Hoodlum Posted July 22 Share Posted July 22 (edited) 11 minutes ago, hardcorevalue said: Explain it to me like I’m 12 why this makes more sense than buying back their own stock... It allows shareholders to sleep better at night. The only thing I can think is that this was a rare opportunity to buy a Company providing long term earnings/dividends, albeit in a slow-growth industry. On the face if it, stock buy backs would be a better option over the sort term. Edited July 22 by Hoodlum Link to comment Share on other sites More sharing options...
TwoCitiesCapital Posted July 22 Share Posted July 22 34 minutes ago, hardcorevalue said: Explain it to me like I’m 12 why this makes more sense than buying back their own stock... Repurchases are done at the holding co level with hold co cash. Stelco cash and investment portfolios are held at the insurance subs level and have to maintain certain levels for the insurance they underwrite. Link to comment Share on other sites More sharing options...
Junior R Posted July 22 Share Posted July 22 35 minutes ago, hardcorevalue said: Explain it to me like I’m 12 why this makes more sense than buying back their own stock... same lol Link to comment Share on other sites More sharing options...
newtovalue Posted July 22 Share Posted July 22 ZZZ - Looks like roughly 10x FCF to equity holders at the acquisition price. Not terrible for an oligopoly business and growing demand due to increased population in Canada. Agree with @hardcorevalue that FFH buybacks would be preferable - but perhaps the capital is trapped in the subs as @TwoCitiesCapital mentioned . Link to comment Share on other sites More sharing options...
MMM20 Posted July 22 Share Posted July 22 (edited) Is ZZZ a good business? It doesn't screen that cheap vs ROIC which is nothing to write home about. Can someone please explain why this is a good use of capital? Do Canadians not buy mattresses online? I'm a bit baffled. Edited July 22 by MMM20 Link to comment Share on other sites More sharing options...
UK Posted July 22 Share Posted July 22 (edited) 1 hour ago, TwoCitiesCapital said: Repurchases are done at the holding co level with hold co cash. Stelco cash and investment portfolios are held at the insurance subs level and have to maintain certain levels for the insurance they underwrite. This was the first thought that also came to my mind as a possible explanation. But, one way or another, this only makes sense if this business is reasonably good and durable. Price paid for it suggests that somehow it has to be the case:)? Edited July 22 by UK Link to comment Share on other sites More sharing options...
KPO Posted July 22 Share Posted July 22 2 hours ago, hardcorevalue said: Explain it to me like I’m 12 why this makes more sense than buying back their own stock... On the surface this seems like a low quality acquisition unless there’s some structural reason that I’m missing as to why this business is better than failing counterparts in the US (e.g Mattress Firm). Retail bedding just seems a tough business with no moat, plus the Costco’s of the world and e-commerce can cherry pick. Link to comment Share on other sites More sharing options...
newtovalue Posted July 22 Share Posted July 22 Sleep country actually owns two of the biggest DTC Canadian brands - Casper and Endy Link to comment Share on other sites More sharing options...
Luke Posted July 22 Share Posted July 22 Who is bullish because of this acquisition? 2b for this seems like a lot... Link to comment Share on other sites More sharing options...
gfp Posted July 22 Share Posted July 22 5 minutes ago, Luke said: Who is bullish because of this acquisition? 2b for this seems like a lot... What is the fully diluted share count of ZZZ? Something like 35 million? I'm not sure I fully understand the convertible note with Casper. Link to comment Share on other sites More sharing options...
MMM20 Posted July 22 Share Posted July 22 1 hour ago, MMM20 said: Is ZZZ a good business? It doesn't screen that cheap vs ROIC which is nothing to write home about. Can someone please explain why this is a good use of capital? Do Canadians not buy mattresses online? I'm a bit baffled. Link to comment Share on other sites More sharing options...
SafetyinNumbers Posted July 22 Author Share Posted July 22 43 minutes ago, Luke said: Who is bullish because of this acquisition? 2b for this seems like a lot... The equity component is less than a quarter’s earnings and It’s got a growing earnings yield higher than treasuries. I prefer them buying assets vs buybacks to a certain extent because it increases durability but I know I’m in the minority on that point. Link to comment Share on other sites More sharing options...
gfp Posted July 22 Share Posted July 22 23 minutes ago, SafetyinNumbers said: The equity component is less than a quarter’s earnings and It’s got a growing earnings yield higher than treasuries. I prefer them buying assets vs buybacks to a certain extent because it increases durability but I know I’m in the minority on that point. Since we usually look at Fairfax's financials in US dollar terms - this is a cash outlay of like $890 million - $900 million USD right? Link to comment Share on other sites More sharing options...
SafetyinNumbers Posted July 22 Author Share Posted July 22 3 minutes ago, gfp said: Since we usually look at Fairfax's financials in US dollar terms - this is a cash outlay of like $890 million - $900 million USD right? I think that’s right. Link to comment Share on other sites More sharing options...
Luke Posted July 22 Share Posted July 22 44 minutes ago, SafetyinNumbers said: The equity component is less than a quarter’s earnings and It’s got a growing earnings yield higher than treasuries. I prefer them buying assets vs buybacks to a certain extent because it increases durability but I know I’m in the minority on that point. I agree that asset durability is important and i understand the acquisition from that POV. I also thought it was USD denominated but its CAD...confusing, not as large as I thought Link to comment Share on other sites More sharing options...
Viking Posted July 22 Share Posted July 22 (edited) Fairfax - Unconstrained Capital Allocation All P/C insurance companies have two engines to drive earnings/business results over time: Insurance Investments Insurance Pretty much all P/C insurance companies try and do the same thing with their insurance operations - they try and generate an underwriting profit. Some are better at it than others. The combined ratio communicates how a company’s insurance business is performing. Investments Pretty much all P/C insurance companies generally do the same thing with their investment portfolio - they invest it primarily in bonds. The average yield on the investment portfolio communicates how a company’s investments are performing. Investors As a result, it is a pretty simple process for investors to evaluate most insurance companies. Warren Buffett Warren Buffett screwed everything up back in 1967 when Berkshire Hathaway purchased National Indemnity, a P/C insurance company. How did Buffett screw things up? Buffett knew something that apparently no one else at the time knew: equities earn a much higher return over time than bonds. So after he bought National Indemnity he began to put some of its investment portfolio into equities. And what was the result? Magic. Excess returns + compounding + time = exponential growth. And that is what happened to Berkshire Hathaway’s earnings and stock price. It was like Buffett had found a golden goose. Capitalism We all know how capitalism works. When someone discovers a better mousetrap - begins earnings outsized profits - everyone else will rush in and copy the better business model. And quickly compete the outsized returns away. And that is what happened. All the big P/C insurance companies began investing a part of their investment portfolio into equities and their returns over time improved markedly. And their investors made out like bandits. EXCEPT THAT IS NOT WHAT HAPPENED. Almost all P/C insurance companies did not copy what Warren Buffett was doing at Berkshire Hathaway. Why not? Are other P/C insurance companies run by stupid people? The fly in the ointment - Wall Street Volatility Efficient Market Hypothesis and Modern Portfolio Theory When it comes to equities, Wall Street says volatility is the same thing as risk. Stocks ARE volatile. So Wall Street decided this also meant that stocks were also very risky - and therefore more likely to go down in value. Of course, this is garbage. Here is what Warren Buffett had to say about risk at the BRK’s AGM in 1994: “We do define risk as the possibility of harm or injury. And in that respect we think it’s inextricably wound up in your time horizon for holding an asset. I mean, if your risk is that if you intend to buy XYZ Corporation at 11:30 this morning and sell it out before the close today, in our view that is a very risky transaction. Because we think 50 percent of the time you’re going to suffer some harm or injury. If you have a time horizon on a business, we think the risk of buying something like Coca-Cola at the price we bought it at a few years ago is essentially so close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you’re going to sell it tomorrow morning, I say that is a very risky transaction.” Short term focus Most P/C insurance companies are publicly traded companies. They are beholden to what Wall Street wants. Wall Street wants companies to hit quarterly earnings estimates - if a company misses, their stock usually gets punished. If this happens too many times, the CEO likely loses his job. Incentives matter. Most CEO’s want to keep Wall Street happy. As a result, they avoid volatility like the plague. The insurance business is volatile enough. Adding volatility to the investment side of the business is a bridge too far for most P/C insurance executives. So they have no interest in investing in equities. The odd ducks Well, there are a few odd ducks that decided to follow Warren Buffett’s lead: Markel Fairfax Financial What allowed these misfits to thumb their nose at Wall Street? Ownership structure Warren Buffett can do what he wants with Berkshire Hathaway because he is in control of the company. It just so happens the other two companies also have controlling shareholders: Markel - Markel family Fairfax Financial - Prem Watsa Long term focus This ownership structure allows each of these companies to focus on long term value creation for their shareholders. Higher lumpy returns (investing in equities) are preferred to lower smooth returns (investing exclusively in bonds). This can’t be right. This sounds too easy. How have these 3 companies performed over time? The long term performance of each of these 3 companies (since inception for each) has been epic. How did they achieve such impressive results? Their P/C insurance business was better than average (much better in the case of Berkshire Hathaway). But their outperformance overwhelmingly came from their investment results and their capital allocation decisions. What about today? A fork in the road. Berkshire Hathaway was so successful at investing in equities that it decided it wanted to own entire companies. This begat more success. Over the past 20 years, Berkshire Hathaway has morphed into a very successful conglomerate, with P/C insurance now only one part of a much larger company. Markel is doing its best to follow in Berkshire Hathaway’s footsteps and become a conglomerate itself. What about Fairfax Financial? Fairfax appears to have little interest in becoming a conglomerate like Berkshire Hathaway (notwithstanding their just announced purchase of Sleep Country). In fact, today Fairfax’s business model looks unique in the P/C insurance industry. Their uniqueness is not on the P/C insurance side of things. Here they have built one of the finest P/C insurance operations anywhere. They have a wonderful global platform. And they have forged a culture of strong underwriting discipline. All of this is similar to other well run P/C insurance companies. Fairfax’s uniqueness comes from how they approach capital allocation. Their approach is very different from traditional P/C insurance companies. And today it is also very different from the approach employed by both Berkshire Hathaway and Markel. When it comes to capital allocation, Fairfax is breaking new ground. Capital allocation Traditional P/C insurers At most P/C insurers, capital allocation is handled in a very traditional / straight forward manner. The basic options are captured in the table below. Berkshire Hathaway & Markel At Berkshire Hathaway and Markel, capital allocation is focussed on building long term shareholder value. But when it comes to capital allocation, certain options are not used and others are frowned upon. 1.) Assets are not sold. Buy and hold (ideally forever) is the goal. Therefore, this source of capital is generally not available. 2.) Equity is used in very limited way. Rarely is equity issued as a source of capital (looking at the past 10 years). Equity is used modestly used as a use of capital (share buybacks). 3.) Neither company pays a dividend. Fairfax Financial Setting the table: The most important source of capital is 'cash flow from operations'.' Fairfax is generating a record amount of cash flow from operations - and this record amount is expected to continue (and grow) in the coming years. Unlike traditional P/C insurance companies and Berkshire Hathaway and Markel, Fairfax uses all the capital allocation options at its disposal. But there is even more. Fairfax is finding new and innovative ways to allocate capital. They are doing some things that haven’t been seen from a P/C insurance company before. Like bringing minority equity partners on board when making large P/C insurance acquisitions. Fairfax has taken Warren Buffett’s original idea and made it even better: unconstrained capital allocation. The restaurant menu is stocked with choices: Sources of capital. Uses of capital. Internal. External. When it comes to capital allocation, Fairfax’s top priority is to be securely financed. After that, the goal is to allocate capital in a way that it results in the greatest long term per share value creation for shareholders. The key with this approach is to be: Open minded. Flexible. Creative. Opportunistic. Conviction - go big. With this capital allocation framework you take what Mr. Market gives you. And that is what Fairfax has been doing. Delivering a master-class in capital allocation. Here are some recent examples of what Fairfax has done: More than doubled the size (per share) of the P/C insurance business (NPW) over the past 5 years from $442/share in 2018 to $996/share in 2023. In late 2020/early 2021, purchased total return swaps - getting exposure to 1.96 million Fairfax shares at $373/share. This investment has increased in value by $1.5 billion over the past 3.5 years. In late 2021, via dutch auction, bought back 2 million Fairfax shares at $500/share. At March 31, 2024, Fairfax’s book value was $945/share. In late 2021, sold $5.2 billion in corporate bonds and shortened average duration of fixed income portfolio to 1.2 years - which shielded Fairfax’s balance sheet from billions in losses when interest rates spiked in 2022/2023. In 2022, sold the pet insurance business and realized a $1 billion gain after-tax. In 2022, sold Resolute Forest Products for $626 million (plus $183 million CVR) at the peak of the lumber market. In 2023, took out majority partner (KIPCO) and increased ownership in Gulf Insurance Group from 44% to 90% for total consideration of $740 million, securing Fairfax’s future in growing MENA region. In late 2023, extended the average duration of fixed income portfolio to about 3 years, locked in record interest income of $2 billion/year for the next 3 or 4 years. In January 2024, increased dividend by 50% to $15/share. In June 2024, Fairfax’s P/C insurance company in India, Digit, completed its successful IPO. In July 2024, sold Stelco (pending approvals) for consideration of $666 million, an 87% premium to where the stock had been trading. The list above is just a start. It really is amazing what Fairfax has been able to accomplish over the past 5 years. What really stands out is the number of tools - the breadth of options - that they have in their capital allocation toolkit today. They are proficient at using all of the tools. And they are using all of them: Organic growth Acquisitions Asset sales IPO Stock buybacks And look at the size/magnitude of the activities - many were +$1 billion in impact. The per share value creation for shareholders has been impressive. Importantly, Fairfax is not trying to copy someone else - like Berkshire Hathaway. Instead, Fairfax is now blazing their own trail. They are focussed on doing what they are really good at. Fairfax looks like a star athlete that is just hitting their prime. They have building towards this moment for 38 years. ————— If you want to better understand what is happening at Fairfax today you might want to read the following book. And pay special attention to the chapter on Henry Singleton - someone who will be the topic of a future post. “An outstanding book about CEOs who excelled at capital allocation.” Warren Buffett The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by William Thorndike https://www.amazon.ca/Outsiders-Unconventional-Radically-Rational-Blueprint/dp/1422162672 Edited July 22 by Viking Link to comment Share on other sites More sharing options...
Hoodlum Posted July 22 Share Posted July 22 22 hours ago, Santayana said: That's multiple years of earnings for CrowdStrike, will be interesting to see who ends up paying. It looks like CrowdStrike's CEO was also in leadership at McAfee in 2010 when there was a similar outage. Four months later McAfee was purchased by Intel. It will be interesting to see how CrowdStrike is able to handle this. Link to comment Share on other sites More sharing options...
Parsad Posted July 22 Share Posted July 22 7 hours ago, newtovalue said: Sleep country actually owns two of the biggest DTC Canadian brands - Casper and Endy It's also better managed than similar companies in the U.S. It's not a game-changing acquisition, but it's not a bad one. The price seems fair to both parties...not a steal on either side. Cheers! Link to comment Share on other sites More sharing options...
Viking Posted July 22 Share Posted July 22 (edited) 1 hour ago, Parsad said: It's also better managed than similar companies in the U.S. It's not a game-changing acquisition, but it's not a bad one. The price seems fair to both parties...not a steal on either side. Cheers! Some initial thoughts: I think Sleep Country has been quite the success story over the past 30 years. Interesting to see Fairfax buying the whole company. This will be a significant add to the 'non-insurance consolidated' group of companies (Thomas Cook India, Recipe, Grivalia Hospitality, Dexter etc). It will be interesting to see if Fairfax keeps growing this bucket of companies. Fairfax has been heavily invested in this segment over the past decade, more recently with Leon's (the largest furniture retailer in Canada) and with The Brick before that. Bill Gregson, former CEO of the Brick, was probably involved. I wonder who the driver was of this deal: Prem / Wade / Other? Regardless, it will be interesting to hear what Wade Burton has to say about it on the Q2 conference call. Fairfax is buying Sleep Country at what must be at close to the bottom of the cycle. IF this is the kind of business you want to own - now is probably the right time to buy it. The housing market in Canada is terrible right now (interest rates ARE biting here). Another big private transaction. And another publicly traded holding is gone (Stelco). The publicly traded (especially the mark to market) part of Fairfax's equity holdings has been dramatically shrinking in recent years. The private part has been rapidly growing. Are more asset sales (like Stelco) on the way? What I want to know about Sleep Country (I know nothing about the company, other than it is usually where we shop - and have for decades - when we buy a new mattress set): How good is the management team? If they are good, are they all sticking around? What is the normalized earnings power of this business? How stable are earnings? What are the prospects for the business? What are the strategic reasons for this purchase? Cash cow type of business to be milked over time? Does this signify a trend to more aggressively grow the 'non-consolidated' bucket of holdings? Edited July 22 by Viking Link to comment Share on other sites More sharing options...
Haryana Posted July 23 Share Posted July 23 10 hours ago, gfp said: Since we usually look at Fairfax's financials in US dollar terms - this is a cash outlay of like $890 million - $900 million USD right? Should be US$1.24 billion? "Sleep Country Canada Holdings ZZZ-T on Monday agreed to be acquired by a unit of insurer Fairfax Financial in a deal valued at C$1.7 billion ($1.24 billion)." https://www.theglobeandmail.com/investing/markets/stocks/ZZZ-T/pressreleases/27524271/fairfax-to-purchase-sleep-country-in-17-billion-deal/ Link to comment Share on other sites More sharing options...
gfp Posted July 23 Share Posted July 23 Just now, Haryana said: Should be US$1.24 billion? "Sleep Country Canada Holdings ZZZ-T on Monday agreed to be acquired by a unit of insurer Fairfax Financial in a deal valued at C$1.7 billion ($1.24 billion)." https://www.theglobeandmail.com/investing/markets/stocks/ZZZ-T/pressreleases/27524271/fairfax-to-purchase-sleep-country-in-17-billion-deal/ That is the enterprise value, not the cash outlay for 100% of the equity of the business. I'm not sure if they are including lease accounting as "debt" in that figure but the best I can see there are around 35 million fully diluted shares of ZZZ that FFH is buying for $35 CAD each. 35 times 35 is CAD 1.225B and that is around $890m USD Link to comment Share on other sites More sharing options...
UK Posted July 23 Share Posted July 23 2 minutes ago, Haryana said: Should be US$1.24 billion? "Sleep Country Canada Holdings ZZZ-T on Monday agreed to be acquired by a unit of insurer Fairfax Financial in a deal valued at C$1.7 billion ($1.24 billion)." https://www.theglobeandmail.com/investing/markets/stocks/ZZZ-T/pressreleases/27524271/fairfax-to-purchase-sleep-country-in-17-billion-deal/ I think this number includes existing debt. Link to comment Share on other sites More sharing options...
Haryana Posted July 23 Share Posted July 23 1. An angle of a mini hedge on falling interest rates - https://www.theglobeandmail.com/investing/investment-ideas/number-cruncher/article-8-canadian-retailers-poised-to-benefit-from-falling-interest-rates/ 2. One interesting point worth repeating is that they have 40% market share in Canada. 3. Interesting quotes from the article - https://www.theglobeandmail.com/business/article-fairfax-financial-sleep-country-canada-zzz/ ... “I’m not interested in selling at a distressed price because we don’t need to,” Mr. Schaefer said. “We are this great business. We have a strong balance sheet. We’re not worried about economic recessions. I’ve lived through, I don’t know how many stock market crashes and recessions. Everybody needs mattresses. Even if they put a pause on this discretionary spend, they’re eventually going to come back.” ... “I will tell you that I am fearful that there will be a slowdown, and I feel it’s knocking on the door,” Mr. Schaefer said. On the other hand, he added that this could mean further possible acquisitions becoming available for Sleep Country to consider. “When we do see slowdowns, it does create opportunities – maybe here in Canada, maybe outside of Canada – and having a strong financial sponsor behind you may create opportunities that are beyond Canada.” ... “This asset is one of the crown jewels – in my personal opinion because I work here – of retailers in Canada. And Prem was the only one that truly recognized that,” Mr. Schaefer said. “I think he thinks very, very long-term." Link to comment Share on other sites More sharing options...
glider3834 Posted July 23 Share Posted July 23 (edited) 2 hours ago, gfp said: That is the enterprise value, not the cash outlay for 100% of the equity of the business. I'm not sure if they are including lease accounting as "debt" in that figure but the best I can see there are around 35 million fully diluted shares of ZZZ that FFH is buying for $35 CAD each. 35 times 35 is CAD 1.225B and that is around $890m USD yes looks like that CAD 1.7B TEV figure includes lease liabilities Edited July 23 by glider3834 Link to comment Share on other sites More sharing options...
Thrifty3000 Posted July 23 Share Posted July 23 (edited) On 7/22/2024 at 4:16 PM, KPO said: On the surface this seems like a low quality acquisition unless there’s some structural reason that I’m missing as to why this business is better than failing counterparts in the US (e.g Mattress Firm). Retail bedding just seems a tough business with no moat, plus the Costco’s of the world and e-commerce can cherry pick. I just scanned ZZZ’s financials on Morningstar: - book value has compounded by roughly 15% annually since 2014 - net earnings were basically negative ten years ago and have steadily grown to an average $120 million for the last 3 years - cash from operations has been steadily around $160 million for the last 4 years At first glance it seems like FFH has offered a fair price for a solidly performing asset. Seems like a perfectly good way to further diversify. Edited July 23 by Thrifty3000 Link to comment Share on other sites More sharing options...
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