Fairfax 2024

[Hoodlum]

54 minutes ago, Dinar said:

Munich RE was up 4.1% after announcing 2025 earnings forecast, including forecasting a 79 combined ratio in the reinsurance business.

Swiss Re today as well is targeting a P&C CR of below 85 for 2025.  They also committed to at least a 14% ROE over the next few years

 

 

Edited December 13, 2024 by Hoodlum

[Viking]

2 hours ago, mananainvesting said:

Fairfax buys back 14% of Brit from Omers, increasing ownership to 100%. 

 

https://www.fairfax.ca/press-releases/fairfax-announces-acquisition-of-omers-investment-in-brit-2024-12-13/

I love it. This increases the numerator of the EPS calculation. (Buybacks reduce the denominator of the EPS calculation.) Like when they purchased a chunk of Allied World a couple of years ago, I wonder if this will create some minor noise when Fairfax reports Q4 results? I do not understand how a ‘call option’ flows though the financial statements when it is exercised. I am not complaining - more a heads up so we are not surprised.

 

From the announcement today

 

TORONTO, Dec. 13, 2024 – Fairfax Financial Holdings Limited (“Fairfax”) (TSX: FFH and FFH.U) announces that it has increased its ownership interest in Brit Limited to 100% from 86.2% by acquiring the interest of OMERS, the pension plan for Ontario’s municipal employees, for cash consideration of approximately US$383 million.

From Fairfax’s 2021AR

 

“Sale of non-controlling interest in Brit On August 27, 2021 Brit issued shares representing a 13.9% equity interest to OMERS for cash consideration of $375.0 which was subsequently paid by Brit as a dividend to Fairfax. The company recorded an aggregate equity gain of $115.4, principally comprised of a dilution gain and the fair value of a call option received, which was presented as other net changes in capitalization in the consolidated statement of changes in equity.The company has the option to purchase OMERS’ interest in Brit at certain dates commencing in October 2023.”

 

“Brit, based in London, England, is a market-leading global Lloyd’s of London specialty insurer and reinsurer. In 2021, Brit’s net premiums written were US$1,998.3 million. At year-end, the company had shareholders’ equity of US$1,912.1 million and there were 854 employees.”

 

From Fairfax’s 2023AR

 

“Brit, based in London, England, is a market-leading global Lloyd’s of London specialty insurer and reinsurer. In 2023, Brit’s net premiums written were US$2,982.7 million.At year-end, the company had shareholders’ equity of US$2,617.2 million and there were 911 employees.”

Edited December 14, 2024 by Viking

[Hoodlum]

3 minutes ago, Viking said:

I love it. This increases the numerator of the EPS calculation. (Buybacks reduce the denominator of the EPS calculation.) Like when they purchased a chunk of Allied World a couple of years ago, I wonder if this will crease some minor noise when Fairfax reports Q4 results? I am not complaining. This is a solid move.

 

From the announcement today

 

TORONTO, Dec. 13, 2024 – Fairfax Financial Holdings Limited (“Fairfax”) (TSX: FFH and FFH.U) announces that it has increased its ownership interest in Brit Limited to 100% from 86.2% by acquiring the interest of OMERS, the pension plan for Ontario’s municipal employees, for cash consideration of approximately US$383 million.

From Fairfax’s 2021AR

 

“Sale of non-controlling interest in Brit On August 27, 2021 Brit issued shares representing a 13.9% equity interest to OMERS for cash consideration of

$375.0 which was subsequently paid by Brit as a dividend to Fairfax. The company recorded an aggregate equity gain of $115.4, principally comprised of a dilution gain and the fair value of a call option received, which was presented as other net changes in capitalization in the consolidated statement of changes in equity.The company has the option to purchase OMERS’ interest in Brit at certain dates commencing in October 2023.”

 

“Brit, based in London, England, is a market-leading global Lloyd’s of London specialty insurer and reinsurer. In 2021, Brit’s net premiums written were US$1,998.3 million. At year-end, the company had shareholders’ equity of US$1,912.1 million and there were 854 employees.”

 

From Fairfax’s 2023AR

 

“Brit, based in London, England, is a market-leading global Lloyd’s of London specialty insurer and reinsurer. In 2023, Brit’s net premiums written were US$2,982.7 million.At year-end, the company had shareholders’ equity of US$2,617.2 million and there were 911 employees.”

I also wonder if this had to be completed before the transition of KI Insurance transition out of Brit on Jan 1. 

[SafetyinNumbers]

1 hour ago, Hoodlum said:

The first sub buyback with more to come in 2025. It is interesting that Fairfax paid only $8M more than what they sold this for in 2021. So it looks like OMERS only benefited from the Brit dividends over that time. 
 

I believe we have now shifted away from share buybacks, focusing instead on buying back sub minority ownerships.  Odyssey Re will likely be next with the exit of non-profitable contacts completing in Q4. 
 

 

It’s interesting. Unless I did the math wrong, so far the dividends received by OMERS until the end of Q224 were ~19% of their initial investment and with the gain a total of ~21%. So not a huge return over 40 months. It’s possible there was also another dividend in the past 5 months which would add to it.

[Hoodlum]

35 minutes ago, SafetyinNumbers said:

It’s interesting. Unless I did the math wrong, so far the dividends received by OMERS until the end of Q224 were ~19% of their initial investment and with the gain a total of ~21%. So not a huge return over 40 months. It’s possible there was also another dividend in the past 5 months which would add to it.

i suspect that the extra $8m was to cover the dividend for most of Q4. 

[TwoCitiesCapital]

1 hour ago, SafetyinNumbers said:

It’s interesting. Unless I did the math wrong, so far the dividends received by OMERS until the end of Q224 were ~19% of their initial investment and with the gain a total of ~21%. So not a huge return over 40 months. It’s possible there was also another dividend in the past 5 months which would add to it.

 

I don't think it's surprising to most of us to hear it was structured as some form of fixed rate financing arrangement. 

 

But consider where the 10-year treasury was in mid-2021 - like 1.5%. Corporate bonds wouldn't have been much higher. 

 

So this was still a very attractive deal for OMERS in terms of fixed return options. 

 

They got a 4-years bonds paying 4+% instead of 2+%. 

[SafetyinNumbers]

1 hour ago, TwoCitiesCapital said:

 

I don't think it's surprising to most of us to hear it was structured as some form of fixed rate financing arrangement. 

 

But consider where the 10-year treasury was in mid-2021 - like 1.5%. Corporate bonds wouldn't have been much higher. 

 

So this was still a very attractive deal for OMERS in terms of fixed return options. 

 

They got a 4-years bonds paying 4+% instead of 2+%. 

I agree but I did think this financing was more expensive. Happy to be wrong. 

[Redskin212]

I think OMERS hurdle for these type transactions is 9%

[SafetyinNumbers]

7 hours ago, Redskin212 said:

I think OMERS hurdle for these type transactions is 9%

Looks like they made 6% on this one. 

[Thrifty3000]

Anyone else hear rates gonna be higher for longer? Or, just me?

[SafetyinNumbers]

1 hour ago, Thrifty3000 said:

Anyone else hear rates gonna be higher for longer? Or, just me?

Very few stocks available that benefit from higher rates, a stronger USD and a sell off in quality stocks. FFH price might go down with it in the short term (as holders either need liquidity or think they are switching into something cheaper) but expected forward ROE is probably going up.

 

It also looks there is a plan to IPO Ki. I don’t know it well but it seems like BX has 80% of the equity (Class B & C) but there are different classes with different rights. The Class C appear to be cheap leverage with an 8% preferred return that gets repaid at the listing price meaning they may result in a big increase in Brit/FFH’s equity stake. These are like OMERS shares in Brit which appear to be 6% and understated FFH’s economics.
 

Ki might attract a very healthy multiple to book value and/or premiums given the nature of company (fast growth/AI) and the players (BX). Ki will likely do north of $1b in annual premiums soon so it could be material to FV over CV if it lists at 5-10x premiums.

 

Ki Articles of Incorporation 9.23.20.pdf

Edited December 19, 2024 by SafetyinNumbers
Did some work

[TwoCitiesCapital]

1 hour ago, Thrifty3000 said:

Anyone else hear rates gonna be higher for longer? Or, just me?

 

So we're told...

 

And yet, CPI-U is still sub 3%. Perhaps the trend is reaccelerating, but spending a few months between 2.5-2.7% hardly screams danger zone to me. My bias is for the intermediate outlook to be lower rates - especially with industrial activity/manufacturing shitting the bed again. 

Edited December 19, 2024 by TwoCitiesCapital

[Thrifty3000]

16 hours ago, TwoCitiesCapital said:

 

So we're told...

 

And yet, CPI-U is still sub 3%. Perhaps the trend is reaccelerating, but spending a few months between 2.5-2.7% hardly screams danger zone to me. My bias is for the intermediate outlook to be lower rates - especially with industrial activity/manufacturing shitting the bed again. 

Yeah, here’s a chart showing rate predictions vs reality overtime. A big ol’ time waster. 
 

[TwoCitiesCapital]

8 hours ago, Thrifty3000 said:

Yeah, here’s a chart showing rate predictions vs reality overtime. A big ol’ time waster. 
 

 

Historically - the 2-year treasury is a pretty good predictor of the Fed - but is some what volatile itself. 

 

It peaked in 2023 and has mostly been range bound since, but with lower highs and lower lows. The trend is flat-to-down. 

[Viking]

Is Fairfax a Growth Company?

 

Talk to other investors about Fairfax and guess what they usually want to talk about? Investments. Not Fairfax’s insurance businesses. Which is nuts. Because Fairfax is a P/C insurance company. In this post, we will explore Fairfax’s little followed and therefore likely misunderstood and under-appreciated insurance business. 

 

Is Fairfax a growth company?

 

I realize that sounds like a dumb question to ask. I mean this is Fairfax after all. But hey, just for fun, what do the numbers tell us?

 

Despite its sizeable investment management business, Fairfax is - at its core - still a P/C insurance company (sorry to disagree with you Morningstar). And the best measure of top line performance at a P/C insurance company  is to look at the trend in net premiums written. How has Fairfax performed over the past decade with this very important metric?

 

The 10-Year performance of NPW (2014-2024)

 

Fairfax has grown net premiums written (NPW) from $6.1 billion in 2014 to an estimated $25.4 billion in 2024. This performance is on track to deliver a total increase in NPW of $19.3 billion or 315%, which is a compound annual growth rate (CAGR) of 15.3%.

 

To state the obvious, that is an amazingly high level of growth in NWP over a decade. 

 

Importantly, this high level of growth was delivered through both soft and hard P/C insurance markets. And bull and bear financial markets. The external environment did not impede Fairfax’s ability to grow. That is pretty impressive. And really, really instructive. Truth be told, the external environment was one of the key factors that allowed Fairfax to deliver such outstanding growth year after year. Volatility creates opportunity. And one of Fairfax’s core strengths is being opportunistic and capitalizing on volatility.

 

Per Share 

 

Buffett teaches us that total growth numbers are not the metrics investors/shareholders should be primarily focussed on. What really matters is what is going on with the per share metrics. 

 

Per share, Fairfax has grown NPW from $289/share in 2014 to an estimated $1,160/share in 2024. This performance is on track to deliver a total increase in NPW of $871/share or 302%, which is a compound annual growth rate (CAGR) of 14.9%. Bottom line, the phenomenal growth has not been driven by diluting Fairfax's existing shareholders. Much more on this in the next post.

 

 

But Fairfax’s performance over the past decade has actually been much better than this. And that is because the numbers above do not include Fairfax’s P/C insurance company in India - called Digit Insurance.

 

In February 2017, Fairfax made their initial investment in a P/C insurance start-up called Digit. Over the past 8 years, Digit has been one of the fastest growing P/C insurance companies in India. Earlier this year, Digit completed its IPO. The company currently has a market cap of about $3.8 billion, with Fairfax’s position worth around $2 billion. Fairfax is the largest (and controlling) shareholder of Digit.

 

Importantly, India is expected to have the best performing economy in the world over the next decade. With its investment in Digit, Fairfax is perfectly positioned to benefit from this rapid growth in the coming years.

 

Including Digit, the growth of Fairfax’s P/C insurance business over the past 10 years has been best in class among P/C insurance companies.

 

How did Fairfax do it?

 

Fairfax’s management team has been putting on a clinic for the past decade in how to do/utilize capital allocation to rapidly grow a P/C insurance business.

 

But investors/analysts have been so focussed (infatuated?) with Fairfax’s investment business they have completely missed out on what has been happening with its P/C insurance business. And what it means for the company moving forward.

 

Capital allocation

 

Yes, we keep coming back to capital allocation.

 

Why is this?

 

Because it is really important. Especially for a P/C insurance company like Fairfax. As we have discussed in the past, capital allocation is the most important job of a management team.

 

But the funny thing is, when people think about capital allocation and Fairfax they tend to only think (and talk) about the investment side of the business. (Yes, I am including much of my writing/analysis when I say this). That’s the ‘sexy’ part. And yes, Fairfax has done some pretty spectacular things with investments, especially in recent years.

 

But the insurance business?

 

It gets very little thought. Even less discussion. 

 

But guess what?

 

On the capital allocation front, Fairfax has done some pretty spectacular things with its P/C insurance business as well. Of course this matters a great deal. Because the two businesses - insurance and investments - are joined at the hip for Fairfax. Grow insurance and you grow that wonderful thing called float - that liability that is really an asset (for well run insurance companies, like Fairfax).

 

The steady, long term growth of the P/C insurance business was the primary engine that allowed Warren Buffett to deliver decades of outstanding growth for Berkshire Hathaway and its shareholders. Understanding what Buffett was doing with his insurance business over the years was a critical input to properly understanding and valuing Berkshire Hathaway. 

 

So let me say it again.

 

Fairfax has grown its insurance business by 15.3% per year for the past decade. Not including Digit. Guess what this kind of steady, long term growth does to the intrinsic value of a company? Yes, it sends it to the moon.

 

Are we paying attention yet?

 

What happens with insurance matters. A lot. Because the growth of the insurance business is what feeds the investment business.

 

The fact that such little attention is paid to Fairfax’s insurance business (its quality and its growth) puts a smile on my face. It tells me it is likely not yet reflected in the share price. As a result, investors continue to underestimate Fairfax’s future earnings and ROE.

 

Over the past 10 years, Fairfax has made a number of extraordinary moves to rapidly grow their insurance business. Under everyone noses, they have quietly built a power house P/C insurance business - in terms of quality and growth. This post is focussed on the growth aspect. A future post will tackle the quality aspect.

 

The quiet giant

 

Guess how many large cap Canadian companies have grown their top line by 15.3% for a decade straight? 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. In 2023 they were ranked in the #21 position (same as 2022). 

 

 

Source: From Fairfax’s Slide Presentation at April 2024 AGM – Excluding Lloyd’s

 

So, let’s ask the question again that we began our post with…

 

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 so much here in Canada) but actually winning? That is crazy. Canada must be so proud! Let’s invite Prem to Ottawa, hold a parade and celebrate! 

 

Except… ummm… few people in Canada seem 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 share price?

 

My current estimate is Fairfax will earn $160/share in 2024. This would put year-end book value at about $1,085 and would represent an ROE of about 16%.

 

From a valuation perspective, this would put Fairfax’s:

• P/BV at 1.29 x
• PE at 8.7 x

These are very low valuations for a company that:

• Has a CAGR for NPW of 15.3% over the past decade.
• Is also projected to deliver an ROE of 16% in 2024 (and mid teens moving forward).

Why is Fairfax’s valuation so low?

 

One reason is likely because with the hard market slowing, investors/analysts expect top line growth (in net premiums written) to markedly slow at Fairfax in the coming years. That might make sense from an industry perspective. But does that make sense for Fairfax? Looking at Fairfax's past, I don’t think it does. Because Fairfax has a proven ability to grow its insurance business over the long term at above market rates. 

 

 

Accounting value versus economic value

 

Importantly, Fairfax’s book value of $1,085/share does not include the ‘excess of fair value over carrying value’ of associate and consolidated equity holdings, which was $1.9 billion ($86/share pre-tax) at September 30, 2024.

 

And 2024 estimated EPS of $160/share for Fairfax does not include the change in ‘excess of fair value over carrying value’ for associate and consolidated equity holdings in 2024, which was $900 million ($41/share pre-tax) at September 30, 2024.

 

In 2024, Fairfax’s economic results are tracking to be much better than their accounting results.

 

This makes Fairfax’s stock look even cheaper from a valuation perspective.

 

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. 

 

—————

 

What did Fairfax do to drive all that top-line growth in NPW?

 

In our next post, we will dig into exactly what Fairfax did to drive all that top-line growth in net premiums written over the past decade:

• Phase 1: Acquisitions – International expansion (2015-2017)
• Phase 2: Organic - Hard market (2019-2024)

I will also explain why I am optimistic about growth in the coming years, even though it appears parts of the hard market in insurance are slowing.

• Phase 3: Take-out of minority partners (2022-2026)

What we learn should help us better understand Fairfax and their P/C insurance business. And its growth prospects in the coming years. In turn, this should help us to properly value the company. 

 

The next post should be out in the next week

Edited December 22, 2024 by Viking

[villainx]

Thanks!

[nwoodman]

Purely a curiosity, but as we close out the year it’s interesting that the FRFH (USD) share price is +/- the same as a Class A but with 40 years difference to the month.  One hell of a compounding curve over a 40 year time horizon.  Magnificent!

 

 

EDIT: Those minor perturbations between the voting vs weighing machine no doubt were hotly debated and in the end, corrected, but also resulted in large wealth transfers.  Also you needed to survive the 50% draw downs.

Edited December 21, 2024 by nwoodman

[SafetyinNumbers]

4 hours ago, nwoodman said:

Purely a curiosity, but as we close out the year it’s interesting that the FRFH (USD) share price is +/- the same as a Class A but with 40 years difference to the month.  One hell of a compounding curve over a 40 year time horizon.  Magnificent!

 

 

EDIT: Those minor perturbations between the voting vs weighing machine no doubt were hotly debated and in the end, corrected, but also resulted in large wealth transfers.  Also you needed to survive the 50% draw downs.

Thanks for sharing! I love these analogs because it opens my mind up to right tail potential.

1984-1994 is where a lot of the magic happened. BRK’s BV went from ~$1100 to ~$10000 or a ~25% CAGR and the multiple went from ~1.35x to ~2x. Combined that was a ~30% CAGR. Since then it’s been closer to ~12% which is still great but well below most quality investors hurdle rates.

 

Fairfax is a lot bigger than BRK was in 1984 and is actually a lot closer to BRK’s size (market cap) at the end of 1994 but given the set up, it’s not out of the realm of possibility that FFH can match that decade over the next decade. My hurdle rate is 10% so to have that right tail potential with margin of safety is very compelling to me. 

 

 

[Jaygo]

On 12/21/2024 at 8:31 AM, SafetyinNumbers said:

Fairfax is a lot bigger than BRK was in 1984 and is actually a lot closer to BRK’s size (market cap) at the end of 1994 but given the set up, it’s not out of the realm of possibility that FFH can match that decade over the next decade. My hurdle rate is 10% so to have that right tail potential with margin of safety is very compelling to me. 

 

Is that inflation adjusted? I thought brk was quite large by 1984 having well over a billion in common stocks at that point plus the operating companies.

 

A like for like comparison would be really interesting.

 

[SafetyinNumbers]

8 minutes ago, Jaygo said:

 

Is that inflation adjusted? I thought brk was quite large by 1984 having well over a billion in common stocks at that point plus the operating companies.

 

A like for like comparison would be really interesting.

 

No, not inflation adjusted. Just based on market cap at the time. 

[Hoodlum]

It looks like we have a long ways to go before Fairfax would consider moving to more corporate bonds.  The spreads are at multi-decade lows.

 

https://www.theglobeandmail.com/business/article-the-market-euphoria-has-no-limits-even-sophisticated-bond-investors/

 

For investment grade corporate bonds in the U.S., which are bonds issued by blue chip companies, the average spread over government debt is currently around 80 basis points, or 0.8 percentage points, according to the ICE BofA US Corporate Index spread. That’s a 19-year low.

 

The same is true for U.S. high yield debt, or bonds issued by companies with “junk” debt ratings that have lower chances paying the money back. For these bonds, the average spread is around 2.7 percentage points, far below the 4.9 percentage points average over the past two decades, according to the Bloomberg U.S. Corporate High Yield Index.

[dartmonkey]

2 hours ago, SafetyinNumbers said:

No, not inflation adjusted. Just based on market cap at the time. 

When was Berkshire the same size as Fairfax with its current $31.5b valuation? It's an interesting question, as Berkshire is clearly constrained at its current size, most private and public companies being too small to move the needle.

 

In the end of 1988, before the B-shares were introduced (in 1996), Berkshire had 1.72m shares outstanding, share price $4,700, for a market cap of $8.1b, or $21.5b in today's dollars, quite a bit smaller than Fairfax today. But the share price doubled one year after, and Berkshire closed 1989 with a share price of $8675, and a market cap of $15.0b, or $38.1b in 2024 dollars. So we can say that Fairfax is now at Berkshire's size some time in 1989. We still have some room to run.

[benchmark]

23 minutes ago, dartmonkey said:

When was Berkshire the same size as Fairfax with its current $31.5b valuation? It's an interesting question, as Berkshire is clearly constrained at its current size, most private and public companies being too small to move the needle.

 

In the end of 1988, before the B-shares were introduced (in 1996), Berkshire had 1.72m shares outstanding, share price $4,700, for a market cap of $8.1b, or $21.5b in today's dollars, quite a bit smaller than Fairfax today. But the share price doubled one year after, and Berkshire closed 1989 with a share price of $8675, and a market cap of $15.0b, or $38.1b in 2024 dollars. So we can say that Fairfax is now at Berkshire's size some time in 1989. We still have some room to run.

Berkshire is a true unicorn. I don't think that comparison between the two is meaningful. I'd be happy if Fairfax is half as successful as Berkshire.

[SafetyinNumbers]

9 minutes ago, benchmark said:

Berkshire is a true unicorn. I don't think that comparison between the two is meaningful. I'd be happy if Fairfax is half as successful as Berkshire.

They have the same business model i.e. using insurance float for “leverage” to make equity investments so that’s why a comparison is interesting. Just like any investor that invests in equities on an absolute return basis though their idiosyncratic returns will be unique. 
 

I’m using BRK to open my mind up to the possibilities with FFH. The more time I spend on it, the more right tails I get excited about so one can see how ROE can average way higher than anyone expects. Investors selling it at 1.4x BV because they think that’s fair might miss out like those who sold BRK in early 1985. The odds FFH can compound BV at 25% a year for the next decade, like BRK did from 85-94, are probably pretty low but they are not non-zero and could be north of 10%.  I like free/cheap optionality. 

[Viking]

Is Fairfax a Growth Company? Part2

 

In Part 1, we looked at Fairfax’s insurance business and asked the following question: ‘Is Fairfax a growth company?’ Our answer, based on the growth of net premiums written over the past decade, was ‘yes.’

• https://thecobf.com/forum/topic/20517-fairfax-2024/page/99/#findComment-592351

In Part 2, we will now dig into what happened at Fairfax over the past ten years to drive all that top-line growth in NPW.

 

Part II: A short history of the growth of net premiums written (NPW)

 

The 15.3% CAGR in NPW that Fairfax is poised to deliver from 2014-2024 has happened in two pretty distinct phases.

• Phase 1: Acquisitions – International expansion (2015-2017)
• Phase 2: Organic - Hard market (2019-2024)

After we review these two phases, we will then look at what might be coming next, in phase three:

• Phase 3: Take-out of minority partners (2022-2026)

As one would expect, there is some overlap with these phases.

 

So, let’s get started and peel back the onion a little bit. 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 how they do capital allocation looking through the lens of P/C insurance business. In turn, this will help us better understand and evaluate the performance of the management team.

 

Phase 1: Growth via acquisitions – international expansion (2015 to 2017)

 

Throughout their history, Fairfax has used acquisitions to help fuel its growth. Over a 3-year period, from 2015-2017, Fairfax made six different large P/C insurance acquisitions that cost a total of $7.5 billion.

 

How did Fairfax pay for the acquisitions?

 

At the time (2015 to 2017), Fairfax was short on cash as the investment side of the business was underperforming (losses from equity hedges/shorts and poorly performing legacy equity holdings… yes, sorry to keep picking that scab).

 

To fund the acquisitions, Fairfax used the traditional funding sources:

• Equity: Raised $3.34 billion (7.2 million shares at $462/share).
• Debt: from 2015 to 2017, net debt increased $2.1 billion (the average interest rate on the new debt was about 4.55% and the average maturity was about 9 years).

Asset sales have long been an underappreciated tool in Fairfax’s capital allocation tool box. From 2015 to 2017, Fairfax also raised significant cash with asset sales.

• Asset sales: $3.3 billion (Bank of Ireland, ICICI Lombard, First Capital, Ridley)

The sale of First Capital deserves special mention. In 2017, Fairfax sold First Capital for $1.7 billion and booked a $1 billion gain after-tax. First Capital was sold for more than 3 x book value. In comparison, Allied World, Fairfax’s largest acquisition, was purchased for 1.3 x book value. Smart. And very accretive for Fairfax shareholders.

 

But Fairfax wasn’t done with funding sources. They also got creative. They came up with a brand new way to source ‘other people’s money’. For the three larger purchases, Fairfax brought on minority partners - the big pension funds in Canada (OMERS and CPPIB).

• Minority partners: Raised $2.256 billion

Minority partners funded 30% of the $7.5 billion total purchase price.

 

 

How much did Fairfax grow from 2014 to 2018?

 

In a soft P/C insurance market, NPW increased from $6.1 billion in 2014 to $12.0 billion in 2018, for total growth of $5.9 billion or 96% over 4 years. Yes, the share count did increase quite a bit during this time so growth per share in NPW was lower at 53% (more on this later).

 

 

Capital allocation 101

 

Opportunistic: The timing of Fairfax’s acquisitions were close to perfect.

 

Fairfax are a value investors. Not just when it comes to their investment portfolio. They look at their insurance businesses through the same lens. In 2015, they saw great value in buying other P/C insurance companies. Insurance was in a soft market. Well run companies were available at reasonable valuations.

 

Conviction: Fairfax sized their bet appropriately - they backed up the truck.

 

At December 31, 2014, common shareholders’ equity at Fairfax was $8.4 billion. Spending $7.5 billion on acquisitions over a three year period was an extremely aggressive move by the company.

 

Creativity: Fairfax was very creative in how it raised the needed cash.

 

At the time (2015-2017), Fairfax was short on cash (putting it politely). The investment management part of the company was severely underperforming. What to do? In addition to the usual actions (tap equity and debt markets) Fairfax also sold assets at premium valuations. And they brought on minority partners.

 

The net result was Fairfax was able to double the size of their insurance business (net premiums written) in 4 short years from 2014 to 2018. Much of the growth was international. Fairfax now had a global P/C insurance platform.

 

—————

 

Growth by acquisition can be good but it does carry risks. Did 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?

 

The answer is a hard insurance market and that is what started in Q4 of 2019. 

 

Phase 2: Organic growth - hard insurance market (2019-2024)

 

Hard markets for P/C insurers are very rare. The last one was in 2001-2004. So when they happen, you need to capitalize on them. Fairfax understood this and that is what they proceeded to do.

 

What makes a hard market so good?

 

The opportunity to charge higher premiums and to apply more stringent underwriting (more favourable terms and conditions on policies). For well-run insurers like Fairfax, a hard market is like getting a gift from the insurance gods.

 

In late 2019, Fairfax was very well positioned to capitalize on the hard market. By then, the many large insurance acquisitions they had made from 2015 to 2017 had been fully integrated / digested.

 

But to grow aggressively in a hard market an insurance company needs capital. Lots of it. So Fairfax from a capital allocation perspective, Fairfax prioritized supporting the growth of the insurance subs.

 

How much did Fairfax grow over the 6-year period from 2018-2024?

 

Net premiums written increased from $12.0 billion in 2018 to an estimated $25.4 billion in 2024, for total growth of 111% over six years. However, during this period the share count decreased by 19% so growth per share was much higher at 162%. That is rocket-ship-emoji type organic growth over a five year period.

 

 

—————

 

We need to draw attention to two things Fairfax did in Phase 2: Organic Growth phase (2018-2024). Because they had a material impact on the insurance business.

 

1.) Fixed income - Side-stepping the historic bear market in bonds

 

2022 saw the greatest bear market in history in bonds. Most P/C insurers hold the vast majority of their investment portfolio in bonds. As a result of the spike in interest rates in 2022, the value of their bond portfolios got mauled. Book value for many P/C insurance companies fell by 20% to 30%. This had two effects:

• It lit a fire under the hard market in insurance (the losses on the investment side of the business put even more pressure to make money on the insurance side).
• It constrained their ability to capitalize on the hard market and grow their insurance business (the drop in book value lowered capital levels).

What about Fairfax?

 

In late 2021, Fairfax shifted the average duration of their fixed income portfolio to 1.2 years. Fairfax are value investors. In late 2021 they correctly surmised there was no margin of safety in owning duration in the bond portfolio. (Not surprisingly, Warren Buffett reached the same conclusion).

 

As a result, in 2022, Fairfax largely avoided the historic bear market in bonds. This saved Fairfax shareholders billion in losses. As a result, Fairfax was one of the very few P/C insurance companies that actually reported an increase in book value in 2022. This allowed Fairfax to fully capitalize on the hard market - they grew NPW by a staggering 25% in 2022. (Fairfax since extended the average duration of its bond portfolio to about 3.5 years - it is now close to matching the average duration of its insurance liabilities.)

 

Fairfax was able to side-step the greatest bear market in history in bonds. Saved the company billions in losses. And allowed them to fully capitalize on the hard market in insurance. Simply brilliant.

 

2.) Share Buybacks - How to use common shareholders equity to grow the insurance business

 

As a reminder, to support its aggressive acquisition strategy in insurance from 2014 to 2018, Fairfax increased effective shares outstanding by 6 million shares at an average cost of about $462 per share.

 

From 2018 to 2023, Fairfax reduced effective shares outstanding by 4.2 million at an average cost of about $503 per share. Fairfax was able to buy back 70% of the shares issued at a price that was about 10% higher than what they had been issued at - even though the intrinsic value of the company (measured through the lens of NWP/share) had substantially increased.

 

Of the 4.2 million shares bought back, at the end of 2021, Fairfax spent $1 billion to buy back 2 million shares at $500/share. At the time, Fairfax still did not have a lot of excess cash. And what cash they did have was being used to drive growth at the insurance subs in the hard market.

 

What to do?

 

Get creative - again - and sell part of an asset to minority partners. Fairfax sold 9.99% of Odyssey to 2 large Canadian pension funds for $900 million. 9.99% of Odyssey was sold at 1.7 x book value. And the proceeds were used to buy Fairfax shares that were trading at 1.1 times book value (and Fairfax knew intrinsic value was much, much higher).

 

Over the past 3 years, book value at Fairfax has exploded higher. Book value was $1,033 per share at September 30, 2024. (And yes, the intrinsic value of Fairfax is much higher than this). Fairfax’s shares are currently trading at about $1,400 per share. The buybacks made from 2018 to 2023 have delivered exceptional value to Fairfax shareholders.

 

The key takeaway is Fairfax saw a wonderful opportunity and they once again sized their bet appropriately - they backed up the truck. And they found a creative way to execute it.

 

In 2024, Fairfax continues to be very active on the share buyback front. I estimate they will reduce effective shares outstanding by another 1.1 million at an average cost of about $1,127 per share.

 

Full circle.

 

From 2014 to 2018, Fairfax grew effect shares outstanding by 6 million shares. From 2018 to 2024, they are on track to reduce effective shares outstanding by 5.3 million. The dilution caused by share issuance has almost been completely reversed. Importantly, the shares were repurchased at very attractive prices.

 

Fairfax’s use of common shareholders’ equity (issue and then repurchase shares) to aggressively expand its P/C insurance business over the past 10 years has delivered outstanding value to long term shareholders.

 

—————

 

A hard market is the best way for an insurance company to grow but they do not last forever. And it looks like the current hard market is slowing.

 

Does this mean that the growth story at Fairfax is over?

 

No. For a couple of reasons. One reason is Fairfax has set the table nicely for what will likely drive the next phase of growth for the company’s insurance business: the buying out of their minority partners. 

 

Phase 3: Take-out of majority/minority insurance partners (2021-2025)

 

As we have discussed, there were times from 2014 to 2022 when Fairfax was capital constrained. But that all changed in 2023. Earnings at Fairfax exploded higher. Fairfax is now earning around $4 billion per year. Importantly, this level of earnings looks like the new ‘normalized level.’ Not only is it sustainable, it should grow nicely in the coming years.

 

What will Fairfax do with this Smaug-like mountain of gold that is coming in each year?

 

The hard market in insurance appears to be slowing. This means the insurance subs will likely not be needing as much capital.

 

What else could Fairfax do?

 

Now that they are all cashed up, we could see Fairfax take out their insurance partners.

 

And guess what?

 

This is what they have been doing. In recent years, we have seen Fairfax getting more aggressive in taking out their minority/majority insurance partners beginning with the Allied World (2022) and then Gulf Insurance Group (2023). And in December, Fairfax announced the takeout of its minority partner in Brit (2024).

 

We will likely see this continue in 2025 and 2026.

 

How much has Fairfax spent in recent years to take out its insurance partners?

 

Over the past 4 years, Fairfax has committed to spend a total of $2.26 billion. Fairfax has been spending a significant amount of money, especially over the past 3 years, to take out its insurance partners.

 

 

Let’s do a short review of each of these transactions.

 

Eurolife

• 2018 & 2021 Eurolife
  • Increased ownership from 40% to 50% and then to 80%. The last 30% was purchased from OMERS in 2021 for $143 million.

Fairfax now owns 80% of Eurolife. Eurobank owns the remaining 20% of Eurolife.

 

Singapore Re

• 2021 Singapore Re
  • Paid $103 million to increase ownership from 28.1% to 96% (now 100%).

In this example, Fairfax took out the majority partner. Fairfax now owns 100% of Singapore Re. Their buyout in 2021 was timed perfectly - it was done right before the hard market in reinsurance started.

 

Allied World

• 2022 Allied World
  • Paid $733 million to increased ownership from 70.9% to 82.9%
  • In Q2 of 2023, paid $31 million to increase ownership from 82.9% to 83.4%.

In 2022, Fairfax began the process of buying out its partners in Allied World. Given the sums involved it makes sense Fairfax will do this in a couple of bites and over a couple if years.

 

Gulf Insurance Group

• 2023 Gulf Insurance Group
  • Fairfax took out the majority partner, KIPCO, with this purchase.
  • Fairfax increased their stake from 43.7% to 90%.
  • Paid $740 million (‘fair value aggregate valuation’).
  • In April of 2024, paid $126.7 million to increase ownership from 90% to 97.1%.

Like with Singapore Re, Fairfax took out the majority partner (Kipco in this case). Fairfax now owns 97% of GIG. This purchase was very important strategically - it solidifies Fairfax’s presence as one of the largest P/C insurance companies in the important and growing MENA (Middle East / North Africa) region.

 

Brit

• 2024 Brit
  • Paid $383 million to increased ownership from 84.2% to 100%.

Fairfax announced this transaction on December 13, 2024.

 

Why is taking out insurance partners good for Fairfax shareholders?

 

These purchases are a good ‘use of cash’ for Fairfax. They know the assets well (to state the obvious). From a capital allocation perspective, these transactions are very low risk / solid return for Fairfax.

 

Majority partners - from associate to consolidated holdings

 

In two of the transactions, Fairfax took out the majority partners. GIG was the larger purchase. This purchase has been driving the increase in NPW at Fairfax in 2024.

 

Minority partners - equity accounted holdings

 

The minority partners (OMERS and CPPIB) are getting paid for their investment (primarily via dividends in the 8% per year range?). Taking out the minority partners means the amount they are getting paid will now flow to Fairfax shareholders.

 

Taking out the minority insurance partners increases the share of Fairfax’s earnings that accrues to common shareholders - it increases their economic interest in the company.

 

For common shareholders, It increases the numerator in the earnings per share calculation. The ‘net earnings attributable to shareholders of Fairfax’ part.

 

Buying back shares reduces the denominator in the EPS calculation. Doing both at the same time? Yes, the result is magic for shareholders. (What is happening at Fairfax today.)

 

Taking out the minority partners also simplifies Fairfax’s structure and makes the company easier to understand.

 

Minority partners - What is left?

 

Fairfax has three large minority partner positions outstanding:

• Allied World at 16.6%
• Odyssey at 9.9%
• Eurolife at 20% (not included in the chart below because it is primarily a life insurer)

Taking out the minority partners at Allied and Odyssey will increase the economic ownership of Fairfax shareholders by about 6.6% (measured by NWP).

 

How much will it cost?

 

The total cost to Fairfax will likely be a little more than $2 billion.

 

 

—————-

 

After all this, what did we learn?

 

Growth investing is defined as identifying and investing in companies with above average growth prospects compared to the industry/peers. Over time, higher growth leads to higher earnings which usually 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?

 

In Part 1 we learned that Fairfax is a growth company. The numbers are pretty clear. From 2014 to 2024:

• Net premiums written increased from $6.1 to $25.4 billion = CAGR of 15.3%.
• NPW per share increased from $289 to $1,160 = CAGR of 14.9%

In Part 2 we learned how Fairfax achieved such high growth in its insurance business:

• From 2014 to 2018, growth was driven by acquisition.
• From 2019 to 2024, growth was driven by hard market.

This growth was achieved:

• In both soft and hard insurance markets.
• In bull and bear financial markets (stocks and bonds) - many of their best decisions came during times of extreme volatility.
• When they were severely short on cash (2015 to 2021).

Capital allocation

 

When it comes to capital allocation, all the ‘usual’ tools in the toolbox were skillfully used:

• Equity
• Debt
• Asset sales

Fairfax also discovered a new tool - minority partners.

 

Fairfax has been:

• Open minded - read the situation well.
• Rational - fact based decisions.
• Flexible - used the right tools.
• Creative - found solutions to problems.
• Opportunistic - acted when the time was right.
• Conviction - sized their decisions appropriately.
• Long term focus - kept their eye on the prize - building per share value over the long term for shareholders.

As a result, both capital allocation objectives were achieved:

• Increase in per share value for shareholders over the long term.
• Made the company stronger.

Over the past 10 years, Fairfax has been delivering a clinic in how to grow a P/C insurance business. The picture Fairfax has been painting is starting to come into focus for investors - and it looks like a masterpiece. Their strategic vision, planning, creativity and execution has built Fairfax into a global insurance giant that looks exceptionally well positioned today.

 

Based on what we have learned, when it comes to growing a P/C insurance company, I think we can reasonably conclude that the management team at Fairfax is best in class.

 

What about the future?

 

Most investors see the hard market slowing. So they naturally expect Fairfax’s top line growth (NWP) to also slow.

 

But is that what history teaches us?

 

No. History teaches us that Fairfax has been able to significantly grow its insurance business - regardless of where we are in the insurance cycle. The expectations of investors today is contradicted by what has actually happened at Fairfax over the past 10 years.

 

Fairfax grew their insurance business at a CAGR of 15.3% when they were cash poor. And now that they are all cashed up we should expect the growth of the insurance business to flatline?

 

That makes no sense to me.

 

At a minimum, Fairfax should be able to grow its insurance business in the coming years at a rate that exceeds (double?) the growth we see in the overall P/C insurance market.

 

There are some pretty simple things Fairfax can do today to grow the per share economic interest of shareholders:

• Continue to grow in the hard market. Yes, the rate of growth is slowing. However, with inflation staying elevated in the 3% range, we should see 3% to 5% growth in NPW in the coming years.
• Continue with bolt on acquisitions - like they have been doing.
• Take out of minority partners - Allied World, Odyssey and Eurolife. This will likely be a multi-year process.
• Share buybacks - Fairfax shares are still undervalued. Perhaps the pace of buybacks slows to around 2% per year.

These 4 activities alone should drive high single digit / low double digit growth in Fairfax’s insurance business - the economic interest of long term shareholders. Importantly, this does not include the growth that will be coming from Digit.

 

Management

 

Fairfax is generating an enormous amount of free cash flow - and this is expected to continue in the coming years. They also have a best in class management team. That is a wonderful combination.

 

Like they have done repeatedly in the past, I also expect that Fairfax will pull another rabbit out of their hat in the coming years - they will do something big that will build the per share value of their insurance business for long term shareholders. Something we don’t see today - but that will make sense a few years later.

 

What will they do?

 

We won’t know in advance. Because it will depend on what happens in insurance and financial markets. They will be opportunistic. As significant earnings continue to roll in year after year, Fairfax will have the capacity to do something large and transformative.

 

Or perhaps the focus will shift to the non-insurance side of the business for the next couple of years.

 

And that highlights the beauty of Fairfax’s business model (the P/C insurance model exploited so successfully for decades  by Warren Buffett).

 

Capital will go to the best risk adjusted opportunities. Insurance and/or investments. With a long term focus. Volatility will be exploited.

 

As an investor, I can’t wait to see what Fairfax does.

 

—————

 

Was 2010 to 2020 really a lost decade for Fairfax shareholders?

 

Looking at it strictly through the lens of the stock price, yes, it was. However, looking at it through the lens of the insurance business, we get a very different answer - no, 2010 to 2002 was not a lost decade for Fairfax shareholders. From 2015 to 2019, Fairfax did a very good job of significantly growing its insurance business (and integrating the new purchases). This set the table for Fairfax to reap the significant rewards of the hard market that got rolling in 2020.

 

The intrinsic value of Fairfax had been growing nicely at Fairfax from 2010 to 2020. But investors were so focussed on the mis-steps that were happening on the investment management side of the business that they completely missed the significant value that was being created on the insurance side of the business. They forgot that, at its core, Fairfax was still an insurance company. So when Fairfax fixed its problems on the investment management side of the business (the last short position was exited in Dec 2020), the true earnings power of the company was unleashed. Today, both businesses - insurance and investments - have never been positioned better.