Fairfax 2024

[petec]

3 hours ago, glider3834 said:

 

I don't know much about this one but I think @petec mentioned this one previously - it looks like it has come to life a bit this year but a small holding

 

 

 

 

Interesting! This is basically an option on dead Greek loans coming back to life, IIRC.

[nwoodman]

46 minutes ago, petec said:

 

Interesting! This is basically an option on dead Greek loans coming back to life, IIRC.

Ah, saw this earlier today but the penny didn’t drop that it was that “Cairo”.  Thanks @glider3834 @petec

 

From Perplexity:

 

• Cairo Mezz Plc was established in 2020 in Nicosia, Cyprus with the corporate objective to hold the notes issued in the context of the Cairo securitization.
• The company was formerly known as Mairanus Ltd. and changed its name to Cairo Mezz Plc in September 2020.
• Cairo Mezz Plc was incorporated in 2020. Its shares were distributed to Eurobank shareholders in 2020, representing a 75% ownership of Eurobank Cairo's securitisation mezzanine tranche.
• The theoretical value of the distributed shares, based on Deloitte's valuation, was set at EUR 57.5m, EUR 0.0155 per Eurobank share or EUR 0.186 for every 12 shares held.

Cairo Mezz Plc was established in Cyprus in 2020 specifically to hold mezzanine and junior notes from the Cairo securitization of Eurobank's non-performing loans. Its shares originated from being distributed to existing Eurobank shareholders in 2020.

Edited August 13 by nwoodman

[Junior R]

back over $1560 lol

[hardcorevalue]

1 hour ago, Junior R said:

back over $1560 lol

 

What does this mean? I don’t get it. 

[Junior R]

Just now, hardcorevalue said:

 

What does this mean? I don’t get it. 

the stock price...it was under $1450 just a week ago 

[hardcorevalue]

Ha ok thanks, I guess I just think really long term here so it doesn’t seem like a huge drop! 

[petec]

On 8/13/2024 at 12:43 PM, nwoodman said:

Ah, saw this earlier today but the penny didn’t drop that it was that “Cairo”.  Thanks @glider3834 @petec

 

From Perplexity:

 

• Cairo Mezz Plc was established in 2020 in Nicosia, Cyprus with the corporate objective to hold the notes issued in the context of the Cairo securitization.
• The company was formerly known as Mairanus Ltd. and changed its name to Cairo Mezz Plc in September 2020.
• Cairo Mezz Plc was incorporated in 2020. Its shares were distributed to Eurobank shareholders in 2020, representing a 75% ownership of Eurobank Cairo's securitisation mezzanine tranche.
• The theoretical value of the distributed shares, based on Deloitte's valuation, was set at EUR 57.5m, EUR 0.0155 per Eurobank share or EUR 0.186 for every 12 shares held.

Cairo Mezz Plc was established in Cyprus in 2020 specifically to hold mezzanine and junior notes from the Cairo securitization of Eurobank's non-performing loans. Its shares originated from being distributed to existing Eurobank shareholders in 2020.

 

I believe the share price is an absolutely tiny fraction of the gross value of the underlying loans, but for good reason - they've been non-performing for a decade! Very low probability of an immense win here, I suspect.

Edited August 15 by petec

[nwoodman]

1 hour ago, petec said:

 

I believe the share price is an absolutely tiny fraction of the gross value of the underlying loans, but for good reason - they've been non-performing for a decade! Very low probability of an immense win here, I suspect.

Love the asymmetry. It does make you wonder, if on balance, there might be a few more pleasant surprises for Fairfax shareholders from that era. Not necessary for the thesis but  says a lot about management’s staying power IMHO.

 

[petec]

4 hours ago, nwoodman said:

Love the asymmetry. It does make you wonder, if on balance, there might be a few more pleasant surprises for Fairfax shareholders from that era. Not necessary for the thesis but  says a lot about management’s staying power IMHO.

 

 

Deflation swaps? 

[nwoodman]

15 minutes ago, petec said:

 

Deflation swaps? 

Well played sir.  Guess we should be careful of wishful thinking

[petec]

On 8/15/2024 at 9:29 AM, petec said:

 

I believe the share price is an absolutely tiny fraction of the gross value of the underlying loans, but for good reason - they've been non-performing for a decade! Very low probability of an immense win here, I suspect.

 

OK I am in work-avoidance mode today so I did a shallow dive.

 

Cairo Mezz owns mezz (euribor 3m+3%) and junior (euribor 3m+5%) notes due 2035, 2054, and 2062. These notes get paid when collections are made on part of Eurobank's old bad loan book. The notes trade on the Vienna exchange, but they are not active, so valuation is via DCF. The notes rank at the bottom of the payment waterfall for the relevant bad loans (7, 8, 9, and 10 out of 10 levels), so they have received no interest or principal repayments yet. However, in 2023 Cairo recorded a DCF valuation gain on the mezzanine notes, mainly because receipts for the senior notes came in ahead of expectations. (Cairo doesn't own the seniors but obviously improved senior receipts lifts the chance that the mezz and junior notes eventually receive something.) Another reason for the valuation increase was rising Greek real estate prices, which affects the collateral backing some or all of the defaulted loans.

 

Basic financials:

• The mezz notes are valued at E179m using a discount rate of 17%.
• The junior notes are valued at 0.
• There are no material liabilities.
• The book value is E179m.
• The share price is E0.40, giving a market cap of E123m.

The fun bit is that the nominal value of the notes is E2.7bn, of which E1.1bn is in the mezz and E1.6bn is in the juniors. Presumably the nominal value reflects what the notes would be worth if the underlying loans were money good. I assume there are filings for the individual notes somewhere with data on collateral etc. but I can't find them.

 

So, for Fairfax:

• FFH owns 50% of Cairo, worth E61m today.
• Carrying value is probably E56m, which was the market value at the end of 2q (I am not sure because a quick word search of the FFH annual report returns no hits).
• Lookthrough share of nominal value of the mezz: 50% x E1.1bn = E550m. 
• Lookthrough share of total nominal value: 50% x E2.7bn = E1.45bn.

Conclusion: in theory Cairo could be worth E1.45bn to FFH, but in reality E550m (full value for the mezz and nothing for the junior) would be an excellent result. No guarantees, but if the Greek economy continues to perform, and cash starts to trickle in, and underlying collateral values continue to rise, and the discount rate comes down (which it should if all the other factors fall into line), it's possible Cairo contributes a couple of hundred million dollars to FFH's book value over the next few years.  

 

NB I have edited this to correct the error I made regarding FFH's % ownership. 

 

 

 

 

Edited August 17 by petec

[petec]

1 hour ago, nwoodman said:

Well played sir.  Guess we should be careful of wishful thinking

 

Ha!

[gfp]

12 minutes ago, petec said:

FFH owns 33.5% of Cairo, worth E41m.

 

I think Fairfax owns half of Cairo - like 49.99% or something like that

[petec]

28 minutes ago, gfp said:

 

I think Fairfax owns half of Cairo - like 49.99% or something like that

 

Shareholding Structure – Cairo Mezz

 

Might be out of date I guess, but Cairo was basically a spin, and FFH owned 33.5% of Eurobank, so FFH would have had to have bought more since the spin to get to 50% and I don't recall that.

[gfp]

34 minutes ago, petec said:

 

Shareholding Structure – Cairo Mezz

 

Might be out of date I guess, but Cairo was basically a spin, and FFH owned 33.5% of Eurobank, so FFH would have had to have bought more since the spin to get to 50% and I don't recall that.

 

Just scroll up in this thread - I think it came over from Eurolife or something like that.  Out of the office so can't check exactly but for me the 49.99% figure is in this thread several posts above this

 

Edited August 15 by gfp

[StubbleJumper]

54 minutes ago, petec said:

Conclusion: in theory Cairo could be worth E900m to FFH, but in reality E370m (full value for the mezz and nothing for the junior) would be an excellent result. No guarantees, but if the Greek economy continues to perform, and cash starts to trickle in, and underlying collateral values continue to rise, and the discount rate comes down (which it should if all the other factors fall into line), it's possible Cairo contributes a couple of hundred million dollars to FFH's book value over the next few years.  

 

 

Pete,

 

Thanks for digging into that and summarising the results.  That could turn into US$10/sh, and then we should also remember the CVRs from Resolute which might also become a nice little payday.

 

 

SJ

[Viking]

1 hour ago, petec said:

 

OK I am in work-avoidance mode today so I did a shallow dive.

 

Cairo Mezz owns mezz (euribor 3m+3%) and junior (euribor 3m+5%) notes due 2035, 2054, and 2062. These notes get paid when collections are made on part of Eurobank's old bad loan book. They notes trade on the Vienna exchange, but they are not active, so valuation is via DCF. The notes rank at the bottom of the payment waterfall for the relevant bad loans (7, 8, 9, and 10 out of 10 levels), so they have received no interest or principal repayments yet. However, in 2023 Cairo recorded a DCF valuation gain on the mezzanine notes, mainly because receipts for the senior notes came in ahead of expectations. (Cairo doesn't own the seniors but obviously improved senior receipts lifts the chance that the mezz and junior notes eventually receive something.) Another reason for the valuation increase was rising Greek real estate prices, which affect the collateral backing some or all of the defaulted loans.

 

Basic financials:

• The mezz notes are valued at E179m using a discount rate of 17%.
• The junior notes are valued at 0.
• There are no material liabilities.
• The book value is E179m.
• The share price is E0.40, giving a market cap of E123m.

The fun bit is that the nominal value of the notes is E2.7bn, of which E1.1bn is in the mezz and E1.6bn is in the juniors. Presumably the nominal value reflects what the notes would be worth if the underlying loans were money good. I assume there are filings for the individual notes somewhere with data on collateral etc. but I can't find them.

 

So, for Fairfax:

• FFH owns 33.5% of Cairo, worth E41m today.
• Carrying value is probably E38m, which was the market value at the end of 2q, or E19m, which is 33.5% of the book value of Cairo when it was created (I am not sure because a quick word search of the FFH annual report returns no hits).
• Lookthrough share of nominal value of the mezz: 33.5% x E1.1bn = E370m. 
• Lookthrough share of total nominal value: 33.5% x E2.7bn = E900m.

Conclusion: in theory Cairo could be worth E900m to FFH, but in reality E370m (full value for the mezz and nothing for the junior) would be an excellent result. No guarantees, but if the Greek economy continues to perform, and cash starts to trickle in, and underlying collateral values continue to rise, and the discount rate comes down (which it should if all the other factors fall into line), it's possible Cairo contributes a couple of hundred million dollars to FFH's book value over the next few years.  

 

@petec  Great summary - of a topic that has a fair bit of complexity and is not well understood. 

[petec]

25 minutes ago, gfp said:

 

Just scroll up in this thread - I think it came over from Eurolife or something like that.  Out of the office so can't check exactly but for me the 49.99% figure is in this thread several posts above this

 

 

That makes sense re Eurolife - thanks! 

[petec]

24 minutes ago, StubbleJumper said:

 

Pete,

 

Thanks for digging into that and summarising the results.  That could turn into US$10/sh, and then we should also remember the CVRs from Resolute which might also become a nice little payday.

 

 

SJ

 

Pleasure. Good fun, in a weird way!

[Viking]

6 hours ago, StubbleJumper said:

 

Pete,

 

Thanks for digging into that and summarising the results.  That could turn into US$10/sh, and then we should also remember the CVRs from Resolute which might also become a nice little payday.

 

SJ

 

The CVR's from Resolute are interesting. The size of the duties on deposit with US government at the Canadian lumber producers is nuts right now. I think Canfor alone is approaching $1 billion in duties on deposit - and the softwood lumber duty just went up again. Today there appears to be no political will to get this issue resolved (in either country). But there is significant value there (duties on deposit). Tick, tick, tick...

 

'Duties on deposit' does not appear to be priced into any of the stocks today of the Canadian lumber producers. 

----------

In 2006, the first softwood lumber dispute between the US/Canada was resolved. About 20% of the duties on deposit went to the US and 80% went to the Canadian producers. The irony is West Fraser used their windfall gain to fund/kick start their aggressive move into the US South. With hindsight, the softwood dispute/duties imposed by the US were the best thing that ever happened to the large BC producers - it motivated them to think different, which lead them to expand beyond BC.

 

Less than 20 years later, West Fraser, Canfor and Interior have morphed from being large BC lumber companies (back in 2006) to being 3 of the top 4 lumber producers in North America today (and 3 of the largest in the world). And the BC lumber industry is in a massive secular decline (driven by mountain pine beetle and, more recently, terrible provincial government policy). 

 

• https://www.westfraser.com/sites/default/files/MD%26A_2007.pdf

Edited August 15 by Viking

[glider3834]

7 hours ago, petec said:

 

OK I am in work-avoidance mode today so I did a shallow dive.

 

Cairo Mezz owns mezz (euribor 3m+3%) and junior (euribor 3m+5%) notes due 2035, 2054, and 2062. These notes get paid when collections are made on part of Eurobank's old bad loan book. They notes trade on the Vienna exchange, but they are not active, so valuation is via DCF. The notes rank at the bottom of the payment waterfall for the relevant bad loans (7, 8, 9, and 10 out of 10 levels), so they have received no interest or principal repayments yet. However, in 2023 Cairo recorded a DCF valuation gain on the mezzanine notes, mainly because receipts for the senior notes came in ahead of expectations. (Cairo doesn't own the seniors but obviously improved senior receipts lifts the chance that the mezz and junior notes eventually receive something.) Another reason for the valuation increase was rising Greek real estate prices, which affect the collateral backing some or all of the defaulted loans.

 

Basic financials:

• The mezz notes are valued at E179m using a discount rate of 17%.
• The junior notes are valued at 0.
• There are no material liabilities.
• The book value is E179m.
• The share price is E0.40, giving a market cap of E123m.

The fun bit is that the nominal value of the notes is E2.7bn, of which E1.1bn is in the mezz and E1.6bn is in the juniors. Presumably the nominal value reflects what the notes would be worth if the underlying loans were money good. I assume there are filings for the individual notes somewhere with data on collateral etc. but I can't find them.

 

So, for Fairfax:

• FFH owns 50%% of Cairo, worth E41m today.
• Carrying value is probably E38m, which was the market value at the end of 2q (I am not sure because a quick word search of the FFH annual report returns no hits).
• Lookthrough share of nominal value of the mezz: 50% x E1.1bn = E550m. 
• Lookthrough share of total nominal value: 50% x E2.7bn = E1.45bn.

Conclusion: in theory Cairo could be worth E1.45bn to FFH, but in reality E550m (full value for the mezz and nothing for the junior) would be an excellent result. No guarantees, but if the Greek economy continues to perform, and cash starts to trickle in, and underlying collateral values continue to rise, and the discount rate comes down (which it should if all the other factors fall into line), it's possible Cairo contributes a couple of hundred million dollars to FFH's book value over the next few years.  

 

NB I have edited this to correct the error I made regarding FFH's % ownership. 

 

 

 

 

thanks petec

[Xerxes]

This may or may not have been posted.

 

QUARTERLY REPORT #5: PERIOD TO 31 MARCH 2024 - Google Search

 

East 72 Dynasty Trust

QUARTERLY REPORT #5: PERIOD TO 31 MARCH 2024

 

We added new holdings in Fairfax Financial Holdings, a Canadian reinsurance company after an appallingly argued short-sale thesis saw the shares sold off sharply for less than a week in February. We also added Occidental Petroleum, the oil business boasting Berkshire Hathaway as its largest and effective “controlling” shareholder, but more pointedly exercising a capital management philosophy of some note.

 

////

 

Monopolistic but regulated high margin volume growth. A new expanding airport. Bangalore If you sat down to conceive of the perfect investment, how might it look? One interpretation would be that it has monopolistic attributes – the famous “only bridge into town.17 ” But further imagine your “unregulated” toll bridge was located in an area of rapid population growth of highly qualified people - an area of high tech and IT manufacturing. So your toll bridge is going to get ever more use - so you can build a second one next to it. Moreover, you could essentially build your monopoly “bridges” from the ground up with few (if any) legacy issues, using the latest technology to service an industry which cannot function effectively without the latest know-how.
Unfortunately, it’s only a partial reality, but one which is priced at a discount to legacy assets in the same sector. Because this is not an unregulated toll bridge. It’s rather that the toll is actually regulated but you can keep your customers on the bridge for very lengthy periods and they have to spend money at your shops.

BIAL is Bangalore International Airport Limited, operator of Kempegowda18 International Airport located 40km from the centre of Bengaluru, India’s third largest – but fastest growing city – with 14million people in its metro area, up from 6.5million twenty years ago. BIAL has a monopoly within a 150km radius until 2033 and has a 30 year concession with a further 30year option to operate Kempegowda. The airport has an estimated catchment area of 250million people (it’s worth noting when you read the next section, how long any competing facility may take to be planned, let alone built when the monopoly expires).

The dynamics and analysis of Kempegowda are identical to most other “greenfield” airports – gradual expansion and use of adjoining vacant land to add non-airport revenues over time. It’s a model seen elsewhere around the world in recent years, but for one exception: the numbers here are far bigger than anywhere outside the Middle East – and it is predominantly a domestic operation for the time being. Dare to dream of the word “hub” sometime down the track.

BIAL is now 13% owned by each of Karnataka State Industrial & Infrastructure Development Corporation and Airports Authority of India 13% - two Government instrumentalities. The remaining 74% is 20% owned by Siemens Project Ventures – part of the €134billion market cap Siemens AG – and through two entities by Fairfax India Holdings19 (FIH-U.TO20).

 

////

[Haryana]

12 hours ago, Xerxes said:

(it’s worth noting when you read the next section, how long any competing facility may take to be planned, let alone built when the monopoly expires).

 

 

Why do they have to wait till 2033-34 for planning? They already shortlisted locations and expecting the new airport by 2035.

https://www.timesnownews.com/bengaluru/bengalurus-second-airport-harohalli-and-dobbaspet-among-7-key-locations-identified-article-112303818

 

The report is implying 54% with Fairfax but it already increased to 64% after 10% from Siemens.

 

Sure, the report was already posted here. 

 

This should be discussed in Fairfax India thread.

 

[Viking]

Book value is the ‘North Star’ used by Wall Street to value P/C insurance companies.

 

Why?

 

One big reason is it is wicked easy. Book value per share for a company is usually an easy number to find (unless you are a company called Berkshire Hathaway or Markel). Slap a market multiple on it (usually the company’s historical/past multiple) and… it’s like magic… you KNOW what a P/C insurance company is worth.

 

Compare your estimate with the company’s current share price and you KNOW if the stock is fairly priced, undervalued or overvalued. Investing is very easy.   

 

Is investing really that easy?

 

Maybe it is. But sometimes this approach above gets ‘it’ completely wrong.

 

What are the big problems with the approach above?

 

Here are a couple:

• Sometimes book value does not tell investors what they think it does.
• Sometimes the historical/past multiple is not the appropriate number to use.

A great set up for an investor is to find a P/C insurance company where two things exist:

• Book value is materially understated.
• The multiple being attached to book value is too low.

In this post, we will dig into book value to see what we can learn.

 

What is book value?

 

Book value is a proxy for what a company is worth should it be liquidated. It is calculated as follows:

• Assets (A) - Liabilities (L) = Equity/book value (E).

 

The biggest asset of a P/C insurance company - by far - is its investment portfolio. For most P/C insurance companies, the investment portfolio is invested mostly in fixed income instruments, like bonds. Fixed income investments are relatively easy to value. This provides a fair amount of accuracy/certainty when calculating book value for a typical P/C insurance company.

 

Book value and market multiple

 

P/BV is a good measure to use to compare P/C insurance peers.

 

The  ‘rule of thumb’ when it comes to book value and multiple for P/C insurance companies is as follows:

• P/BV = 1 x = This is likely a low quality company.
• P/BV = 2 x = This is likely a high quality company.

Finding a quality P/C insurance company that is trading at a P/BV multiple of 1 x is usually a very good thing - as this likely means it is being undervalued.

 

What can cause book value to not be accurate?

 

To answer this question, we are going to focus on the asset bucket.

 

What if assets are being undervalued on a company’s balance sheet?

 

This will cause book value to be understated.

 

Markets are efficient

 

But I can hear your response… “markets are efficient.” Mr. Market KNOWS when assets are being undervalued on a company’s balance sheet. As a result, book value, multiple and market price will reflect all that is known. Therefore it is not possible for an investor to profit from this set-up.

 

This might be the case for most large companies. However, I doubt it is the case for all companies. Especially smaller companies that are not followed very closely by investors and the investment industry.

 

Peter Lynch and asset plays

 

To help him with his analysis, Peter Lynch separated all of his investments into 6 categories. One of the categories was ‘asset plays.’ An asset play is a company that has a valuable asset(s) that Wall Street is ignoring.

 

What does this have to do with P/C insurance companies?

 

There are lots of things that can cause book value to be understated at a P/C insurance company. Below is one example.

 

Not all P/C insurance companies put most of their investments into fixed income securities. A few put a large chunk of their investment portfolio into equities - both publicly traded and private/consolidated holdings. The market value of some equity holdings might be much higher than their carrying value - this difference will not be captured in book value. And it could grow for years and even decades.

 

Ok, that is enough theory. Let’s pivot to the real world.

 

—————

 

Warren Buffett, Berkshire Hathaway and book value

 

For more than 50 years, Buffett was book value’s biggest cheerleader. He educated two generations of investors to use book value as the core input to:

• Quickly/easily value Berkshire Hathaway (in a very rough way).
• Evaluate the performance of the company’s management team over time (change in BVPS).    

To understand the importance of book value, all an investor had to do was read the opening paragraph of Buffett’s iconic shareholder letters. Buffett wrote pretty much the same introduction every year for decades. Here is an example from Berkshire Hathaway’s 2017AR:

 

“Berkshire’s gain in net worth during 2017 was $65.3 billion, which increased the per-share book value of both our Class A and Class B stock by 23%. Over the last 53 years (that is, since present management took over), per-share book value has grown from $19 to $211,750, a rate of 19.1% compounded annually.” Warrant Buffett - BRK’s 2017AR

 

Warren Buffett’s very public rug-pull on Berkshire Hathaway shareholders

 

But something suddenly changed in early 2019. In Berkshire Hathaway’s 2018AR, Warren Buffett made a very public divorce from book value. Holy shit Batman!

 

Given book value’s importance to Berkshire Hathaway and its investors for over 50 years, this was a seismic event. Buffett is no dummy. He must have had very good reasons for doing this.

 

Below is what Buffett had to say on the matter in Berkshire Hathaway’s 2018AR:

 

“Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice.

 

“The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so.

• “First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.
• “Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.
• “Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.

“In future tabulations of our financial results, we expect to focus on Berkshire’s market price. Markets can be extremely capricious: Just look at the 54-year history laid out on page 2. Over time, however, Berkshire’s stock price will provide the best measure of business performance.” Warren Buffett – Berkshire Hathaway 2018AR

 

Berkshire Hathaway changed as a company

 

Warren Buffett purchase Berkshire Hathaway in 1965. Since then the company has changed dramatically. In 1967, Buffett purchased National Indemnity, which added the P/C insurance business model to the company. The float was invested over the years into publicly traded equities and to buy non-insurance companies.

 

Over the years, the gap between the market/fair value and the carrying value of many of Berkshire Hathaway’s holdings has significantly widened - to the point where Buffett thought book value had lost its relevance as a useful metric for Berkshire Hathaway’s shareholders.

 

A second important reason

 

Buffett recently decided it was time for Berkshire Hathaway to start aggressively buying back its stock. Of course, stock would only be repurchased at prices that were below Buffett’s estimate of intrinsic value - so buybacks would be a good ‘use of cash’ for Berkshire Hathaway and its shareholders.

 

However, the stock would be repurchases at a premium to book value (1.2 x or more). This would cause BVPS to actually go down. Over time, this ‘causes the book-value scorecard to become increasingly out of touch with economic reality.’

 

Buying back a significant amount of stock above book value over many years will mess up the informational value in the BVPS measure for investors. My guess is this a very hard concept for most investors to grasp.

 

So what do you do if you are Warren Buffett?

 

You go cold turkey and stop talking about and publishing book value and BVPS metrics.

 

Buffett said that book value had ‘lost the relevance it once had.’ For long standing Berkshire Hathaway shareholders (of which there are many), it was like getting a bucket of ice water poured on their heads.

 

What was an investor to use as a replacement to value Berkshire Hathaway and evaluate its management team? The change in its share price over time. Moving forward, Berkshire Hathaway shareholders should use Wall Street/ Mr. Market as their primary guide.

 

WTF? Really?

 

I get that book value has its flaws. But to flush in down the toilet as a useful tool and replace it with Wall Street/Mr. Market just seems a little bizarre/extreme. But I digress. And who am I to disagree with Warren Buffett?

 

What does all of this have to do with Fairfax?

 

Fairfax has a significant portion of its equity portfolio in equities (about 30%). Over the past 5 years, Fairfax has been shifting from mark to market type holdings to associate/consolidated holdings. The proposed Sleep Country acquisition is the latest example of this trend. A gap between the fair value and the carrying value of these holdings has been growing in recent years. It is sizeable today – at June 30, 2024, the excess of FV over CV was $1.5 billion, or $68/effective share (pre-tax). Importantly, the excess of FV over CV has increased by $508 million over the first 6 months of 2024. This value creation is not captured in EPS or BVPS.

 

And there is likely a sizeable gap between intrinsic value and fair value, as we recently learned with the sale of Stelco (it was sold for much more than ‘fair value.’

 

What did Fairfax have to say on the matter in their Q2, 2024 earnings report?

 

Excess (deficiency) of fair value over adjusted carrying value 

 

"The table below presents the pre-tax excess (deficiency) of fair value over adjusted carrying value of investments in non-insurance associates and market traded consolidated non-insurance subsidiaries the company considers to be portfolio investments. Those amounts, while not included in the calculation of book value per basic share, are regularly reviewed by management as an indicator of investment performance. The aggregate pre-tax excess of fair value over adjusted carrying value of these investments at June 30, 2024 was $1,514.5 (December 31, 2023 - $1,006.0)."

 

 

Stock buybacks

 

Fairfax has also been very aggressive with stock buybacks in recent years. And they have picked up the pace so far in 2024. 

 

"During the first six months of 2024 the company purchased for cancellation 854,031 subordinate voting shares (2023 – 179,744) principally under its normal course issuer bids at a cost of $938.1 (2023 - $114.9), of which $726.5 (2023 - $70.4) was charged to retained earnings." Fairfax Q2-2024 Report

 

This year Fairfax has been buying back stock at an average price of $1,098/share. At Q2-2024, book value was $979.63. Fairfax is buying back a meaningful amount of stock at a price that is higher than book value. This will likely continue moving forward.

 

Why are they doing this? Fairfax understands its book value is understated. 

 

Fairfax appears to have contracted the ‘Berkshire Hathaway disease.’

 

Book value is less useful than most investors realize - as a tool to use to value the company or evaluate the performance of the management team. And over time, book value will become even less useful.

 

A couple of things suggest the impact on Fairfax will likely be more muted than Berkshire Hathaway:

• It is not clear that Fairfax wants to go full-on Berkshire Hathaway towards operating companies. But we will see what they do in the coming years.
• Fairfax has been keen over the years to surface significant hidden value via asset sales/asset revaluations. Berkshire Hathaway has largely been buy and hold forever, especially when it comes to the operating companies it owns.

Fairfax’s current valuation

 

Fairfax is trading today at P/BV multiple of 1.16 times. This is significantly lower than P/C insurance peers.

 

This also does not include the estimated $390 million gain that is coming from the sale of Stelco. Or the earnings QTD. Or the significant undervaluation of the equity holdings (publicly traded and private/consolidated).

 

Bottom line, despite the monster increase in the share price over the past 4 years, Fairfax’s stock looks like it continues to trade at a large margin of safety.

 

 

How much is book value understated at Fairfax

 

We can estimate some of the undervaluation for Fairfax. For associate/consolidated holdings, Fairfax does provide a fair value calculation for most holdings. This can be compared to their carrying value to come up with one measure of undervaluation for the group of holdings. But as helpful as this is, on its own it is incomplete.

 

For some holdings, their ‘intrinsic value’ is likely much higher than Fairfax’s reported ‘fair value.’ What investments? My top 3 today would probably be: Poseidon, Grivalia Hospitality and BIAL.

 

What about the P/C insurance holdings?

 

Fairfax sold its pet insurance business in 2022 and realized a $1 billion gain (after tax). They also sold of Ambridge in 2023 for a sizeable gain. 

 

In 2021, Fairfax sold 10% of Odyssey for $900 million. Odyssey is NOT carried at a value of $9 billion. 

 

My guess is Fairfax's P/C insurance companies are carried on the balance sheet at a discount to their true value (and the gap could be significant for some assets). If so, this would just be another example of how Fairfax's book value is understated today.

 

What do other board members think?

 

Is Fairfax's book value understated? If so, how much? What is causing/driving the 'undervaluation?'

 

Watch buybacks

 

It will be interesting to see:

• If Fairfax remains aggressive with stock buybacks moving forward.
• The P/BV multiple they will pay.

This will provide investors with important insight into how the management team at Fairfax values the company and its stock.

 

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Intrinsic Value and Book Value - From Berkshire Hathaway’s Owner’s Manual

 

The excerpt below is from Berkshire Hathaway’s Owner’s Manual - 1999 (this was the version that was on Berkshire Hathaway’s web site on August of 2024)

 

INTRINSIC VALUE

 

Now let's focus on two terms that I mentioned earlier and that you will encounter in future annual reports.

 

Let's start with intrinsic value, an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.

 

The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at the same set of facts, moreover - and this would apply even to Charlie and me - will almost inevitably come up with at least slightly different intrinsic value figures. That is one reason we never give you our estimates of intrinsic value. What our annual reports do supply, though, are the facts that we ourselves use to calculate this value.

 

Meanwhile, we regularly report our per-share book value, an easily calculable number, though one of limited use. The limitations do not arise from our holdings of marketable securities, which are carried on our books at their current prices. Rather the inadequacies of book value have to do with the companies we control, whose values as stated on our books may be far different from their intrinsic values.

 

The disparity can go in either direction. For example, in 1964 we could state with certitude that Berkshire's per-share book value was $19.46. However, that figure considerably overstated the company's intrinsic value, since all of the company's resources were tied up in a sub-profitable textile business. Our textile assets had neither going- concern nor liquidation values equal to their carrying values. Today, however, Berkshire's situation is reversed: Now, our book value far understates Berkshire's intrinsic value, a point true because many of the businesses we control are worth much more than their carrying value.

 

Inadequate though they are in telling the story, we give you Berkshire's book-value figures because they today serve as a rough, albeit significantly understated, tracking measure for Berkshire's intrinsic value. In other words, the percentage change in book value in any given year is likely to be reasonably close to that year's change in intrinsic value.

 

You can gain some insight into the differences between book value and intrinsic value by looking at one form of investment, a college education. Think of the education's cost as its "book value." If this cost is to be accurate, it should include the earnings that were foregone by the student because he chose college rather than a job.

 

For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its economic value. First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that figure an estimate of what he would have earned had he lacked his education. That gives us an excess earnings figure, which must then be discounted, at an appropriate interest rate, back to graduation day. The dollar result equals the intrinsic economic value of the education.

 

Some graduates will find that the book value of their education exceeds its intrinsic value, which means that whoever paid for the education didn't get his money's worth. In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed. In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.

Edited August 20 by Viking

[nwoodman]

@@Viking Good post and guilty as charged, the P/B heuristic is just so tempting. I think it has caused me to underestimate the true earning potential—and hence value—of both Fairfax and Berkshire over the years.  Although P/B of 0.6x’s was a decent marker of a margin of dafety.