Jump to content

Greg Speicher article in GuruFocus on Fairfax


cwericb
 Share

Recommended Posts

Guest misterstockwell

That article is all about the great investment ability at Fairfax, yet says nothing about the underwriting side. No matter how you slice it, that part is mediocre at best. The multiple to book takes a hit because of that. No way FFH deserves 1.5X book in this environment. 

Link to comment
Share on other sites

I understand that many assess FFH on their underwriting abilities, rather than their investment prowess. But here is where this logic escapes me. In the long run, what difference does lower underwriting profitability make if it is more than offset by the profit produced by their investing side of the business? Isn’t the objective to have a profitable company, who cares which part of the company that profit comes from? Would you give a higher value to a company that didn`t show the profits that FFH has, just because it had better underwriting numbers and yet its overall profit wasn`t as good? What ever happened to `the bottom line`.

 

I am involved in retail. At times we have loss leaders to stimulate sales in other areas. If you look at it in this way, perhaps FFH would be even better off if they lost more on the underwriting side if that in turn generated more customer’s premiums which FFH could use to produce even more profits from investments . I’m not recommending this, just using the analogy.

Link to comment
Share on other sites

Guest Bronco

Cwericb - of course, only a fool would criticize the $2+ billions FFH made on CDS instruments by complaining about the combined ratio during that time frame. 

 

I believe you are right in saying the NPV of future earnings - Investment Earnings plus or minus underwriting earnings, is the appropriate approach.  Some may argue that underwriting results are easier to model or predict.  I don't know the answer to that.  And I don't know if Prem can generate future earnings results that are satisfactory.

 

I do know you can place a bet with the best jockeys.  BRK, L, FFH - I'm in.

 

 

Link to comment
Share on other sites

 

First I have to give Prem credit. Most insurers with great underwriting are trading at .80 book value and we are standing at 1.05 BV. Delisting from the NYSE was a great move, and has removed a lot of volatility. Unfortunately we don’t have the fat pitches on FFH stock / options that we have become used to.

Second the article is pretty much how I look at FFH and similar to how I look at Lancashire (but underwriting instead of investing). I think both deserve 1.5 BV over the long term, and both will get it at some point. Till then buy, hold, and add when under book value. We aren’t going to get it anytime soon though with a soft market, and top underwriters trading below book.

 

Third, I and many on this board am pretty agnostic when it comes to profits. We count cash and want there to be more next year then the current one. That’s all well and good though, but we need Mister Market for 1.5 BV, and Mister Market cares about underwriting. Insurance Analysts view investment gains as one time deals, and can’t really annualize or model them. Good underwriting and, a solid bond portfolio which throws off cash consistently are much easier, than lumpy one time CDS, Bonds, and Equity gains.

 

Prem is holding his line. He said he will be ready for the hard market, and appears willing to let the expense ratio grow as the top line declines. I applaud him. It sends the wrong message to fire good underwriters to keep the CM below 100% and will cause adverse underwriting in the long run due to underwriters writing to keep business. This principled stance, the positive reserve developments over the short term, the amazing Equity results combined with the hedges, and the solid bond yield all make me wise I never sold and will have me buying fairly soon.

 

Plus if the world falls apart, Prem will be there awash with cash to help put it back together. Too many ways to win, and only really 1 way to lose (Huge Black Swan Event, which would likely take down more than just FFH).

 

Link to comment
Share on other sites

Guest misterstockwell

 

Prem is holding his line. He said he will be ready for the hard market, and appears willing to let the expense ratio grow as the top line declines. I applaud him. It sends the wrong message to fire good underwriters to keep the CM below 100% and will cause adverse underwriting in the long run due to underwriters writing to keep business. 

 

There's the rub--do we have any evidence that he has "good underwriters" employed currently? I would venture that there are many weak links that could have been eliminated.

Link to comment
Share on other sites

“Third, I and many on this board am pretty agnostic when it comes to profits. We count cash and want there to be more next year then the current one.”

 

Look, any way you cut it we are all looking for profits in one form or another. Profits generated year over year increase book value. I would not be particularly intersted in investing in any company that was not interested in profits. Perhaps I took this out of context?

 

“...Mister Market cares about underwriting. Insurance Analysts view investment gains as one time deals...”

 

Unfortunately that is true but one would think that there would come a point where Mr. Market would eventually clue in to the fact that HWIC has built a track record that deserves to be factored into the value of this company. And yes, a serious downturn could adversely effect those investment gains but the same climate would also tend to depress underwriting profits. Those Insurance Analysts might also remember that we had a pretty nasty bump in the economy a year or so ago and FFH didn’t fare too badly - to put it mildly. Perhaps some of those guys should start to “think outside the box”.

Link to comment
Share on other sites

Paying 1.5x book for Fairfax based on the investing acumen of Watsa & his team is similar to paying 1.5x book for a mutual fund.  Would you pay 50% above the current quote for the Fairholme fund because of the investing acumen of Berkowitz and his team?  Why not?

Link to comment
Share on other sites

 

Prem is holding his line. He said he will be ready for the hard market, and appears willing to let the expense ratio grow as the top line declines. I applaud him. It sends the wrong message to fire good underwriters to keep the CM below 100% and will cause adverse underwriting in the long run due to underwriters writing to keep business. 

 

There's the rub--do we have any evidence that he has "good underwriters" employed currently? I would venture that there are many weak links that could have been eliminated.

 

Lol, Interesting point. One I cant counter actually. Other companies seem to do better here.

 

Paying 1.5x book for Fairfax based on the investing acumen of Watsa & his team is similar to paying 1.5x book for a mutual fund.  Would you pay 50% above the current quote for the Fairholme fund because of the investing acumen of Berkowitz and his team?  Why not?

 

Yes I would. If Bruce was levered 4 to 1 or 3 to 1. Maybe not Bruce, but if Pimco's Bill Gross had 4 to 1 leverage on a bond portfolio I would pay 2x book for it.

Link to comment
Share on other sites

Paying 1.5x book for Fairfax based on the investing acumen of Watsa & his team is similar to paying 1.5x book for a mutual fund.  Would you pay 50% above the current quote for the Fairholme fund because of the investing acumen of Berkowitz and his team?  Why not?

 

Tiddman, Fairfax is a great insurance company which is temporarily experiencing mediocre results due to a soft market and artificially high expense ratios (due to being sized to write much more business, when doing so becomes profitable).

 

You are essentially saying that you would like FFH to get out of the insurance business, fire everyone, sell-off the runoff insurance liabilities and associated assets, and run a hedge fund for below-market compensation levels.  Do you really think the insurance business is worth zero?  Would it make no difference to you if they handed the entire insurance business over to bruce berkowitz and just managed the surplus capital that remained?

Link to comment
Share on other sites

 

Paying 1.5x book for Fairfax based on the investing acumen of Watsa & his team is similar to paying 1.5x book for a mutual fund.  Would you pay 50% above the current quote for the Fairholme fund because of the investing acumen of Berkowitz and his team?  Why not?

 

Yes I would. If Bruce was levered 4 to 1 or 3 to 1. Maybe not Bruce, but if Pimco's Bill Gross had 4 to 1 leverage on a bond portfolio I would pay 2x book for it.

 

Maybe if Pimco somehow had long-term low-cost leverage so he wouldn't be at the mercy of market movements . . . and at a minimum I think thats the value of the insurance business, it provides long-term low cost leverage.

 

I think the insurance side (a.k.a the business) will turn out to be an incredibly profitable enterprise regardless of hamblin watsa, but until that happens, at a minimum I think everyone has to admit that the insurance side provides leverage for a bond portfolio at less cost than the yield on that bond portfolio . . . adding a couple percentage points a year to the "pure" investment side of surplus, and warranting a premium to book value.

 

If someone devised a derivative that paid me the annual return on Berkowitz' portfolio plus 6% every year, I would be willing to pay 1.5 times book value for that.

Link to comment
Share on other sites

Speicher suggests that Fairfax fair value should be in the range of $574/ share.

 

http://www.gurufocus.com/news.php?id=101996

 

 

I think 1.25 book would be pretty reasonable.  This assumes ROE of 15% and cost of equity of 12%.  A P/BV of 1.5 would require a cost of equity to be 10%; that is pretty low for a levered financial institution with cat exposure. 

Link to comment
Share on other sites

Yes I would. If Bruce was levered 4 to 1 or 3 to 1. Maybe not Bruce, but if Pimco's Bill Gross had 4 to 1 leverage on a bond portfolio I would pay 2x book for it.

 

The Fairholme fund fell about 30% in 2008.  If they had been levered 3 to 1 or 4 to 1 shareholders would have been completely wiped out... the leverage works both ways.  You can't just say that a great manager is more great if you apply leverage.  That only works during the good times.

 

You are essentially saying that you would like FFH to get out of the insurance business, fire everyone, sell-off the runoff insurance liabilities and associated assets, and run a hedge fund for below-market compensation levels.

 

Gee I don't remember saying anything of the sort :).

 

Fairfax's insurance operations, exclusive of investments, are approximately average in terms of long term results and will probably remain so.  Average insurance operations with average investment results are worth book value or slightly less (look at WTM at 78% of book for example).

 

What differentiates Fairfax is the investment returns.  The results from Watsa & team are fantastic.  But I am not willing to pay a 50% premium to book for that, because if I did, their fantastic results would lead to average results for me.  I would rather pay book value, and get the fantastic results for myself.

 

Link to comment
Share on other sites

I think Speicher's calculation is too complicated to be useful. I would suggest it is more useful to either separate the "book value" or "hedge fund" portion of FFH (worth about $8 Billion) and the "insurance side" with about $16 billion of assets and liabilities.

 

I think the "hedge fund" side is worth the same as any other good fund, NAV, or in this case Book Value. I think this is roughly equal to Seth Klarman's fund . . . great long term performance, usually holds a lot of cash, and makes conservative long-term investments along with opportunistic short-term ones with a large margin of safety.

 

I think the insurance side should be viewed as a kicker of sorts . . . what percent of book value (the "hedge fund") will this entire operation add each year (dividends and capital appreciation of assets minus cost of float, on an after-tax basis).  Right now it is probably around 2% (I assume a 5% return, 2% cost of float, and 33% taxes) of $16 Billion or 4% per year on the book value of $8 Billion. . . Maybe this is only worth paying an extra .25 of book to have (but I think this implies that hamblin watsa will return a steady 16% on the rest, since a 4% return is worth only 0.25 of book and everyone seems willing to pay book value for the "hedge fund" side of the business.  

 

We know that expense ratios are at least 5% too high because they aren't writing much insurance.  I think it's safe to assume that at some point they will write twice as much insurance as they are writing now - Prem has said they have the capacity to do so. Without any improvement in the loss ratio or asset return (bonds mostly) This will take the after-tax return on the insurance side to about 5% - but 5% of $32 billion is 20% of the "hedge fund" . . . what is this worth?  Is it that unrealistic to think that a harder market would lead to a lower loss ratio AND higher bond yields?  What is the posibility of owning this asset worth today?

Link to comment
Share on other sites

Yes I would. If Bruce was levered 4 to 1 or 3 to 1. Maybe not Bruce, but if Pimco's Bill Gross had 4 to 1 leverage on a bond portfolio I would pay 2x book for it.

 

The Fairholme fund fell about 30% in 2008.  If they had been levered 3 to 1 or 4 to 1 shareholders would have been completely wiped out... the leverage works both ways.  You can't just say that a great manager is more great if you apply leverage.  That only works during the good times.

 

You are essentially saying that you would like FFH to get out of the insurance business, fire everyone, sell-off the runoff insurance liabilities and associated assets, and run a hedge fund for below-market compensation levels.

 

Gee I don't remember saying anything of the sort :).

 

Fairfax's insurance operations, exclusive of investments, are approximately average in terms of long term results and will probably remain so.  Average insurance operations with average investment results are worth book value or slightly less (look at WTM at 78% of book for example).

 

What differentiates Fairfax is the investment returns.  The results from Watsa & team are fantastic.  But I am not willing to pay a 50% premium to book for that, because if I did, their fantastic results would lead to average results for me.  I would rather pay book value, and get the fantastic results for myself.

 

 

If you aren't willing to pay more than book value, wouldn't you rather that they just ran a hedge fund or mutual fund?

Link to comment
Share on other sites

If you aren't willing to pay more than book value, wouldn't you rather that they just ran a hedge fund or mutual fund?

 

If it were possible to invest in just the equity portion of Watsa & Hamblin's investments, I would eagerly do that... without leverage and for the long term.  Their track record there is fantastic.  I wouldn't pay more than NAV though... that defeats the goal of obtaining the superior returns.

 

But at Fairfax, you have to take the fixed income and insurance operations along with the equity investing, plus leverage, plus exposure to super-cats.  This package is not quite as appealing to me as just the straight equity investments but should provide solid returns... but only if I pay book value.

 

I am probably in the minority here but I don't feel that Fairfax is worth a big premium to book value, and history has shown that there are ample opportunities to buy it below book, so I don't see any reason to pay a premium.

Link to comment
Share on other sites

Thats perfectly fair Tiddman, and the recent results suggest you are correct, I just wanted to make sure we are on the same page.

 

I think its worth more than book, but only because I think the insurance side (leverage, bonds, mega cats) is worth a LOT . . .

 

I completely agree with you though. I would not pay more than book value to have Hamblin Watsa manage money for me in a hedge fund or mutual fund vehicle, regardless of whether or not they employed leverage

Link to comment
Share on other sites

I think its worth more than book, but only because I think the insurance side (leverage, bonds, mega cats) is worth a LOT . . .

 

Maybe it depends on where you draw the line between the insurance and investment ops (which are inherently part and parcel with one another).

 

The typical insurance company underwrites at a small loss (say 2-5%), has investments equal to about 2-3x book value, debt-to-equity of around 25%, and earns a yield of about 4-5% on those investments, which are usually almost exclusively in safe bonds.  This leads to an ROE of maybe 10-12% when nothing goes wrong, and, on average, something goes wrong once every 5 years or so.  This leads to a nonzero but unimpressive return over the long term.

 

The place where Fairfax differs from this model is in the investment returns which are much higher, and higher overall leverage due to use of debt.  The insurance operations are, over the long term, basically average.  The leverage can be dangerous and has gotten them in trouble in the past but is probably manageable they way they are now.  But the investment returns, in both stocks and bonds, is the major differentiator, which is what makes it an attractive investment IMHO.

Link to comment
Share on other sites

I think things are getting slightly confused / muddled.

 

What’s something is worth and what one is willing to pay are 2 different things. I would part with my FFH shares at 1.5 book. I wouldn’t be buying at that point. I believe we are all saying that we want Mr. Market to pay us 1.5 book value for FFH. Not we want to pay 1.5 book value for FFH. At 1.5 BV it’s a fair deal. At book or below it’s a great deal. Value investors go for great deals, and then sell them to Mr. Market when they become fair / bad deals. I think everyone here is willing to hold FFH at up to 1.5 BV barring any hidden gains. At that point we will likely have to reconsider.

 

Link to comment
Share on other sites

"What’s something is worth and what one is willing to pay are 2 different things. I would part with my FFH shares at 1.5 book. I wouldn’t be buying at that point. I believe we are all saying that we want Mr. Market to pay us 1.5 book value for FFH. Not we want to pay 1.5 book value for FFH. At 1.5 BV it’s a fair deal. At book or below it’s a great deal. Value investors go for great deals, and then sell them to Mr. Market when they become fair / bad deals. I think everyone here is willing to hold FFH at up to 1.5 BV barring any hidden gains. At that point we will likely have to reconsider."

 

Agree 100%...I was going to right the same response as I was reading the above.

 

Another possible way to look at it, would be how much would we be willing to sell FFH to someone taking it private so that we would never be able to own it. Perhaps it may be worth more than 1.5x  BV.(I think we all have a feeling that we can sell at 1.5X, then Mr Market will give us another chance to buy at< 1 x BV) I think we would be all disappointed if HW decided to buyout all the public shares at <1.5 x BV

Link to comment
Share on other sites

If you agree with the 12% growth estimate and the 1.5X book valuation, then you are implying a 10.5% return at intrinsic value. That's a pretty high required return relative to current borrow costs, and a pretty low growth estimate relative to historical returns. 1.5X is a good starting point to think about selling significant amounts of stock, but I would want ready alternatives before selling at that price.

Link to comment
Share on other sites

Guest longinvestor

If you agree with the 12% growth estimate and the 1.5X book valuation, then you are implying a 10.5% return at intrinsic value. That's a pretty high required return relative to current borrow costs, and a pretty low growth estimate relative to historical returns. 1.5X is a good starting point to think about selling significant amounts of stock, but I would want ready alternatives before selling at that price.

 

Agree wholeheartedly. Appears like many here have absolute assumptions....."Poor insurance business", "Hedge fund quality" etc. Much of this rear view mirror approach. The world is relative and most importantly, Prem is totally focused on the future. What we have seen in the past is nothing like what FFH is being prepared for in the future. Like growth in India, Brazil, Poland, like taking their businesses private, like not writing unprofitable business etc. FFH is likely to explode in the long term and the market is totally wrong in pricing the stock. More power to them!

Link to comment
Share on other sites

If it were possible to invest in just the equity portion of Watsa & Hamblin's investments, I would eagerly do that... without leverage and for the long term.  Their track record there is fantastic.  I wouldn't pay more than NAV though... that defeats the goal of obtaining the superior returns.

 

But at Fairfax, you have to take the fixed income and insurance operations along with the equity investing, plus leverage, plus exposure to super-cats.  This package is not quite as appealing to me as just the straight equity investments but should provide solid returns... but only if I pay book value.

 

Just thought I'd point out that actually their fixed income investing is probably more impressive than their equity investing.  Their outperformance there is outstanding considering the divergence of performance between the best and worst bond managers is much smaller than that between the best and worst equity managers. 

Link to comment
Share on other sites

If it were possible to invest in just the equity portion of Watsa & Hamblin's investments, I would eagerly do that... without leverage and for the long term.  Their track record there is fantastic.  I wouldn't pay more than NAV though... that defeats the goal of obtaining the superior returns.

 

But at Fairfax, you have to take the fixed income and insurance operations along with the equity investing, plus leverage, plus exposure to super-cats.  This package is not quite as appealing to me as just the straight equity investments but should provide solid returns... but only if I pay book value.

 

Just thought I'd point out that actually their fixed income investing is probably more impressive than their equity investing.  Their outperformance there is outstanding considering the divergence of performance between the best and worst bond managers is much smaller than that between the best and worst equity managers. 

 

Yes, their bond record is probably the very best in the world, without including the CDS.  Company is trading too cheap by half - at least.  They have 20 years on Buffet and worldwide bench depth far greater than Berkshire in investments.

 

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
 Share

×
×
  • Create New...