Fairfax 2025

[Viking]

This is our second in three posts on leverage and Fairfax. In our first post we introduced the topic and looked at 2 structural ways that Fairfax uses leverage - debt and float. In this post we will review 3 tactical ways that Fairfax has used leverage - to grow their P/C insurance by acquisition and to buy back stock (total return swaps and dutch auction). 

 

To read our first post ‘Leverage - Part 1’ click the link below:

• https://thecobf.com/forum/topic/21117-fairfax-2025/page/38/#findComment-622326

Definition of leverage: “Using other people and/or their money to boost returns and/or improve the quality of the company.”

 

Leverage - Part 2

 

When people think about leverage they tend to only think about debt. But it can also be attained using equity. How? That is what we will review next.

 

3.) Equity - Minority partners

 

Growth by acquisition

 

From 2015 to 2017, Fairfax executed an aggressive acquisition strategy to build out its global P/C insurance footprint. At the time PC insurance was in a soft market so top-line growth was stagnant and underwriting margins were under pressure. The investment side of the business was also struggling - bond yields were very low. As a result, the stocks of P/C insurance companies were cheap. This was the perfect time to grow by acquisition.

 

From 2015 to 2017, Fairfax made 11 different purchases of P/C insurance companies. The total cost was $7.6 billion.

 

To provide context, at the end of 2014, common shareholders’s equity at Fairfax was $8.4 billion. Fairfax saw a big opportunity and they acted with conviction and backed up the truck.

 

How did Fairfax pay for the acquisitions?

 

To pay Fairfax used the traditional sources: equity (it issued Fairfax shares) and debt. But Fairfax used one more novel source of capital - it brought on minority equity partners.

 

Of the total cost of $7.6 billion, Fairfax supplied $5.3 billion (70%) and minority partners supplied $2.3 billion (30%). Fairfax's contribution was $3.3 equity (new share issuance) and about $2 billion in a combination of new borrowings (debt) and retained earnings. 'Other people’s money' - debt + minority partners - funded a significant portion of the total purchase price of $7.6 billion. 

 

Why did Fairfax use minority partners?

 

As we explained earlier, P/C insurance stocks were on sale. At the same time, Fairfax’s investment management business was underperforming. As a result, Fairfax’s shares were also on sale - trading only at a slight premium to book value. This was not a good time to issue equity. So Fairfax wanted to limit the amount of equity it used (shares it issued).

 

At the same time, Fairfax also needed to be careful with the amount of debt it used. It needed to keep the ratings agencies and insurance regulators happy.

 

What was the solution?

 

Classic Fairfax. Get creative. Do something no one else was doing/thought of - bring on minority equity partners.

 

The benefit

 

By bringing on minority equity partners Fairfax was able to do more acquisitions - it allowed them to buy more with less up front capital (supplied by Fairfax). Most importantly, Fairfax had complete control of all P/C insurance acquisitions - its partners were passive partners.

 

 

Exit strategy

 

Using minority partners is a temporary funding arrangement for Fairfax. By temporary I mean a 5-year or so arrangement. Yes, that is 'short term' for Fairfax. Down the road, when Fairfax had the cash, they would take out their minority partners.

 

And this is what has happened over the past 3 years. Fairfax is flush with cash these days. Today, Fairfax owns 100% of Brit and 80% of Eurolife (minority partner OMERS was taken out completely). At Allied World, the minority stake has been reduced from 32.5% to 16.6%. And it looks likely increase their ownership of Allie world to 100% in the next couple of years.

 

Call option feature

 

When the deal is put in place with the minority partner it includes a call option feature. The call option gives Fairfax the right - but not the obligation - to buy out their minority partner at a specified price and by a specified date. Fairfax profits if the underlying asset increases in price.

 

What was the cost to Fairfax?

 

Allied World paid dividends to its minority partners in 2019, 2020 and 2021 of $126 million. This provided minority partners with an 8.0% return (using $1,560 million as the cost base). If accurate, this is a solid return for the minority partners (remember, this was a time when interest rates were very low).

 

This has been a great deal for Fairfax. Why? Let’s discuss this next.

 

What are the benefits to Fairfax from bringing on minority partners?

 

Using minority partners allowed Fairfax to be opportunistic and maximize the size of its P/C insurance purchases from 2015 to 2017 (secure control). While at the same time keeping total debt and new share issuance (Fairfax shares) at a reasonable level. With these transactions, Fairfax used two different kinds of leverage: debt and equity (minority partners).

 

Strategic: From 2015 to 2017, Fairfax was able to build out its global platform and significantly increase the size of the company’s P/C insurance business. This was a significant accomplishment that mades Fairfax today a much stronger company. It diversifies their insurance business. It also provides them with significant growth opportunities.

 

Financial: Fairfax made their acquisitions at the perfect time.

• P/C insurance companies were out of favour. This means they did not overpay.
• They made the purchases a couple of years before the onset of the hard market in 2019. This gave Fairfax a couple of years to integrate the new companies. And then to fully capitalize on the historic hard market that has played out over the past 6 years. Fairfax has been able to double the size of its insurance business (net premiums written) in the current hard market. Organic growth is the best kind of growth for a P/C insurance company.
• With the call option feature, Fairfax is able to take out the minority partners at an attractive price (given how much the businesses have increased in value over the holding period).

This was only possible with the use of minority partners and the $2.3 billion of capital that they supplied to Fairfax. This is a great example of Fairfax using other people’s money to capitalize on a temporary and significant opportunity that existed (P/C insurance companies were on sale).

 

With these transactions, Fairfax did both - boosted returns and improved the quality of the company. This is yet another example of exceptional capital allocation from the management team at Fairfax.

 

————

 

Running the business with a long term focus

 

I described this use of leverage by Fairfax as being ‘temporary.’ Is that correct? Yes. Fairfax runs its business for the long term. Decisions, like the ones described above that play out over 5 or 10-year spans of time are ‘short term’ for them. Managing the business with a long term focus is a competitive advantage for Fairfax. It allows them to think and manage the business differently than other P/C insurance peers - and as a result deliver higher returns for shareholders.

 

————

 

Minority partners (equity) - Capital allocation

 

Fairfax added a new tool to their capital allocation toolbox - minority partners (equity). Yes, this is a non-traditional tool. As we described above, it is very effective when used properly.

 

This gives them an important source of future cash. Temporary - usually paid back after 5 or so years. Acceptable cost. Not debt (keeps the ratings agencies and regulators happy). Equity. Most importantly, it gives them another tool that allows them to be opportunistic and capitalize on significant short term opportunities.

 

————

 

The team at Fairfax was not resting on their laurels. In late 2020, Fairfax added a brand new tool to their capital allocation toolbox.

 

Is volatility in financial markets a good or a bad thing for Fairfax? The next two examples of leverage will be instructive.

 

4.) Total Return Swaps (late 2020/early 2021) - Getting exposure to 1.96 million shares at $373/share

 

“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble” Warren Buffett

 

A wonderful opportunity presents itself

 

In 2020, financial markets experienced some wicked volatility. But what happened in the broader market was nothing like what happened to Fairfax. For most of 2020 Fairfax's stock was trading at a historically low valuation. 

 

Fairfax communicated this loudly to investors: in June 2020, Prem Watsa bought $149 million in Fairfax stock ($311/share). (For context, when Jamie Dimon made his famous and much lauded 'vote of confidence' purchase of JP Morgan shares in 2016 he spend $25 million).    

 

Circle of competence

 

In late 2020, Fairfax understood how undervalued their stock was. As a result, buying back stock was a high certainty / low risk investment for Fairfax.

 

Position size

 

What should an investor do when they find a great investment that they understand better than anybody else and it is trading at a historically cheap valuation?

 

They should ‘back up the truck.’ They should make the investment a concentrated position.

 

The investment

 

In late 2020/early 2021, Fairfax purchased credit default swaps giving it exposure to 1.96 million Fairfax shares at an average cost of $373/share. The total notional value of the investment was $731 million. Yes, a total return swap is a non-traditional tool for P/C insurance companies to use in their investment management business.

 

At the time, Fairfax had 26.2 million effective share outstanding. This investment gave them exposure to 7.5% of shares outstanding. This was a very large investment.

 

Where did they get the cash?

 

The FFH-TRS position had a notional value of $731 million. That is what it would have cost Fairfax to buy 1.96 million shares.

 

Back in late 2020/early 2021, Fairfax did not have a lot of extra cash. The hard market in P/C insurance was taking off. Hard markets happen only about once every 20 years - when they happen they need to be the priority for excess capital. Fairfax also closed out its last short position in December 2020 and this resulted in a $529 million investment loss.

 

Debt levels at Fairfax were ok. But taking on more debt to fund a buyback was not an option.

 

What else could they do?

 

Fairfax got creative. They pulled a play from the hedge fund playbook. They didn’t buy the shares directly. They did the next best thing… they purchased total return swaps. This kept their capital outlay to a minimum. And they got exposure to 1.96 million shares of Fairfax (without actually owning the stock).

 

What has been the gross return from this investment?

 

Since being put on, the FFH-TRS position has delivered to Fairfax a total return of about $2.54 billion. This is before carrying costs. That is an exceptional return over a 4.5-year period. The FFH-TRS has become one of their best investments ever.

 

 

What is the cost of this investment?

 

The cost to carry this investment is a component of two things:

• LIBOR/SOFR plus a fixed rate (2%?) = 4.32% + 2% = @ 6.5%?
• While holding the TRS, Fairfax collects the dividend paid on its shares. The dividend was $10/share in 2021, 2022 and 2023. And $15/share in 2024 and 2025. Total dividends paid since the position was established = $60/share. Fairfax has received more than $100 million in dividends since the position was put on.

Does this look roughly correct? I look forward to hearing what other board members think. 

 

How has the investment worked out?

 

Bottom line, the return to Fairfax from this investment has been significant.

 

This is a great example of how the team at Fairfax has used other people’s money to boost earnings. To be opportunistic and take advantage of a short term market dislocation - this time the historically low price of Fairfax’s shares.

 

Exit strategy

 

The FFH-TRS is an investment for Fairfax. It is not a permanent holding.

 

Fairfax began exiting the position in Q4, 2024 when they reduced their exposure by 203,800 shares. At March 31, 2025, Fairfax continued to have exposure to 1.76 million shares.

 

Of interest, Fairfax purchased the shares from the counterparty and retired them. The FFH-TRS investment was like a stealth buyback (at $373/share).

 

—————

 

You are going to experience deja vu with this next example.

 

What is better than making one great investment? Making two great investments.

 

5.) Dutch Auction (December 2021) - Buy back 2 million shares

 

"Too much of a good thing can be wonderful!" Mae West

 

Another wonderful opportunity presents itself

 

In 2021, Fairfax’s shares continued to trade at a very cheap valuation.

 

Circle of competence

 

In December 2021, Fairfax understood how undervalued their stock was. As a result, buy back stock was a high certainty / low risk investment for Fairfax.

 

Position size

 

What should an investor do when they find a great investment that they understand better than anybody else and it is trading at a historically cheap valuation?

 

They should ‘back up the truck.’ They should make the investment a concentrated position.

 

The investment

 

On November 17, 2021, Fairfax announced a Substantial Issuer Bid. They repurchased 2 million shares at $500/share. The total cost to Fairfax was $1 billion.

 

At the time, Fairfax had about 26 million effective share outstanding. Buying back 2 million reduced effective shares outstanding by 7.7%. This was a very large share repurchase.

 

Where did they get the cash?

 

Fairfax did not have $1 billion lying around at the time. What capital they did have was being used to allow the P/C insurance companies to drive growth/capitalize on the hard market.

 

Debt levels at Fairfax were ok. But taking on more debt to fund a buyback was not an option.

 

What else could they do?

 

Pull out the 'minority shareholder' tool from their capital allocation toolbox and use equity. 

 

To fund the big buyback Fairfax sold 9.99% of Odyssey to OMERS. They tapped the private equity market. This raised $900 million for Fairfax.

 

Fairfax issued equity in Odyssey at 1.7x book value. And bought back Fairfax shares at 0.9x book value (from Fairfax's Q4 conference call in February 2022).

 

What has been the gross return from this investment?

 

To calculate the return from this investment, let’s keep things really simple. Let’s pretend that instead of buying back shares, Fairfax had simply bought shares in another company. This makes the return calculation simple.

 

Looking at it this way, the gross return Fairfax has earned over the past 3.5 years from buying back 2 million shares in December 2021 has been $2.35 billion. This is what Fairfax has earned before costs.

 

 

What is the cost of this investment?

 

OMERS invested $900 million. Let’s assume OMERS is earnings 8% = $72 million per year (Fairfax paid OMERS a dividend of $65 million in 2022). This puts the total cost over the past 3.5 years at about $252 million ($72 x 3.5 years).

 

Fairfax no longer has to pay a dividend on 2 million shares. The total savings from this over the past 3.5 years has been $100 million (4 payments of $10+$10+$15+$15=$50 x 2 million = $100).

 

If my numbers are roughly accurate, the net cost to Fairfax to execute this investment over the past 3.5 years has been about $142 million.

 

How has the investment worked out?

 

The ‘net’ return from this investment has been about $2.2 billion.

 

This is yet another example of how the team at Fairfax has used other people’s money to boost its returns. Yes. I know my return calculation is not technically the right way to look at this. But the benefits of stock buybacks can be really hard to conceptualize. The important message here is Fairfax’s dutch auction in 2021 has delivered an amazing return for the company and for shareholders.

 

Exit strategy

 

Fairfax uses minority partners as a source of capital to take advantage of a significant short term opportunity that has materialized. It is used as a short term source of funds (not intended to be permanent). Now that Fairfax is flush with cash it can take OMERS out and return its ownership position in Odyssey to 100%. My guess is this is what Fairfax will do in the next couple of years.

 

Using leverage (other people’s money) to capitalize on a temporary significant short term opportunity was a brilliant move on the part of the management team at Fairfax.

 

—————

 

Fairfax was very opportunistic in late 2020 and 2021. They were able to buy back/get exposure to 4 million Fairfax shares at an average cost of $437/share. This was 15% of shares outstanding. How much of their own capital did they have to use? Very little. The ‘return’ over the past 4.5 years from these two investment has been over $4 billion. How did they do it? They used other people’s money. Freaking brilliant.

 

—————

 

We have one more post coming in our 3-post review of how Fairfax uses leverage. We have much more to cover on this interesting and important topic. Among other things, our next post will dig into how Fairfax is leveraging 'human capital' in new ways that are not yet recognized or fully understood (in terms of its impact on future results). 

[73 Reds]

26 minutes ago, Viking said:

This is our second in three posts on leverage and Fairfax. In our first post we introduced the topic and looked at 2 structural ways that Fairfax uses leverage - debt and float. In this post we will review 3 tactical ways that Fairfax has used leverage - to grow their P/C insurance by acquisition and to buy back stock (total return swaps and dutch auction). 

 

To read our first post ‘Leverage - Part 1’ click the link below:

• https://thecobf.com/forum/topic/21117-fairfax-2025/page/38/#findComment-622326

Definition of leverage: “Using other people and/or their money to boost returns and/or improve the quality of the company.”

 

Leverage - Part 2

 

When people think about leverage they tend to only think about debt. But it can also be attained using equity. How? That is what we will review next.

 

3.) Equity - Minority partners

 

Growth by acquisition

 

From 2015 to 2017, Fairfax executed an aggressive acquisition strategy to build out its global P/C insurance footprint. At the time PC insurance was in a soft market so top-line growth was stagnant and underwriting margins were under pressure. The investment side of the business was also struggling - bond yields were very low. As a result, the stocks of P/C insurance companies were cheap. This was the perfect time to grow by acquisition.

 

From 2015 to 2017, Fairfax made 11 different purchases of P/C insurance companies. The total cost was $7.6 billion.

 

To provide context, at the end of 2014, common shareholders’s equity at Fairfax was $8.4 billion. Fairfax saw a big opportunity and they acted with conviction and backed up the truck.

 

How did Fairfax pay for the acquisitions?

 

To pay Fairfax used the traditional sources: equity (it issued Fairfax shares) and debt. But Fairfax used one more novel source of capital - it brought on minority equity partners.

 

Of the total cost of $7.6 billion, Fairfax supplied $5.3 billion (70%) and minority partners supplied $2.3 billion (30%). Fairfax's contribution was $3.3 equity (new share issuance) and about $2 billion in a combination of new borrowings (debt) and retained earnings. 'Other people’s money' - debt + minority partners - funded a significant portion of the total purchase price of $7.6 billion. 

 

Why did Fairfax use minority partners?

 

As we explained earlier, P/C insurance stocks were on sale. At the same time, Fairfax’s investment management business was underperforming. As a result, Fairfax’s shares were also on sale - trading only at a slight premium to book value. This was not a good time to issue equity. So Fairfax wanted to limit the amount of equity it used (shares it issued).

 

At the same time, Fairfax also needed to be careful with the amount of debt it used. It needed to keep the ratings agencies and insurance regulators happy.

 

What was the solution?

 

Classic Fairfax. Get creative. Do something no one else was doing/thought of - bring on minority equity partners.

 

The benefit

 

By bringing on minority equity partners Fairfax was able to do more acquisitions - it allowed them to buy more with less up front capital (supplied by Fairfax). Most importantly, Fairfax had complete control of all P/C insurance acquisitions - its partners were passive partners.

 

 

Exit strategy

 

Using minority partners is a temporary funding arrangement for Fairfax. By temporary I mean a 5-year or so arrangement. Yes, that is 'short term' for Fairfax. Down the road, when Fairfax had the cash, they would take out their minority partners.

 

And this is what has happened over the past 3 years. Fairfax is flush with cash these days. Today, Fairfax owns 100% of Brit and 80% of Eurolife (minority partner OMERS was taken out completely). At Allied World, the minority stake has been reduced from 32.5% to 16.6%. And it looks likely increase their ownership of Allie world to 100% in the next couple of years.

 

Call option feature

 

When the deal is put in place with the minority partner it includes a call option feature. The call option gives Fairfax the right - but not the obligation - to buy out their minority partner at a specified price and by a specified date. Fairfax profits if the underlying asset increases in price.

 

What was the cost to Fairfax?

 

Allied World paid dividends to its minority partners in 2019, 2020 and 2021 of $126 million. This provided minority partners with an 8.0% return (using $1,560 million as the cost base). If accurate, this is a solid return for the minority partners (remember, this was a time when interest rates were very low).

 

This has been a great deal for Fairfax. Why? Let’s discuss this next.

 

What are the benefits to Fairfax from bringing on minority partners?

 

Using minority partners allowed Fairfax to be opportunistic and maximize the size of its P/C insurance purchases from 2015 to 2017 (secure control). While at the same time keeping total debt and new share issuance (Fairfax shares) at a reasonable level. With these transactions, Fairfax used two different kinds of leverage: debt and equity (minority partners).

 

Strategic: From 2015 to 2017, Fairfax was able to build out its global platform and significantly increase the size of the company’s P/C insurance business. This was a significant accomplishment that mades Fairfax today a much stronger company. It diversifies their insurance business. It also provides them with significant growth opportunities.

 

Financial: Fairfax made their acquisitions at the perfect time.

• P/C insurance companies were out of favour. This means they did not overpay.
• They made the purchases a couple of years before the onset of the hard market in 2019. This gave Fairfax a couple of years to integrate the new companies. And then to fully capitalize on the historic hard market that has played out over the past 6 years. Fairfax has been able to double the size of its insurance business (net premiums written) in the current hard market. Organic growth is the best kind of growth for a P/C insurance company.
• With the call option feature, Fairfax is able to take out the minority partners at an attractive price (given how much the businesses have increased in value over the holding period).

This was only possible with the use of minority partners and the $2.3 billion of capital that they supplied to Fairfax. This is a great example of Fairfax using other people’s money to capitalize on a temporary and significant opportunity that existed (P/C insurance companies were on sale).

 

With these transactions, Fairfax did both - boosted returns and improved the quality of the company. This is yet another example of exceptional capital allocation from the management team at Fairfax.

 

————

 

Running the business with a long term focus

 

I described this use of leverage by Fairfax as being ‘temporary.’ Is that correct? Yes. Fairfax runs its business for the long term. Decisions, like the ones described above that play out over 5 or 10-year spans of time are ‘short term’ for them. Managing the business with a long term focus is a competitive advantage for Fairfax. It allows them to think and manage the business differently than other P/C insurance peers - and as a result deliver higher returns for shareholders.

 

————

 

Minority partners (equity) - Capital allocation

 

Fairfax added a new tool to their capital allocation toolbox - minority partners (equity). Yes, this is a non-traditional tool. As we described above, it is very effective when used properly.

 

This gives them an important source of future cash. Temporary - usually paid back after 5 or so years. Acceptable cost. Not debt (keeps the ratings agencies and regulators happy). Equity. Most importantly, it gives them another tool that allows them to be opportunistic and capitalize on significant short term opportunities.

 

————

 

The team at Fairfax was not resting on their laurels. In late 2020, Fairfax added a brand new tool to their capital allocation toolbox.

 

Is volatility in financial markets a good or a bad thing for Fairfax? The next two examples of leverage will be instructive.

 

4.) Total Return Swaps (late 2020/early 2021) - Getting exposure to 1.96 million shares at $373/share

 

“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble” Warren Buffett

 

A wonderful opportunity presents itself

 

In 2020, financial markets experienced some wicked volatility. But what happened in the broader market was nothing like what happened to Fairfax. For most of 2020 Fairfax's stock was trading at a historically low valuation. 

 

Fairfax communicated this loudly to investors: in June 2020, Prem Watsa bought $149 million in Fairfax stock ($311/share). (For context, when Jamie Dimon made his famous and much lauded 'vote of confidence' purchase of JP Morgan shares in 2016 he spend $25 million).    

 

Circle of competence

 

In late 2020, Fairfax understood how undervalued their stock was. As a result, buying back stock was a high certainty / low risk investment for Fairfax.

 

Position size

 

What should an investor do when they find a great investment that they understand better than anybody else and it is trading at a historically cheap valuation?

 

They should ‘back up the truck.’ They should make the investment a concentrated position.

 

The investment

 

In late 2020/early 2021, Fairfax purchased credit default swaps giving it exposure to 1.96 million Fairfax shares at an average cost of $373/share. The total notional value of the investment was $731 million. Yes, a total return swap is a non-traditional tool for P/C insurance companies to use in their investment management business.

 

At the time, Fairfax had 26.2 million effective share outstanding. This investment gave them exposure to 7.5% of shares outstanding. This was a very large investment.

 

Where did they get the cash?

 

The FFH-TRS position had a notional value of $731 million. That is what it would have cost Fairfax to buy 1.96 million shares.

 

Back in late 2020/early 2021, Fairfax did not have a lot of extra cash. The hard market in P/C insurance was taking off. Hard markets happen only about once every 20 years - when they happen they need to be the priority for excess capital. Fairfax also closed out its last short position in December 2020 and this resulted in a $529 million investment loss.

 

Debt levels at Fairfax were ok. But taking on more debt to fund a buyback was not an option.

 

What else could they do?

 

Fairfax got creative. They pulled a play from the hedge fund playbook. They didn’t buy the shares directly. They did the next best thing… they purchased total return swaps. This kept their capital outlay to a minimum. And they got exposure to 1.96 million shares of Fairfax (without actually owning the stock).

 

What has been the gross return from this investment?

 

Since being put on, the FFH-TRS position has delivered to Fairfax a total return of about $2.54 billion. This is before carrying costs. That is an exceptional return over a 4.5-year period. The FFH-TRS has become one of their best investments ever.

 

 

What is the cost of this investment?

 

The cost to carry this investment is a component of two things:

• LIBOR/SOFR plus a fixed rate (2%?) = 4.32% + 2% = @ 6.5%?
• While holding the TRS, Fairfax collects the dividend paid on its shares. The dividend was $10/share in 2021, 2022 and 2023. And $15/share in 2024 and 2025. Total dividends paid since the position was established = $60/share. Fairfax has received more than $100 million in dividends since the position was put on.

Does this look roughly correct? I look forward to hearing what other board members think. 

 

How has the investment worked out?

 

Bottom line, the return to Fairfax from this investment has been significant.

 

This is a great example of how the team at Fairfax has used other people’s money to boost earnings. To be opportunistic and take advantage of a short term market dislocation - this time the historically low price of Fairfax’s shares.

 

Exit strategy

 

The FFH-TRS is an investment for Fairfax. It is not a permanent holding.

 

Fairfax began exiting the position in Q4, 2024 when they reduced their exposure by 203,800 shares. At March 31, 2025, Fairfax continued to have exposure to 1.76 million shares.

 

Of interest, Fairfax purchased the shares from the counterparty and retired them. The FFH-TRS investment was like a stealth buyback (at $373/share).

 

—————

 

You are going to experience deja vu with this next example.

 

What is better than making one great investment? Making two great investments.

 

5.) Dutch Auction (December 2021) - Buy back 2 million shares

 

"Too much of a good thing can be wonderful!" Mae West

 

Another wonderful opportunity presents itself

 

In 2021, Fairfax’s shares continued to trade at a very cheap valuation.

 

Circle of competence

 

In December 2021, Fairfax understood how undervalued their stock was. As a result, buy back stock was a high certainty / low risk investment for Fairfax.

 

Position size

 

What should an investor do when they find a great investment that they understand better than anybody else and it is trading at a historically cheap valuation?

 

They should ‘back up the truck.’ They should make the investment a concentrated position.

 

The investment

 

On November 17, 2021, Fairfax announced a Substantial Issuer Bid. They repurchased 2 million shares at $500/share. The total cost to Fairfax was $1 billion.

 

At the time, Fairfax had about 26 million effective share outstanding. Buying back 2 million reduced effective shares outstanding by 7.7%. This was a very large share repurchase.

 

Where did they get the cash?

 

Fairfax did not have $1 billion lying around at the time. What capital they did have was being used to allow the P/C insurance companies to drive growth/capitalize on the hard market.

 

Debt levels at Fairfax were ok. But taking on more debt to fund a buyback was not an option.

 

What else could they do?

 

Pull out the 'minority shareholder' tool from their capital allocation toolbox and use equity. 

 

To fund the big buyback Fairfax sold 9.99% of Odyssey to OMERS. They tapped the private equity market. This raised $900 million for Fairfax.

 

Fairfax issued equity in Odyssey at 1.7x book value. And bought back Fairfax shares at 0.9x book value (from Fairfax's Q4 conference call in February 2022).

 

What has been the gross return from this investment?

 

To calculate the return from this investment, let’s keep things really simple. Let’s pretend that instead of buying back shares, Fairfax had simply bought shares in another company. This makes the return calculation simple.

 

Looking at it this way, the gross return Fairfax has earned over the past 3.5 years from buying back 2 million shares in December 2021 has been $2.35 billion. This is what Fairfax has earned before costs.

 

 

What is the cost of this investment?

 

OMERS invested $900 million. Let’s assume OMERS is earnings 8% = $72 million per year (Fairfax paid OMERS a dividend of $65 million in 2022). This puts the total cost over the past 3.5 years at about $252 million ($72 x 3.5 years).

 

Fairfax no longer has to pay a dividend on 2 million shares. The total savings from this over the past 3.5 years has been $100 million (4 payments of $10+$10+$15+$15=$50 x 2 million = $100).

 

If my numbers are roughly accurate, the net cost to Fairfax to execute this investment over the past 3.5 years has been about $142 million.

 

How has the investment worked out?

 

The ‘net’ return from this investment has been about $2.2 billion.

 

This is yet another example of how the team at Fairfax has used other people’s money to boost its returns. Yes. I know my return calculation is not technically the right way to look at this. But the benefits of stock buybacks can be really hard to conceptualize. The important message here is Fairfax’s dutch auction in 2021 has delivered an amazing return for the company and for shareholders.

 

Exit strategy

 

Fairfax uses minority partners as a source of capital to take advantage of a significant short term opportunity that has materialized. It is used as a short term source of funds (not intended to be permanent). Now that Fairfax is flush with cash it can take OMERS out and return its ownership position in Odyssey to 100%. My guess is this is what Fairfax will do in the next couple of years.

 

Using leverage (other people’s money) to capitalize on a temporary significant short term opportunity was a brilliant move on the part of the management team at Fairfax.

 

—————

 

Fairfax was very opportunistic in late 2020 and 2021. They were able to buy back/get exposure to 4 million Fairfax shares at an average cost of $437/share. This was 15% of shares outstanding. How much of their own capital did they have to use? Very little. The ‘return’ over the past 4.5 years from these two investment has been over $4 billion. How did they do it? They used other people’s money. Freaking brilliant.

 

—————

 

We have one more post coming in our 3-post review of how Fairfax uses leverage. We have much more to cover on this interesting and important topic. Among other things, our next post will dig into how Fairfax is leveraging 'human capital' in new ways that are not yet recognized or fully understood (in terms of its impact on future results). 

Great post @Viking.  Of particular interest was your take on minority partners and Fairfax's options to buy out their interests at a future date.  Options are such a wonderful - and often overlooked secret to so much business and financial success.  They can be used in countless ways to make deals, contracts, leases, etc... much more valuable for both the option giver (seller) and option holder (buyer).   

[Viking]

2 hours ago, 73 Reds said:

Great post @Viking.  Of particular interest was your take on minority partners and Fairfax's options to buy out their interests at a future date.  Options are such a wonderful - and often overlooked secret to so much business and financial success.  They can be used in countless ways to make deals, contracts, leases, etc... much more valuable for both the option giver (seller) and option holder (buyer).   

 

@73 Reds , I agree. Options can be a hugely asymmetric bet = at a low cost, can provide a great deal of upside leverage to a transaction/investment.

 

I think we are all still learning (do not fully appreciate) all the different things Fairfax has been doing with its business model over the past 7 or 8 years. Of course, over time (the past 3 or 4 years) the picture is coming more into focus - as what they have done flows though into earnings (FFH-TRS is one of many good examples of this). But there is a lag. And lots of what they have been putting in place has not yet hit reported results (it is coming). The optionality/leverage is being embedded all over the place. 

 

I am especially interested/excited with what they have been doing with their equity holdings. Investing in equities (unlimited upside) is a form of leverage compared to investing in bonds (where you get a fixed return - your upside is capped). But Fairfax is taking it one step further - with their equity holdings they are now partnering with outstanding founders/entrepreneurs/capital allocators. It has been a 7 or 8 year journey (from old Fairfax to new Fairfax).

 

The result? It is a shift to high quality investing with their equity portfolio (public and private). But quality in a different way (i.e. it is not like buying Coke back in the 1980's) - they are doing it in a way that fits with Fairfax and the current economic/market environment. Partnering with outstanding founders/entrepreneurs/CEO with their equity holdings is giving the equity portfolio at Fairfax an enormous amount of upside leverage moving forward. (Buying/holding shitty equities gives you some leverage to the upside... buying/holding quality equities gives you much, much more leverage to the upside.)

 

Stelco is a great example of the power of the model (and the types of returns that are possible) that Fairfax is currently executing with their equity holdings.

 

---------

 

Here is another way of looking at/understanding the sea-change that has happened over the past 7 or 8 years with how Fairfax manages its equity portfolio. 

 

With 'old Fairfax', when volatility hit financial markets hard it usually hit Fairfax's low quality equity portfolio especially hard. This resulted in big mark to market (unrealized) losses for Fairfax. And this usually caused Fairfax's share price to plummet. As a result, high downside volatility usually caused long term Fairfax shareholders to curl up in a fetal position and hug their blanket tightly.

 

With 'new Fairfax', when volatility hits financial markets the founders/entrepreneurs/CEO's managing Fairfax's equity holdings will (in general) view it as opportunity - something to be exploited (which is the same approach Fairfax will have). Exceptional/smart people tend to find a way to make lemonade out of lemons. Yes, there will be some short term volatility in price - but the majority of the holdings are not mark to market (they are associate or consolidated). It is a brave new world for long term Fairfax shareholders.

Edited June 5, 2025 by Viking

[Maverick47]

54 minutes ago, 73 Reds said:

Great post @Viking.  Of particular interest was your take on minority partners and Fairfax's options to buy out their interests at a future date.  Options are such a wonderful - and often overlooked secret to so much business and financial success.  They can be used in countless ways to make deals, contracts, leases, etc... much more valuable for both the option giver (seller) and option holder (buyer). 

Agreed @73 Reds!  And @Viking, how much better was it for Fairfax to structure the minority partners the way they have done with OMERS for these deals.?  In the early 2000’s, I recall that Fairfax was capital constrained and under attack by short sellers.  Selling minority stakes in some of their insurance subs allowed them to survive that period.  I even owned some of the Odyssey Re minority stock in my own retirement account at the time, but after the CD swaps paid out, Fairfax subsequently took out their minority shareholders at Odyssey (and was Northridge also a similar situation?). 

 

The difference was that Fairfax would have to pay a premium to recent market prices to accomplish the buyout.  The apparent fixed 8% return for OMERS in some of the more recent minority deals strikes me as being beneficial to both parties, but likely much better for Fairfax than spinning off minority equity stakes in the open market as was done more than a decade earlier.

 

As an aside, an insurance company I worked for was bought out by a mutual insurance company in 2008 and since mutual companies can’t generally issue equity, and they didn’t want to incur too much debt for the purchase, they issued some very long term “hybrid” debt securities that were counted as equity by rating agencies/regulators.  They issued a little over $1 billion of 80 year bonds that paid 10.75% coupons…which were only callable after the first 30 years.  Since the bonds weren’t callable, when the company wanted to retire them early they had to pay a sizable premium to face value some years later to encourage some of the holders to tender their bonds….and in 2025 they still have about $100 million outstanding from this issue held by owners who are only too happy to hang on and collect the high coupon payments until the 2038 call date.

 

What a contrast with the wisdom of Fairfax in having trusted minority partners such as OMERS to accomplish something similar in a much more efficient and cost effective manner, not to mention having the option to take them out in a much more reasonable time frame than 30 years…

[Redskin212]

Fairfax really has a great relationship (almost marriage) with OMERS and other minority partners.   Fairfax ensures that have the optionality/leverage to buyback minority interest - so Fairfax can profit on the upside. And the minority partner is "guaranteed" a nice solid fixed return for four or five years - perfect for pension funds like OMERS.

 

The use of minority interest partners and how Fairfax uses this source of funding/leverage has evolved over the years.  If you go back 20+ years ago Fairfax sold 20% of Odyssey Re to raise cash when the recent acquisitions (TIG and Crum) were experiencing significant losses.  At the time, I am guessing, Fairfax had not yet built the current relationships it has with the pension funds and was forced to go the public route.  Odyssey was the crown jewel and thus they sold 20% into the public market - but mind you only temporarily as they bought it all back within four or five years ("short term" in Fairfax's world) when the ship righted and they had the cash once again.  Same playbook, just a little harder back then. The value of the pension funds relationships cannot be understated as it allows Fairfax to act and operate at light speed compared to performing a secondary offering of one their subsidiaries.

[Viking]

9 minutes ago, Maverick47 said:

Agreed @73 Reds!  And @Viking, how much better was it for Fairfax to structure the minority partners the way they have done with OMERS for these deals.?  In the early 2000’s, I recall that Fairfax was capital constrained and under attack by short sellers.  Selling minority stakes in some of their insurance subs allowed them to survive that period.  I even owned some of the Odyssey Re minority stock in my own retirement account at the time, but after the CD swaps paid out, Fairfax subsequently took out their minority shareholders at Odyssey (and was Northridge also a similar situation?). 

 

The difference was that Fairfax would have to pay a premium to recent market prices to accomplish the buyout.  The apparent fixed 8% return for OMERS in some of the more recent minority deals strikes me as being beneficial to both parties, but likely much better for Fairfax than spinning off minority equity stakes in the open market as was done more than a decade earlier.

 

As an aside, an insurance company I worked for was bought out by a mutual insurance company in 2008 and since mutual companies can’t generally issue equity, and they didn’t want to incur too much debt for the purchase, they issued some very long term “hybrid” debt securities that were counted as equity by rating agencies/regulators.  They issued a little over $1 billion of 80 year bonds that paid 10.75% coupons…which were only callable after the first 30 years.  Since the bonds weren’t callable, when the company wanted to retire them early they had to pay a sizable premium to face value some years later to encourage some of the holders to tender their bonds….and in 2025 they still have about $100 million outstanding from this issue held by owners who are only too happy to hang on and collect the high coupon payments until the 2038 call date.

 

What a contrast with the wisdom of Fairfax in having trusted minority partners such as OMERS to accomplish something similar in a much more efficient and cost effective manner, not to mention having the option to take them out in a much more reasonable time frame than 30 years…

 

@Maverick47 , BINGO! Of course, what Fairfax is doing with minority partners - using equity - isn't new for them. It's just the latest iteration (tapping private markets versus public markets). As you say, the previous model involved taking part of the insurance company public. And yes, public markets are a big pain in the ass (compared to private markets) - especially later when you are flush with cash and want to buy out the minority partners. And you have to pay a big premium - and even then lots of people are not happy. 

 

Thanks for providing some additional colour based on experiences from your previous life. It is very instructive! 

[Hoodlum]

What I find interesting is when Fairfax sells minority interests, they just payout a dividend at prime+.  Meanwhile, they provide debt to public companies at a reduced interest rate, but then have the option to convert that debt to shares at a later date for pre-determined price.  Basically, Fairfax is willing to give up some short term gains on any debt they take, for a larger potential longer term gain in the business they issued the debt to. 

 

Meanwhile, ORLA was up 8% today on some positive news.  Another ~$100M gain on Fairfax's stake in ORLA.  

 

Edited June 5, 2025 by Hoodlum

[Viking]

4 minutes ago, Redskin212 said:

Fairfax really has a great relationship (almost marriage) with OMERS and other minority partners.   Fairfax ensures that have the optionality/leverage to buyback minority interest - so Fairfax can profit on the upside. And the minority partner is "guaranteed" a nice solid fixed return for four or five years - perfect for pension funds like OMERS.

 

The use of minority interest partners and how Fairfax uses this source of funding/leverage has evolved over the years.  If you go back 20+ years ago Fairfax sold 20% of Odyssey Re to raise cash when the recent acquisitions (TIG and Crum) were experiencing significant losses.  At the time, I am guessing, Fairfax had not yet built the current relationships it has with the pension funds and was forced to go the public route.  Odyssey was the crown jewel and thus they sold 20% into the public market - but mind you only temporarily as they bought it all back within four or five years ("short term" in Fairfax's world) when the ship righted and they had the cash once again.  Same playbook, just a little harder back then. The value of the pension funds relationships cannot be understated as it allows Fairfax to act and operate at light speed compared to performing a secondary offering of one their subsidiaries.

 

@Redskin212 , great post. You highlight another super important advantage to going the private versus the public route - speed in executing the deal. This is important for how Fairfax typically uses this source of funds (opportunistically to take advantage of short term dislocations).

 

You also highlight the importance of having a long term relationship and a high level of trust - with your private partner. 

[glider3834]

https://www.barrons.com/articles/berkshire-hathaway-warren-buffett-companies-howard-hughes-loews-fairfax-financial-greenlight-capital-markel-white-mountains-e631c648

 

'

Fairfax Financial Holdings

Fairfax has generated phenomenal long-term returns as the stock has risen at a Berkshire-like compound annual rate of 19.2% since going public in 1985. Founder, chairman, and controlling shareholder Watsa has assembled an impressive group of property-and-casualty insurers with over $30 billion in annual premiums—a third that of Berkshire—and made some shrewd and diverse investments in container ships, European banking, and insurance, particularly in India.

Fairfax has a Berkshire connection in David Sokol, who once led Berkshire Hathaway Energy, the company’s utility unit. Sokol now heads Poseidon, the world leader in container ships, and Fairfax holds a 43% stake in the private company. Fairfax values the stake at about $2 billion, but it could be worth considerably more.

 

Fairfax aims to boost book value by 15% annually, an impressive goal that it has achieved over the past six years. Berkshire, by contrast, is probably capable of about 10% yearly growth in book value going forward.

“You can’t go back and invest in Berkshire in 1992, but Fairfax looks and smells like Berkshire of 30 years ago,” says investor Charlie Frischer, who runs a Seattle family office that holds the stock. Investors have warmed to the Fairfax story in the past year, as the stock, which is mainly traded in Toronto but also has liquid U.S.-listed shares traded over the counter, has gained 50%

The stock still looks attractive, trading around 1.6 times book value and about 11 times projected 2025 earnings. Raymond James analyst Stephen Boland is bullish, writing earlier this year that the “growth and evolution” at the company should allow it to “meet or exceed” the book value target growth of 15% annually. He has an Outperform rating and a price target of about $1,900 a share, compared with a recent $1,685.'

[SafetyinNumbers]

43 minutes ago, glider3834 said:

https://www.barrons.com/articles/berkshire-hathaway-warren-buffett-companies-howard-hughes-loews-fairfax-financial-greenlight-capital-markel-white-mountains-e631c648

 

'

Fairfax Financial Holdings

Fairfax has generated phenomenal long-term returns as the stock has risen at a Berkshire-like compound annual rate of 19.2% since going public in 1985. Founder, chairman, and controlling shareholder Watsa has assembled an impressive group of property-and-casualty insurers with over $30 billion in annual premiums—a third that of Berkshire—and made some shrewd and diverse investments in container ships, European banking, and insurance, particularly in India.

Fairfax has a Berkshire connection in David Sokol, who once led Berkshire Hathaway Energy, the company’s utility unit. Sokol now heads Poseidon, the world leader in container ships, and Fairfax holds a 43% stake in the private company. Fairfax values the stake at about $2 billion, but it could be worth considerably more.

 

Fairfax aims to boost book value by 15% annually, an impressive goal that it has achieved over the past six years. Berkshire, by contrast, is probably capable of about 10% yearly growth in book value going forward.

“You can’t go back and invest in Berkshire in 1992, but Fairfax looks and smells like Berkshire of 30 years ago,” says investor Charlie Frischer, who runs a Seattle family office that holds the stock. Investors have warmed to the Fairfax story in the past year, as the stock, which is mainly traded in Toronto but also has liquid U.S.-listed shares traded over the counter, has gained 50%

The stock still looks attractive, trading around 1.6 times book value and about 11 times projected 2025 earnings. Raymond James analyst Stephen Boland is bullish, writing earlier this year that the “growth and evolution” at the company should allow it to “meet or exceed” the book value target growth of 15% annually. He has an Outperform rating and a price target of about $1,900 a share, compared with a recent $1,685.'

Great quote @kodiak

[ValueMaven]

Barrons is running an article this weekend on mini-Berkshire's and will be listing out FairFax, Markel, White Mountain, and a few other companies ... I believe FFH will be listed out first!!  decent read! 

Edited June 6, 2025 by ValueMaven

[Junior R]

4 hours ago, ValueMaven said:

Barrons is running an article this weekend on mini-Berkshire's and will be listing out FairFax, Markel, White Mountain, and a few other companies ... I believe FFH will be listed out first!!  decent read! 

isnt that the link above your post or is this a new one

[SafetyinNumbers]

1 hour ago, Junior R said:

isnt that the link above your post or is this a new one

Free link to Barron’s article: https://www.msn.com/en-us/money/savingandinvesting/here-come-the-berkshire-hathaway-wannabes/ar-AA1GbLiM

[Junior R]

Just now, SafetyinNumbers said:

Free link to Barron’s article: https://www.msn.com/en-us/money/savingandinvesting/here-come-the-berkshire-hathaway-wannabes/ar-AA1GbLiM

Thanks

[Hektor]

19 minutes ago, SafetyinNumbers said:

Free link to Barron’s article: https://www.msn.com/en-us/money/savingandinvesting/here-come-the-berkshire-hathaway-wannabes/ar-AA1GbLiM

Thanks @SafetyinNumbers

 

Look who managed to fly under the radar! Francis Chou!

[Parsad]

4 hours ago, Hektor said:

Thanks @SafetyinNumbers

 

Look who managed to fly under the radar! Francis Chou!

 

The only thing I worry about Wintaai is who runs it or invests the float after Francis.  He needs to scout out a good young, investment manager with insurance experience to bring under his wing.  This is his vehicle for his personal wealth as well, so he needs someone good who he can trust to look after it for his family and other shareholders.  He could always poach someone from Fairfax too!    Cheers!

[Hektor]

11 hours ago, Parsad said:

The only thing I worry about Wintaai is who runs it or invests the float after Francis.  He needs to scout out a good young, investment manager with insurance experience to bring under his wing.  This is his vehicle for his personal wealth as well, so he needs someone good who he can trust to look after it for his family and other shareholders.  He could always poach someone from Fairfax too!    Cheers!

Do you feel Fairfax might acquire Wintaai at some time in the future?

[Parsad]

On 6/7/2025 at 6:13 AM, Hektor said:

Do you feel Fairfax might acquire Wintaai at some time in the future?

 

It's always possible.  They love acquiring companies somehow related to them or they've worked with or know the people.  That would be a perfect solution for Francis, so that he doesn't have to worry about a successor manager and there probably would be no tax consequences if they received Fairfax shares.  Cheers!

[Viking]

This is the third in a series of posts we are doing on leverage at Fairfax. Links to the first two posts are provided below:

 

The first post introduced the topic and reviewed debt (holding company) and float.

• https://thecobf.com/forum/topic/21117-fairfax-2025/page/38/#findComment-622326

The second post reviewed 3 tactical ways that Fairfax uses leverage.

• https://thecobf.com/forum/topic/21117-fairfax-2025/page/39/#findComment-622725

In our post today we will review another way that Fairfax uses debt - in a way that provides embedded leverage.

 

6.) Debt - At the non-insurance consolidated company level

 

Fairfax’s equity portfolio had a value of about $24.8 billion at June 5, 2025.

 

The equity holdings that are captured in the ‘consolidated’ bucket had a total value of about $4.3 billion, or 17% of Fairfax’s total equity portfolio. These are holdings where Fairfax owns more than 50% and/or exerts control over the business.

 

 

Fairfax has been aggressively growing the holdings in the ‘consolidated’ bucket of holdings. Over the past three years, Fairfax has made 5 different investments for total purchase consideration of $2 billion.

 

 

Where did the cash come from?

 

This is where the story gets interesting. Fairfax did not spend $2 billion in cash. It was much less than that. Fairfax used other people’s money to finance a large part of the total purchase price. Usually debt. Equity in one case (Recipe’s minority partner). This is a form of embedded leverage.

 

What is Fairfax doing?

 

With many of its recent large consolidated equity purchases, Fairfax is using a strategy that is similar to one used by private equity funds:

 

Leveraged buyout (LBO) merger and acquisition (M&A) model

 

The LBO M&A model used by private equity can be summarized as follows: Buy another company (using a lot of leverage). Improve its operations. Use the cash flow from the business to reduce leverage. Sell the company for a big profit five or more years later. A small up-front equity investment can deliver an exceptional rate of return over time.

 

The financial assets of the acquired company are used as collateral to obtain the debt financing. The debt is non-recourse to the financial sponsor.

 

The free cash flow of the acquired company is used to:

• Pay the interest costs.
• Pay down debt.
• Grow the business.

Funding most of the purchase price with debt applies a significant amount of leverage to the deal for the financial sponsor. As the debt is paid down, the value of the equity increases. Because a small amount of equity was used to make the initial purchase, over time the return on equity for the financial sponsor can be quite large.

 

For this model to work the company being acquired needs to have:

• A strong management team.
• Strong free cash flow generation - consistent and resilient (not highly cyclical).

Let’s apply what we learned to Fairfax’s many take-private deals from the past 3 years.

 

Fairfax’s ‘LBO light’ M&A model

 

“If it If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.”

 

Fairfax is not a private equity shop. It is a P/C insurance company. As a result, it is going to ‘tweak’ the LBO M&A model described above to fit its business model. Fairfax made two important ‘tweaks’ to the traditional LBO M&A model with its consolidated equity purchases of the past few years:

• They go easy on the total amount of leverage they use (which lowers the risk).
• And they sometimes use both debt and equity as sources of leverage (which lowers the risk even more).

Because of how they execute the model, I call it ‘LBO light.’

 

Fairfax has a stated return target of 15% when making equity investments. Using a modest amount of leverage helps Fairfax achieve this target.

 

Let’s look at one example of what they did.

 

Sleep Country

 

In July 2024, Fairfax purchased publicly traded Sleep Country for total purchase consideration of $880 million. Fairfax paid $562.7 million in cash. The remaining $317.9 million came from borrowings. Fairfax supply 64% and ‘other people’ provided 36% of the total amount required to take Sleep Country private.

 

Importantly, the borrowings reside on Sleep Country’s balance sheet and are non-recourse to Fairfax. The free cash flow from Sleep Country will be used to pay the interest costs, grow the business and pay down debt.

 

 

What does Fairfax like about Sleep Country?

 

My guess is Fairfax likes:

• The senior management team.
• The size and stability of the earnings stream that Sleep Country is generating.
• The long-term prospects of the business.

Fairfax bought a quality business for a fair price. Exactly the sort of thing that many investors have

been hoping Fairfax would do more of. Welcome to ‘new Fairfax.’

 

Let’s start to wrap this post up.

 

Why does Fairfax use debt with its non-insurance consolidated holdings?

 

1.) To achieve the long-term strategic goals of the company.

• To be opportunistic - strike when the opportunity presents itself.
• To make larger acquisitions.
• To make private/control acquisitions.

2.) To maximize value creation for shareholders.

• To improve the return profile of the acquisition.

Is Fairfax being responsible with its use of debt?

 

IMHO, it looks to me like Fairfax is being thoughtful and responsible with the amount of debt that it is using is at the non-insurance consolidated company level.

 

—————

 

The big picture of what Fairfax is doing

 

Let’s close off by reviewing what Fairfax is doing with its non-insurance consolidated companies bucket of holdings and how it fits in to the bigger picture for the company.

 

Fairfax has 5 income streams that drives its earnings. The first 4 are:

• Underwriting profit
• Interest and dividend income
• Share of profit of associates
• Investment gains

The 5th income stream is ‘non-insurance consolidated companies.’

 

This is the smallest income stream. But as we learned above, over the past three years, Fairfax has been aggressively building out this collection of holdings. From a run rate today of about $150 million annually, earnings from this collection of holdings could increase to over $300 million annually as soon as 2025 or 2026. This income stream is poised to be Fairfax’s fastest growing income stream in the coming years.

 

This 5th income stream also provides Fairfax with many structural and strategic benefits:

• Earnings diversification: The earnings from this income stream are not correlated with the

P/C insurance cycle.

• Liquidity: These holdings provide Fairfax with an important source of liquidity - holdings

could be sold (in whole or in part) if Fairfax needed cash.

• Capital allocation benefits: Retained earnings/free cash flow from the various holdings can be re-invested into the best available opportunity within the Fairfax organization.

—————

 

Comments from Wade Burton on Fairfax’s Q3-2024 earnings conference call:

 

“For the $20 billion in equities, not much changed. Our core holdings and investments continued to perform well, all making good income against invested capital. Our experienced investment team is constantly searching for new opportunities, but as managers of insurance float, we have the very great benefit of taking a long term approach to investing. It means we can wait for prices to come to us, and we won’t invest unless we see a margin of safety.

 

“We did make one significant announcement in the quarter. We bought out our main partners in Peak Achievement, an athletic wear and equipment company focused on hockey and lacrosse. It is an outstanding business operating in a highly consolidated industry, well run by Ed Kinnaly and his team, incredible track record, and we paid a fair price. We think we will make a very good return over the long run for our shareholders, and importantly, Ed runs the company very much in tune with the Fairfax culture.

 

“Looking back over the last two years, we’ve made three significant long term equity investments, one in Meadow Dairy, a dominant milk ingredients company in the U.K. that is doing very well; another in Sleep Country, a dominant mattress distributor and retailer in Canada; and now a third, Peak, a dominant sporting goods company focused on hockey and lacrosse. All immediately are or will contribute to our earnings, and we believe all will continue to contribute more and more as their businesses progress.”

 

Jen Allen’s comments on Fairfax’s Q3-2024 conference call

 

“As Wade noted, with our recently announced Sleep Country and Peak Achievement transactions,

we expect the operating income from our non- insurance companies reporting segment will grow in the future periods, reflecting the operating income diversity these investments will add to the

segment.”

 

—————

 

Do total debt levels really come down over time?

 

To answer this question, let’s look at two legacy consolidated holdings: Recipe and AGT Food Ingredients.

 

Recipe Unlimited

 

At the time of the take private in 2022, total borrowings at Recipe increased to $464 million. Total borrowings at Recipe were reduced by $154 million in 2023 and 2024, finishing the year at $310 million.

 

In Q1 2025, Fairfax bought out its 16% minority equity partner in Recipe (CARA Operations and the founding Phelan family). The purchase was paid from an increase in borrowings at Recipe of $132.1 million. Fairfax now owns 100% of Recipe (and its significant free cash flow) and did not have to inject any new capital to make it happen.

 

 

AGT Food Ingredients

 

In Q1, 2025, AGT Food Ingredients sold its non-core rail and infrastructure assets for $132 million and the proceeds were used to pay down debt. AGT had total borrowings of $465 million at December 31, 2024. This drops total borrowing to $333 million, a significant reduction.

 

In both of our examples, yes, total debt levels are coming down over time.

 

----------

 

We will continue to go down the leverage rabbit hole... our next post should be out in the next week. In it we will explore human capital. Leveraging human capital was Warren Buffett's real genius (with the help of Munger).

Edited June 9, 2025 by Viking

[Viking]

36 minutes ago, Viking said:

This is the third in a series of posts we are doing on leverage at Fairfax. Links to the first two posts are provided below:

 

The first post introduced the topic and reviewed debt (holding company) and float.

• https://thecobf.com/forum/topic/21117-fairfax-2025/page/38/#findComment-622326

The second post reviewed 3 tactical ways that Fairfax uses leverage.

• https://thecobf.com/forum/topic/21117-fairfax-2025/page/39/#findComment-622725

In our post today we will review another way that Fairfax uses debt - in a way that provides embedded leverage.

 

6.) Debt - At the non-insurance consolidated company level

 

Fairfax’s equity portfolio had a value of about $24.8 billion at June 5, 2025.

 

The equity holdings that are captured in the ‘consolidated’ bucket had a total value of about $4.3 billion, or 17% of Fairfax’s total equity portfolio. These are holdings where Fairfax owns more than 50% and/or exerts control over the business.

 

 

Fairfax has been aggressively growing the holdings in the ‘consolidated’ bucket of holdings. Over the past three years, Fairfax has made 5 different investments for total purchase consideration of $2 billion.

 

 

Where did the cash come from?

 

This is where the story gets interesting. Fairfax did not spend $2 billion in cash. It was much less than that. Fairfax used other people’s money to finance a large part of the total purchase price. Usually debt. Equity in one case (Recipe’s minority partner). This is a form of embedded leverage.

 

What is Fairfax doing?

 

With many of its recent large consolidated equity purchases, Fairfax is using a strategy that is similar to one used by private equity funds:

 

Leveraged buyout (LBO) merger and acquisition (M&A) model

 

The LBO M&A model used by private equity can be summarized as follows: Buy another company (using a lot of leverage). Improve its operations. Use the cash flow from the business to reduce leverage. Sell the company for a big profit five or more years later. A small up-front equity investment can deliver an exceptional rate of return over time.

 

The financial assets of the acquired company are used as collateral to obtain the debt financing. The debt is non-recourse to the financial sponsor.

 

The free cash flow of the acquired company is used to:

• Pay the interest costs.
• Pay down debt.
• Grow the business.

Funding most of the purchase price with debt applies a significant amount of leverage to the deal for the financial sponsor. As the debt is paid down, the value of the equity increases. Because a small amount of equity was used to make the initial purchase, over time the return on equity for the financial sponsor can be quite large.

 

For this model to work the company being acquired needs to have:

• A strong management team.
• Strong free cash flow generation - consistent and resilient (not highly cyclical).

Let’s apply what we learned to Fairfax’s many take-private deals from the past 3 years.

 

Fairfax’s ‘LBO light’ M&A model

 

“If it If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.”

 

Fairfax is not a private equity shop. It is a P/C insurance company. As a result, it is going to ‘tweak’ the LBO M&A model described above to fit its business model. Fairfax made two important ‘tweaks’ to the traditional LBO M&A model with its consolidated equity purchases of the past few years:

• They go easy on the total amount of leverage they use (which lowers the risk).
• And they sometimes use both debt and equity as sources of leverage (which lowers the risk even more).

Because of how they execute the model, I call it ‘LBO light.’

 

Fairfax has a stated return target of 15% when making equity investments. Using a modest amount of leverage helps Fairfax achieve this target.

 

Let’s look at one example of what they did.

 

Sleep Country

 

In July 2024, Fairfax purchased publicly traded Sleep Country for total purchase consideration of $880 million. Fairfax paid $562.7 million in cash. The remaining $317.9 million came from borrowings. Fairfax supply 64% and ‘other people’ provided 36% of the total amount required to take Sleep Country private.

 

Importantly, the borrowings reside on Sleep Country’s balance sheet and are non-recourse to Fairfax. The free cash flow from Sleep Country will be used to pay the interest costs, grow the business and pay down debt.

 

 

What does Fairfax like about Sleep Country?

 

My guess is Fairfax likes:

• The senior management team.
• The size and stability of the earnings stream that Sleep Country is generating.
• The long-term prospects of the business.

Fairfax bought a quality business for a fair price. Exactly the sort of thing that many investors have

been hoping Fairfax would do more of. Welcome to ‘new Fairfax.’

 

Let’s start to wrap this post up.

 

Why does Fairfax use debt with its non-insurance consolidated holdings?

 

1.) To achieve the long-term strategic goals of the company.

• To be opportunistic - strike when the opportunity presents itself.
• To make larger acquisitions.
• To make private/control acquisitions.

2.) To maximize value creation for shareholders.

• To improve the return profile of the acquisition.

Is Fairfax being responsible with its use of debt?

 

IMHO, it looks to me like Fairfax is being thoughtful and responsible with the amount of debt that it is using is at the non-insurance consolidated company level.

 

—————

 

The big picture of what Fairfax is doing

 

Let’s close off by reviewing what Fairfax is doing with its non-insurance consolidated companies bucket of holdings and how it fits in to the bigger picture for the company.

 

Fairfax has 5 income streams that drives its earnings. The first 4 are:

• Underwriting profit
• Interest and dividend income
• Share of profit of associates
• Investment gains

The 5th income stream is ‘non-insurance consolidated companies.’

 

This is the smallest income stream. But as we learned above, over the past three years, Fairfax has been aggressively building out this collection of holdings. From a run rate today of about $150 million annually, earnings from this collection of holdings could increase to over $300 million annually as soon as 2025 or 2026. This income stream is poised to be Fairfax’s fastest growing income stream in the coming years.

 

This 5th income stream also provides Fairfax with many structural and strategic benefits:

• Earnings diversification: The earnings from this income stream are not correlated with the

P/C insurance cycle.

• Liquidity: These holdings provide Fairfax with an important source of liquidity - holdings

could be sold (in whole or in part) if Fairfax needed cash.

• Capital allocation benefits: Retained earnings/free cash flow from the various holdings can be re-invested into the best available opportunity within the Fairfax organization.

—————

 

Comments from Wade Burton on Fairfax’s Q3-2024 earnings conference call:

 

“For the $20 billion in equities, not much changed. Our core holdings and investments continued to perform well, all making good income against invested capital. Our experienced investment team is constantly searching for new opportunities, but as managers of insurance float, we have the very great benefit of taking a long term approach to investing. It means we can wait for prices to come to us, and we won’t invest unless we see a margin of safety.

 

“We did make one significant announcement in the quarter. We bought out our main partners in Peak Achievement, an athletic wear and equipment company focused on hockey and lacrosse. It is an outstanding business operating in a highly consolidated industry, well run by Ed Kinnaly and his team, incredible track record, and we paid a fair price. We think we will make a very good return over the long run for our shareholders, and importantly, Ed runs the company very much in tune with the Fairfax culture.

 

“Looking back over the last two years, we’ve made three significant long term equity investments, one in Meadow Dairy, a dominant milk ingredients company in the U.K. that is doing very well; another in Sleep Country, a dominant mattress distributor and retailer in Canada; and now a third, Peak, a dominant sporting goods company focused on hockey and lacrosse. All immediately are or will contribute to our earnings, and we believe all will continue to contribute more and more as their businesses progress.”

 

Jen Allen’s comments on Fairfax’s Q3-2024 conference call

 

“As Wade noted, with our recently announced Sleep Country and Peak Achievement transactions,

we expect the operating income from our non- insurance companies reporting segment will grow in the future periods, reflecting the operating income diversity these investments will add to the

segment.”

 

—————

 

Do total debt levels really come down over time?

 

To answer this question, let’s look at two legacy consolidated holdings: Recipe and AGT Food Ingredients.

 

Recipe Unlimited

 

At the time of the take private in 2022, total borrowings at Recipe increased to $464 million. Total borrowings at Recipe were reduced by $154 million in 2023 and 2024, finishing the year at $310 million.

 

In Q1 2025, Fairfax bought out its 16% minority equity partner in Recipe (CARA Operations and the founding Phelan family). The purchase was paid from an increase in borrowings at Recipe of $132.1 million. Fairfax now owns 100% of Recipe (and its significant free cash flow) and did not have to inject any new capital to make it happen.

 

 

AGT Food Ingredients

 

In Q1, 2025, AGT Food Ingredients sold its non-core rail and infrastructure assets for $132 million and the proceeds were used to pay down debt. AGT had total borrowings of $465 million at December 31, 2024. This drops total borrowing to $333 million, a significant reduction.

 

In both of our examples, yes, total debt levels are coming down over time.

 

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We will continue to go down the leverage rabbit hole... our next post should be out in the next week. In it we will explore human capital. Leveraging human capital was Warren Buffett's real genius (with the help of Munger).

 

I have a question for those posters on the board who follow Berkshire Hathaway closely... When Buffett took BNSF private in 2009 was part of the take-out price funded by an increase in borrowings at BNSF? Has Buffett also been using the 'LBO light' model I reference in my previous post?

Edited June 9, 2025 by Viking

[gfp]

20 hours ago, Viking said:

 

I have a question for those posters on the board who follow Berkshire Hathaway closely... When Buffett took BNSF private in 2009 was part of the take-out price funded by an increase in borrowings at BNSF? Has Buffett also been using the 'LBO light' model I reference in my previous post?

 

The initial purchase was partially funded with Berkshire parent level borrowings.  Ever since the initial purchase, there have been substantial cash distributions out of BNSF and steadily increasing debt at the BNSF level.

 

BNSF was definitely a "leveraged buyout / light" by Berkshire.  Before you even factor in the fact that it happened inside National Indemnity who's capital is some mix of equity and "other people's money."

 

From memory, I think it was something like $8 billion of the BNI purchase price was borrowed by Berkshire at the parent level.

 

Edit: @Viking here is the relevant detail from the cash portion of Berkshire's BNSF acquisition:

 

"

The aggregate consideration paid of $26.5 billion consisted of cash of approximately $15.9

billion with the remainder in Berkshire Class A and B stock (about 95,000 shares on an equivalent Class A basis).

Approximately 50% of the cash component was funded with existing cash balances and the remaining 50% was funded with the

proceeds from newly issued debt."

Edited June 10, 2025 by gfp

[Viking]

3 hours ago, gfp said:

 

The initial purchase was partially funded with Berkshire parent level borrowings.  Ever since the initial purchase, there have been substantial cash distributions out of BNSF and steadily increasing debt at the BNSF level.

 

BNSF was definitely a "leveraged buyout / light" by Berkshire.  Before you even factor in the fact that it happened inside National Indemnity who's capital is some mix of equity and "other people's money."

 

From memory, I think it was something like $8 billion of the BNI purchase price was borrowed by Berkshire at the parent level.

 

Edit: @Viking here is the relevant detail from the cash portion of Berkshire's BNSF acquisition:

 

"

The aggregate consideration paid of $26.5 billion consisted of cash of approximately $15.9

billion with the remainder in Berkshire Class A and B stock (about 95,000 shares on an equivalent Class A basis).

Approximately 50% of the cash component was funded with existing cash balances and the remaining 50% was funded with the

proceeds from newly issued debt."

 

@gfp , I appreciate you post for 2 reasons:

1.) Confirmation on the specifics of the deal. 

2.) Help clarifying my thinking around stock issuance. That is (obviously) a pretty clear example of using 'other people's money.' I need to refine my thinking about stock issuance and leverage. 

 

Here is a summary of how BRK paid for BNSF. A total of 70% of the total purchase price came from other people. Actual cash contribution from BRK was 30%. Super interesting.

 

 

From BRK's 2009AR

 

Edited June 10, 2025 by Viking

[gfp]

He was not pleased to be issuing Berkshire stock but that is what it took to get the deal done and he wanted his railroad.  You only have to buy a great asset once!  Maaayybee he should have started repurchasing those shares a little sooner to soften the sting but Warren moves slow.

 

[gfp]

I will add that everyone looks for Berkshire to do an acquisition to "soak up" some of their large cash holdings - but I'll bet that if Berkshire were to do another acquisition of BNSF -ish size they would, once again, issue fixed rate debt to fund a portion of the deal (unless the acquired company had a bunch of debt on it for some reason).  Combine that with the operating cash flow accumulated during the time it takes to vote on, receive regulatory approvals, and close the deal and it is likely the cash balance wouldn't even decrease.

 

Maybe Greg will be slightly less stingy on share repurchase.  Warren says that he loves what Tim Cook is doing.  Beats me!  But Berkshire could stay pretty much the same size and the share price could have a hell of a run if Greg just methodically knocks down the share count.

[73 Reds]

3 minutes ago, gfp said:

I will add that everyone looks for Berkshire to do an acquisition to "soak up" some of their large cash holdings - but I'll bet that if Berkshire were to do another acquisition of BNSF -ish size they would, once again, issue fixed rate debt to fund a portion of the deal (unless the acquired company had a bunch of debt on it for some reason).  Combine that with the operating cash flow accumulated during the time it takes to vote on, receive regulatory approvals, and close the deal and it is likely the cash balance wouldn't even decrease.

 

Maybe Greg will be slightly less stingy on share repurchase.  Warren says that he loves what Tim Cook is doing.  Beats me!  But Berkshire could stay pretty much the same size and the share price could have a hell of a run if Greg just methodically knocks down the share count.

@gfp was more debt rather than stock an option for Buffett in 2009?