to log a year-over-year increase in market share. The insurer's share of the E&S market rose to 4.77% from 4.50%. Fairfax Financial jumped two spots in the rankings, thanks to a 40% increase in premiums to $3.0 billion from $2.14 billion a year ago.”

 

[Dipesh Patel]

FFH - AGM slide show

Fairfax-AGM-2023-FINAL.pdf

[Parsad]

10 hours ago, DM1 said:

FFH - AGM slide show

Fairfax-AGM-2023-FINAL.pdf 1.29 MB · 46 downloads

 

Thanks!  Cheers!

[thowed]

Yes, thanks for this, & also especially to Viking who has helped me understand Fairfax so much better recently.

 

To ask a stupid question: The average long-term return of their Investment Portfolio is 7.7%.  If Book Value has

compounded at c.18%, doesn't this indicate they should get out of this & do more of the other stuff?

 

I appreciate their investment style has been 'out of fashion' somewhat since 2009 but this is over 38 years.

 

Thanks.

 

[MMM20]

3 hours ago, thowed said:

Yes, thanks for this, & also especially to Viking who has helped me understand Fairfax so much better recently.

 

To ask a stupid question: The average long-term return of their Investment Portfolio is 7.7%.  If Book Value has

compounded at c.18%, doesn't this indicate they should get out of this & do more of the other stuff?

 

I appreciate their investment style has been 'out of fashion' somewhat since 2009 but this is over 38 years.

 

Thanks.

 

~7-8% return on investments would be a home run b/c it translates to ~15%+ return for FFH shareholders b/c of leverage. Rough numbers, roughly right.
 

If FFH underwrites at breakeven, that equates to borrowing at a 0% interest rate on roughly half the asset base at the current size of the insurance operations.
 

This is why the intelligent growth in the insurance side over the last 5-7 years is such a big deal even if they “only” break even longer term.
 

Buffett has talked about that power of insurance float for 60 years and it is still widely misunderstood IMHO… at least in the Fairfax case.

 

FWIW, that float leverage is a big absolute *and relative* advantage for well managed insurance companies again, with borrowing costs for other industries back off the zero bound.

Also, as they flip to highly cash generative, the share count and minority interests should continue to shrink.

 

From this valuation starting point, that all could translate to a ~8-10x return over the next decade with mid teens EPS growth (even with zero growth on the insurance side) if the “exit” multiple expands to a fair low-to-mid teens multiple of earnings.
 

Haters would be in shambles

 

not investment advice

 

 

Edited April 26, 2023 by MMM20

[thowed]

Thanks for this.

[MMM20]

3 hours ago, MMM20 said:

~7-8% return on investments would be a home run b/c it translates to ~15%+ return for FFH shareholders b/c of leverage. Rough numbers, roughly right.
 

If FFH underwrites at breakeven, that equates to borrowing at a 0% interest rate on roughly half the asset base at the current size of the insurance operations.
 

This is why the intelligent growth in the insurance side over the last 5-7 years is such a big deal even if they “only” break even longer term.
 

Buffett has talked about that power of insurance float for 60 years and it is still widely misunderstood IMHO… at least in the Fairfax case.

 

FWIW, that roughly zero cost float based leverage is a big relative advantage for well managed insurance companies again, with borrowing costs for other industries back off the zero bound.

Also, as they flip to highly cash generative, the share count and minority interests should continue to shrink.

 

From this valuation starting point, and even with zero growth on the insurance side, that all could translate to a ~8-10x return over the next decade with mid teens EPS growth if the “exit” multiple expands to a fair low-to-mid teens multiple of earnings.
 

Haters would be in shambles

 

not investment advice

 

 

 

Data below is from Research Affiliates...IMHO one good way to frame expected returns and the range of outcomes from the top down to supplement the bottoms up work that @Viking and others have laid out so well here. ~7.5% asset level return with about half financed with ~0 cost leverage and a shrinking share count (and minority interests) = ~15%+ total shareholder return, even if valuation stays at mid single digits on earnings. 

 

 

 

 

 

 

Edited April 26, 2023 by MMM20

[Luke]

7 hours ago, MMM20 said:

~7-8% return on investments would be a home run b/c it translates to ~15%+ return for FFH shareholders b/c of leverage. Rough numbers, roughly right.
 

If FFH underwrites at breakeven, that equates to borrowing at a 0% interest rate on roughly half the asset base at the current size of the insurance operations.
 

This is why the intelligent growth in the insurance side over the last 5-7 years is such a big deal even if they “only” break even longer term.
 

Buffett has talked about that power of insurance float for 60 years and it is still widely misunderstood IMHO… at least in the Fairfax case.

 

FWIW, that float leverage is a big absolute *and relative* advantage for well managed insurance companies again, with borrowing costs for other industries back off the zero bound.

Also, as they flip to highly cash generative, the share count and minority interests should continue to shrink.

 

From this valuation starting point, that all could translate to a ~8-10x return over the next decade with mid teens EPS growth (even with zero growth on the insurance side) if the “exit” multiple expands to a fair low-to-mid teens multiple of earnings.
 

Haters would be in shambles

 

not investment advice

 

 

I agree with the bullish thesis, long fairfax. But 10x? What all has to go right to land at a 10x? I cant make my numbers work really to get to that outcome, could you walk us through it? 

 

 

[MMM20]

5 hours ago, Luca said:

I agree with the bullish thesis, long fairfax. But 10x? What all has to go right to land at a 10x? I cant make my numbers work really to get to that outcome, could you walk us through it? 

 

 

Something like 4-6% on cash/fixed income, 10-12% on all equities, and little to no growth in insurance but an aggregate 98-100% combined ratio
 

Excess cash -> buy back stock and minority interests, then more stuff like their recent JAB investment as opposed to early 2010s era rescue financings

 

That pencils out to ~15-17% EPS CAGR = ~4-5x EPS growth over a decade… valuation on earnings doubles or better to a fair 12x+ multiple = ~8-10x MOIC

 

Just one scenario and guaranteed to be precisely wrong, but IMHO no heroic assumptions…those are just market beta type e(r)s, and seems like the insurance side still has runway to “top 10” status from this position of strength (and/or might sustainably underwrite to 97% or better combined)

 

I continue to believe 12-15x earnings (yes, 2x+ BV) is quite clearly much fairer than 6x if looking forward instead of backward… still not holding my breath

 

I was just trying to point out the potential power of so much ~0% cost float leverage (and a low starting point for valuation) if they continue to execute well

 

Edited April 27, 2023 by MMM20

[Luke]

10 hours ago, MMM20 said:

Something like 4-6% on cash/fixed income, 10-12% on all equities, and little to no growth in insurance but an aggregate 98-100% combined ratio
 

Excess cash -> buy back stock and minority interests, then more stuff like their recent JAB investment as opposed to early 2010s era rescue financings

 

That pencils out to ~15-17% EPS CAGR = ~4-5x EPS growth over a decade… valuation on earnings doubles or better to a fair 12x+ multiple = ~8-10x MOIC

 

Just one scenario and guaranteed to be precisely wrong, but IMHO no heroic assumptions…those are just market beta type e(r)s, and seems like the insurance side still has runway to “top 10” status from this position of strength (and/or might sustainably underwrite to 97% or better combined)

 

I continue to believe 12-15x earnings (yes, 2x+ BV) is quite clearly much fairer than 6x if looking forward instead of backward… still not holding my breath

 

I was just trying to point out the potential power of so much ~0% cost float leverage (and a low starting point for valuation) if they continue to execute well

 

Thanks for sharing, yeah, with a triple in valuation, very nice returns on equity+continued higher interest rates above 4% and no big disasters would produce an insane amount of cash. If the Stars Allign the underwriting could also jump on top and than we could really see a big lift off here. What is the likely hood of a stronger soft market happening? Premiums declining? I know @Viking mentioned its softening a bit already. The great thing is really that the valuation is so undemanding that the upside is quite free and the downside over 10 years is quite limited. 

 

Thanks for all the hard work for everyone who shares details here, helped me a lot to figure out fairfax! 

[Viking]

6 hours ago, Luca said:

Thanks for sharing, yeah, with a triple in valuation, very nice returns on equity+continued higher interest rates above 4% and no big disasters would produce an insane amount of cash. If the Stars Allign the underwriting could also jump on top and than we could really see a big lift off here. What is the likely hood of a stronger soft market happening? Premiums declining? I know @Viking mentioned its softening a bit already. The great thing is really that the valuation is so undemanding that the upside is quite free and the downside over 10 years is quite limited. 

 

Thanks for all the hard work for everyone who shares details here, helped me a lot to figure out fairfax! 

@Luca On the Chubb call yesterday Evan Greenberg sounded pretty confident that 2023 would be another solid year in terms of top line growth (high single digit). This suggests to me that that the hard market is slowing - but we are still in a hard market. 
 

What comes next? Looking at history i think it is normal after the hard market to get a couple of sideway years (not hard or soft). And then a soft market. No one really knows… so we take it one quarter at a time. 

[Thrifty3000]

 

Bought back 87,000 shares last month. That’s a nice pace.

[Luke]

18 hours ago, MMM20 said:

Something like 4-6% on cash/fixed income, 10-12% on all equities, and little to no growth in insurance but an aggregate 98-100% combined ratio
 

Excess cash -> buy back stock and minority interests, then more stuff like their recent JAB investment as opposed to early 2010s era rescue financings

 

That pencils out to ~15-17% EPS CAGR = ~4-5x EPS growth over a decade… valuation on earnings doubles or better to a fair 12x+ multiple = ~8-10x MOIC

 

Just one scenario and guaranteed to be precisely wrong, but IMHO no heroic assumptions…those are just market beta type e(r)s, and seems like the insurance side still has runway to “top 10” status from this position of strength (and/or might sustainably underwrite to 97% or better combined)

 

I continue to believe 12-15x earnings (yes, 2x+ BV) is quite clearly much fairer than 6x if looking forward instead of backward… still not holding my breath

 

I was just trying to point out the potential power of so much ~0% cost float leverage (and a low starting point for valuation) if they continue to execute well

 

A lot depends on interest rates here and how well they make their bets, past performance is quite decent already. Future has a lot of economic and geopolitical uncertainty, wouldnt surprise me if we go away from the peaceful 0% growth mode. How do you guys personally see interest rates developing? 

 

 

 

 

 

 

 

 

 

[MMM20]

4 hours ago, Luca said:

How do you guys personally see interest rates developing? 

I put zero stock in my own personal view on that. But I do think Research Affiliates estimates and confidence intervals above are better than nothing in framing asset allocation decisions.
 

I also think FFH has earned shareholders trust on that front. Frankly I would look at what they’re doing rates+credit and let that inform my own positioning.
 

Clearly it’s prudent to assume reversion to the mean on insurance growth and profitability. But that doesn’t mean things are about to fall apart tomorrow or that float will shrink, just that this piece will prob grow much slower over the next few years than the last few. 
 

I think the most important thing is that FFH has built up a big structural advantage in that float over the last 5-7 years with smart acquisitions and organic growth.

And now we really need no additional insurance growth - just good management - and only ok investment results for FFH to compound at 2-3x the returns of a 60/40 index portfolio from this starting point. 

 

I think that’s true whether we end up with 1% or, idk, 8% returns from cash+fixed income. 

 

Edited April 27, 2023 by MMM20

[Viking]

3 hours ago, Thrifty3000 said:

 

Bought back 87,000 shares last month. That’s a nice pace.

@Thrifty3000 what Fairfax does with capital allocation in 2023 will be super interesting to follow. They could easily take out 1 million shares = 4% of shares outstanding. Fairfax had to pay the dividend in Q1 = @ $250 million so it makes sense share buybacks might be lighter to start the year. I really like what they have been doing the last couple of years - a nice balance between:

- strengthen balance sheet - buy out minority partners - Allied World last year
- growth - organic - support subs - hard market

- growth - acquisition - insurance - GIG is a good example here

- growth - acquisition - non-insurance - Recipe is a good example here

- share buybacks

 

Edited April 27, 2023 by Viking

[Parsad]

On 4/21/2023 at 4:41 PM, Thrifty3000 said:

 

^ @Parsad What’s the beef with Robert Gunn? 42% of subordinate shares voted against him is pretty aggressive.

 

Not sure.  He had 97% voting support in 2021, then it fell dramatically in 2022 and then again in 2023.  

 

He's 77, which isn't much older than Prem and he's younger than David Johnston.  He's attended all meetings in 2023.  I can't find anything that would indicate a group of investors has an issue with him.  Perhaps it was an accidental click by a large pension fund or investor...but that's a lot of votes...I can't see it being just one.

 

Maybe some investor's are upset with Northbridge or something?  I don't know.  Anyone have any idea?

 

Cheers!

[glider3834]

viking suggested I put up a post on this subject - buyout of 12% stake from Allied minority shareholders - I won't detail all the background here but just the key points - just to qualify I am not an expert on IFRS accounting, I have cobbled this info together from filings and we are missing shareholder agreement bw minority investors & Fairfax.

 

I guess the purpose of this post is to try and look at the mechanics of this deal and how future transactions with minority interests in Allied, Odyssey, Brit or other subs might look.

 

So here we go

 

1. What did Fairfax pay for the 12% stake in Allied?

 

Fairfax paid $650M cash to minority shareholders for their 12% stake in Allied in Sep-22, this is actually equal to the minority shareholders original investment in July 2017. 

 

 

Here is the calculation (12%/29.1%) x $1580M = $650M

 

So we could infer that its likely Fairfax will need to spend $930M to acquire the remaining 17.1% stake in Allied now held by minority shareholders.

 

Question: Can we also infer that  this is the buyout price template for Odyssey & Brit minority stakes as well?

 

2. What was Fairfax's equity financing cost for this deal? Minority shareholders received a priority, fixed 8% annual dividend (or $126.4M on $1580M investment) from Allied.

 

 

Putting 1. & 2. together - both the equity financing and buyout price are fixed. Fairfax benefit is that it retains all the upside from Allied's revenue, net income and shareholder equity growth.

 

3. What is the immediate cash benefit to Fairfax of this deal?

By my estimate = $22.7M per annum

Calculation

8% dividend paid on 12% stake = $52M less $29.3M (after-tax interest cost on senior notes used to fund deal ie $650M x 5.63% x (1-0.2) - lets assume a 20% tax rate

 

Any further upside that Fairfax receives from this acquired 12% share of Allied over & above $52M is gravy.

 

4. How is fair value of consideration (including accrued dividend)  of $733.5M calculated?

 

This is equal to $650M cash paid plus $38.5M accrued dividend paid (on 12% stake for 1 Jan to 27 Sep) plus (I am estimating) $45M fair value of call option exercised.

 

5. Does the 12% Allied buyout impact earnings or book value?

 

It increases Fairfax's share of Allied's operating earning & going forward EPS - common shares 

It reduced BVPS as the fair value of consideration (excluding accrued dividend paid) = $695M was more than $467M carrying value of 12% stake in Allied - so the difference is a $228M reduction in common shareholder equity (important point this impacts shareholders equity (specifically its a loss of retained earnings) and it doesn't run through the earnings statement).

 

I hope I haven't given anyone a headache! lol

 

 

 

 

 

 

 

 

 

 

 

Edited April 28, 2023 by glider3834