Fairfax Releases Q1 Financial Data; Rocked by Japan

[Guest HarryLong]

The writing is on the wall. Companies led by investors will attempt to acquire companies led by strong underwriting teams.

 

The investors will eventually realize, if they don't already, that strong underwriting will provide greater flexibility in persuing strong/flexible/go anywhere investment strategies.

 

That's going to be the major trend going forward in the industry.

[Guest ValueCarl]

Just a casual observation that makes me laugh a little bit. At least for the guys like Bronco wanting to fill their trucks up on some near term dip; they could have done that in the wake of the quake if they were nibble and quick!  ;D

 

The price went to where some are believing this is heading back to tomorrow, at that time, i.e., US $350 area, and bounced rather quickly by memory!

 

In the case of this insurance stock, the market seems to be exhibiting some level of "efficiency."  ;)    

 

Either way, if they lop off ten or fifteen percent tomorrow or the next few days, a similar result would have been established by having bought in the wake of the storm accept for the time delay in going back there again, assuming it does.  

[Rabbitisrich]

Stated differently, the goodwill is a relic of what happened to them.  Had they never IPO'd NB and ORH in the first place (in a parallel universe), then they never would have needed to buy them back above book value and thus there would be no goodwill.  They would have a cash asset instead of the intangible asset.  

 

I can't argue that the cash from that parallel world is worth as much as the goodwill from our real world.  I think the cash is worth full value and the goodwill can be ignored.  In that parallel world, the goodwill is implicitly there (in addition to the cash!) just as in today's world the previously consolidated majority positions have goodwill that is implicitly there (but not explicitly stated as a component of book value).

 

Aside from accounting consistency, what is the economic reason to only include tangible assets in your valuation? Writing off the goodwill is that same as stating that the ORH purchase was too dear, and that you need to reduce your entry price to reflect a higher expected return.

 

At $3.65 B implied for a profitable developer of $4.8 B in float with historical BV growth of 20%, losing ORH to Fairfax was not necessarily a wonderful point in time for ORH shareholders.

[Guest Bronco]

Value Carl, not only did I buy on the dip, but i posted on here that the news was overblown (and was one of the few).  And I did buy fairfax, along with exelon and others.  I have since sold these positions.

 

Not sure how this is funny but as long as someone enjoys that is good enough for me.

[ERICOPOLY]

 

Aside from accounting consistency, what is the economic reason to only include tangible assets in your valuation? Writing off the goodwill is that same as stating that the ORH purchase was too dear, and that you need to reduce your entry price to reflect a higher expected return.

 

 

Because...

 

The day after the ORH minority buyout transaction hit the FFH books it looked like this:

roughly 80% of ORH is still valued at tangible book value

roughly 20% of ORH is now valued at roughly 130% of tangible book value.

 

 

So I ask...

 

WTF???

 

Why is 20% of ORH worth 1.3x but 80% of it is only worth 1x?

 

Did they like buy the best part of it or something?

 

It's nonsense.

 

So why don't you value the goodwill for ORH at 5x in YOUR book value assessment?  Why not?  After all, they've undervalued the goodwill by 80% by having grown the majority stake organically rather than buying it at a premium.

 

Put it this way... had they not owned any of ORH prior to the transaction, then the goodwill from the ORH purchase would be roughly 5x what it is today.  

 

So why not just pound the table that book value is really $400 instead of $350?

 

 

Moving on to another example:

1)  You own a holding company that only holds cash, until it acquires 100% of WFC at $45 per share.  

2)  Let's say book value today (before the buyout) is stated at 22.50 (including intangibles).  Today people are looking at WFC as trading at 1.3x book.  So they thing "Wow, WFC is really cheap at 1.3x book".

3)  After the purchase, your holding company has no more cash and only owns 100% of WFC.

4)  Assume your holdco trades at book value -- and that book value is including the new goodwill from your buyout at $45.

5)  Now people say... OH MY GOSH.  This holdco is effectively just a terrific bank trading at book value!

 

Get it?  Your holding company is so great because it trades at book value (even though it's effectively just WFC at $45), even though it's a far worse value than when WFC traded at 1.3x book (including intangibles before your purchase). 1x at $45 is better than 1.3x at $30?  Now, that's why I think the goodwill is basically rubbish.

 

I'm just scratching my head.

 

My point is that book value just starts becoming relatively meaningless when it's stuffed with this kind of takeover induced goodwill.  You wind up with the new entity having a sum of the parts book value IDENTICAL to what the two parts were worth before the takeover... except minus a good chunk of the cash (turned into goodwill).  The combined company no longer has that cash -- the selling shareholders do now.

 

Are you guys trying to tell me that having less cash between the two companies didn't destroy any value?  They don't have that cash anymore -- gone, out the door.  It's like the cash looked at Medusa and just turned to stone.  The lifeless stone has the same mass, but is it as valuable as the previously living being?  The stone is the goodwill (I hope it was clear).

 

[Rabbitisrich]

That difference only emphasizes the point that BV is an approximation of value, rather than a measure. Certain Fairfax subs probably warrant a bigger discount, though I wouldn't use tangible BV except as a mechanical rule for conservatism, but ORH always deserved a premium, at least from my perspective.

[Rabbitisrich]

The WFC SPAC scenario assumes that it's the manager's business to compare potential returns on company investments to potential returns of specific investors on a specific trade (i.e. SPAC purchase of WFC versus distributing the cash). Unless the charter is so specific as to mandate WFC or bust, then the company should compare the investment to its universe of investments.

 

You are right that FRFHF shareholders would have been better off had they recieved $1 B in dividends and been told to purchase ORH shares trading at a low valuation. But the argument that goodwill should be written off in the valuation process argues that the company received an improper return on investment, in other words that ORH will underperform relative to the universe of companies with its risk profile.

 

 

 

 

[ERICOPOLY]

the argument that goodwill should be written off in the valuation process argues that the company received an improper return on investment, in other words that ORH will underperform relative to the universe of companies with its risk profile.

 

Does the lack of the goodwill on the other 80% of ORH imply that it's inferior to the richly valued 20%?

 

I really don't mean to imply anything by writing off the goodwill.  I just want to put apples-to-apples.

 

You could be accused of undervaluing the first 80% of ORH by not demanding to upvalue the goodwill by 5x.

 

The goodwill is just a balance sheet tombstone:  "Here lies the premium to book paid for 20% of ORH.  RIP."  It tells me nothing of the value there... just as the lack of goodwill on the first 80% of ORH tells me nothing about the value.  Only the earnings power tells me that, and insurers get their earnings power from their tangible assets.  Let's put it this way -- the cash premium paid reduced potential statutory capital.  Can we agree on that?  When the hard market hits, intangible asset cannot be used to grow premiums.  Therefore, the combined companies can write less business than they could before... so keeping that intangible asset around at full value as if it were still cash is hard for me to swallow.

[twacowfca]

It makes sense to begin the valuation of a financial company at tangible book and then assign a multiple to it.  Thus, if ORH had IV of 1.5•TBV, the purchase of the remaining 20% was acretive to value because ORH and the entire organization under the holdco is not currently writing premiums at their capacity.  However, if IV were only 1.3•TBV and there was no benefit from full ownership, the purchase at 1.3•TBV would not have been acretive to the holdco's IV because the extra cash paid above TBV might constrain the capacity of the entire organization to write business in a hard market.

[niels12think]

I really don't mean to imply anything by writing off the goodwill.  I just want to put apples-to-apples.

 

You could be accused of undervaluing the first 80% of ORH by not demanding to upvalue the goodwill by 5x.

 

The goodwill is just a balance sheet tombstone:  "Here lies the premium to book paid for 20% of ORH.  RIP."  It tells me nothing of the value there... just as the lack of goodwill on the first 80% of ORH tells me nothing about the value.  

 

The book value of companies can be rather meaningless, so maybe we shouldn't try to attach meaning to it?

From my point of view, the intrinsic value is much higher than the book value - and it's the intrinsic value - and the change in intrinsic value - which is important for investment purpose.

The book value is more or less just an artifact which is determined by the way a company has grown and the management judgement used in determining a number of things, including loss reserves, accounting policies, write-offs & impairment, amortization plus the prices at which the company stocks were issued and/or bought back.

Just because the book value is determined very elaborately and accurately doesn't mean it's all-important.

 

Let's put it this way -- the cash premium paid reduced potential statutory capital.  Can we agree on that?  When the hard market hits, intangible asset cannot be used to grow premiums.  Therefore, the combined companies can write less business than they could before... so keeping that intangible asset around at full value as if it were still cash is hard for me to swallow.

 

Hasn't Fairfax issued new shares in order to take over (minority interests in) companies?

Further, the cash paid is from the holding company, which doesn't write any insurances and therefore doesn't really have statutory capital. Changes at the holding co shouldn't directly affect the business that the subs can write?

 

cheers!

[Packer16]

I agree with ERICOPOLY.  For insurance companies comparability you need to use tangible book to measure historic growth and to measure a premium to BV.  This helps to identify and show the relative value of insurance cos.

 

Packer

[Parsad]

I agree with ERICOPOLY.  For insurance companies comparability you need to use tangible book to measure historic growth and to measure a premium to BV.  This helps to identify and show the relative value of insurance cos.

 

Not necessarily.  That would be the case where you have no idea what the true value of the intangible portion of book value was.  In Odyssey's case, we do know what the historical operating results have been, including underwriting standards, and as management has not changed, you could project that future expectations for the business would be similar. 

 

The easiest way to view this would be to use Fairfax's own history:  When TIG and C&F were acquired, there was no premium paid, thus no goodwill attributed to the acquisition.  Yet we know through hindsight, that the intrinsic value of both businesses was less than the price paid.  In Odyssey's case, we can establish that while a premium was paid, and goodwill established on the balance sheet, the intrinsic value of the business is significantly greater than the price paid.  In essence, tangible book value is not an accurate tool to estimate the intrinsic value of Fairfax.  Cheers!

[niels12think]

I agree with ERICOPOLY.  For insurance companies comparability you need to use tangible book to measure historic growth and to measure a premium to BV.  This helps to identify and show the relative value of insurance cos.

 

Even in tangible book, the loss reserves may turn out to be over or under what is eventually necessary to cover the claims. Loss reserves are not like ordinary debt, where the amount is known with certainty.

Also, the tangible book doesn't take into account, the risk in the underlying business, nor the earnings potential. Reinsurance adds to the uncertainty. Example: Even if two insurers has exactly the same tangible book value, then the worst case (and best case) scenarios for the two insurers in case of natural disasters, "black Tuesdays" and sensitivity to political, macro or other risks may differ significantly.

So especially for insurers, it seems to me it's not possible to do an "apples-to-apples" comparison by just looking at tangible book.

 

Cheers!

[Guest misterstockwell]

Misterstockwell - John Mayer playing "say what you mean to say" in the background.

 

Don't beat around the bush - how do you really feel?

 

Ahhhh....I was waiting for the classic line on the call...."WITHOUT catastrophe losses, our combined ratio was....."

 

Someday, I hope to hear them say WITH cat losses, our combined ratio was in the 90's, or dare I say, 80's!

[Guest Bronco]

I haven't gone back and read the entire thread but I also agree w/ Eric if the issue is the value of goodwill.  It is worth zero to me when assessing any business.  It is accounting bullshit, and this is coming from a CPA. 

 

I use the balance sheet quite often to analyze companies, but I strip out goodwill and tax assets - they are complete crap.  Accounting rules go against their own commandments - i.e. consistency.

 

You can very easily have a company with half the assets carried at cost and the other half carried at FMV.  Stupid. 

 

The goodwill piece gets valued when you perform your NPV analysis of either FCF or earnings.  That simple.

 

So Goodwill is crap.  Deferred tax assets are in general crap.  The problem is you have a bunch of CPA's in their own nerdy world talk about FASB's and pronouncements.  No clue on investing or what investors truly need to make decisions.  So you end up with these magical, ridiculous concepts. 

 

Go ask the IRS if you can deduct goodwill in a stock deal.  Ask them if you can deduct a deferred state tax.  Good luck.

[link01]

the argument that goodwill should be written off in the valuation process argues that the company received an improper return on investment, in other words that ORH will underperform relative to the universe of companies with its risk profile.

 

Does the lack of the goodwill on the other 80% of ORH imply that it's inferior to the richly valued 20%?

 

I really don't mean to imply anything by writing off the goodwill.  I just want to put apples-to-apples.

 

You could be accused of undervaluing the first 80% of ORH by not demanding to upvalue the goodwill by 5x.

 

The goodwill is just a balance sheet tombstone:  "Here lies the premium to book paid for 20% of ORH.  RIP."  It tells me nothing of the value there... just as the lack of goodwill on the first 80% of ORH tells me nothing about the value.  Only the earnings power tells me that, and insurers get their earnings power from their tangible assets.  Let's put it this way -- the cash premium paid reduced potential statutory capital.  Can we agree on that?  When the hard market hits, intangible asset cannot be used to grow premiums.  Therefore, the combined companies can write less business than they could before... so keeping that intangible asset around at full value as if it were still cash is hard for me to swallow.

 

do alot of value investors still pay attention to goodwill as if it were the be all & end all of valuation yardsticks. if not, this discussion is kind of like a tempest in a teapot.

 

if you are willing to buy a co that has a demonstarted long history of earning 20 on its stated equity, with 20% growth, would you insist on waiting until that co traded down to book val until even considering an investment in it? or should you be open to paying 2x stated  book val, which gives you a 10% return on your purchase price (your purchase price  goodwill), compounding at 20% a year going forward? after all, that investment earns superior returns to paying 1 x stated book val for a co earning 10% on it equity & growing at 10%, doesnt it? no one value yardstick can be applied to all investments, including book val with goodwill or without it.

[Guest ValueCarl]

Bronco, this is exactly my point whether or not it's a fly in the ointment of Grahamites, i.e. buy below IV and sell above IV. You're in, you're out, you're up, you're down, and notwithstanding all of your "frictional costs" not the least of which are taxes, broker commissions being hidden or otherwise, as well as "miscalculations" when "Mr. Market" eats your lunch and turns you into a fool, you'll be a rare individual to "COMPOUND" like those who purchased great businesses at fair prices incessantly for the long term without attempting to be a trading bandit or sometimes even; a degenerate gambler. More than likely, you will also place wear and tear on your physical health attempting to be so damn shrewd. That cracks me up.  ;D Sorry, but to think that WEB's advice of long term buy and hold is a MYTH, never to be valid again, is just plain wrong headed for the MAJORITY of foot walkers roaming Planet Earth.      

 

Take some time to smell the roses and those hot women you have talked about previously, Bronco. imo  

 

<not only did I buy on the dip, but i posted on here that the news was overblown (and was one of the few).  And I did buy fairfax, along with exelon and others.  I have since sold these positions.

 

Not sure how this is funny but as long as someone enjoys that is good enough for me.>

[link01]

intersting to compare wtm's eanrnings with ffh. interestingly, wtm catastrophic losses were very much less than ffh's, & they were modeled on a higher industry loss estimate of 35 bil vs 30 bil.

 

<<HAMILTON, Bermuda, April 29, 2011 /PRNewswire/ -- White Mountains Insurance Group, Ltd. (NYSE:WTM - News) reported an adjusted book value per share of $447 at March 31, 2011, an increase of 1.6% for the first quarter of 2011, including dividends. 

 

Ray Barrette, Chairman and CEO, commented, "It was a good quarter, as we grew adjusted book value despite big earthquakes in Japan and New Zealand. White Mountains Re's combined ratio was 132%, driven by catastrophe losses.  However, the much weaker U.S. dollar boosted results, offsetting a good part of those losses.  OneBeacon posted a strong 3.5% growth in book value per share and a 94% combined ratio.  Esurance's adjusted combined ratio improved to 102% and premiums grew 6% on strong new policy sales at both Esurance and Answer Financial.  Investment returns were good. We bought back almost 250,000 shares in the quarter, adding about $3 to adjusted book value per share."     

 

Adjusted comprehensive income was $34 million in the first quarter of 2011 compared to an adjusted comprehensive loss of $51 million in the first quarter of last year, while net loss was $28 million compared to $40 million in the first quarter of last year.

 

...

 

 

White Mountains Re

 

White Mountains Re's GAAP combined ratio for the first quarter of both 2011 and 2010 was 132%, as both periods were significantly impacted by catastrophe losses.  Catastrophe losses in the first quarter of 2011 included $80 million related to the Japan earthquake and tsunami, $42 million related to the February 2011 New Zealand earthquake and $3 million related to floods and cyclone Yasi in Australia.  Catastrophe losses in the first quarter of 2010 were principally from the Chilean earthquake and European windstorm Xynthia.  The first quarter of 2011 also included 5 points of favorable loss reserve development compared to 3 points for the first quarter of last year. 

 

White Mountains Re's recorded property losses from the earthquake and tsunami in Japan are currently estimated principally using third party and internal catastrophe models, applying overall estimates of industry insured losses to White Mountains Re's exposure information. The modeled portion of the property loss estimate is based upon an industry loss event of $35 billion, currently the upper end of the AIR and RMS estimates of insured losses. The overall loss estimate also includes estimated losses for marine, accident and health, aviation and contingency lines.  Catastrophe exposure modeling and loss estimation is inherently uncertain, and as claims are reported and settled, White Mountains Re's estimates could change, maybe materially.

 

Allan Waters, CEO of White Mountains Re, said, "While the extent of the devastation in Japan makes our initial loss estimate particularly difficult to pin down at this point, the impact will remain manageable under any foreseeable scenario.  We were intentionally underweighted in Japan, New Zealand and Australia.  We continue to be strongly capitalized and well positioned to take advantage of underwriting opportunities in the market."

 

Gross written premiums were down 4% for the first quarter of 2011, while net written premiums were down 1%. These decreases were primarily due to property lines, where ceding companies are reducing their writings and restructuring programs to retain more net exposure. >>

 

 

http://finance.yahoo.com/news/White-Mountains-Reports-prnews-1116477800.html?x=0&.v=1

 

 

 

 

[T-bone1]

I think Eric is right that you need to either multiply the ORH goodwill by 5X to be consistent (and end up with a meaningless BV number) or remove all goodwill - although I think you should also adjust upward for the value of the investments held at equity.

 

Tangible book value is the relevent metric, but are we not just dancing around the idea that FFH is worth a premium to tangible book value?

[Guest Bronco]

ValueCarl - I'm not even going to respond to your prior post, as I really didn't understand it. 

 

I just posted a lot of stuff on my thoughts on different stocks.  Just my opinions, which I share freely. 

 

I would suggest you do the same - we can move forward constructively on stock ideas rather than philosofize.  I don't want to debate Graham philosophy, and I can't spell.  But I do enjoy talking stocks.

[bluedevil]

It makes sense to begin the valuation of a financial company at tangible book and then assign a multiple to it.  Thus, if ORH had IV of 1.5•TBV, the purchase of the remaining 20% was acretive to value because ORH and the entire organization under the holdco is not currently writing premiums at their capacity.  However, if IV were only 1.3•TBV and there was no benefit from full ownership, the purchase at 1.3•TBV would not have been acretive to the holdco's IV because the extra cash paid above TBV might constrain the capacity of the entire organization to write business in a hard market.

 

This is the way I look at it too.  It seems to me the prize of owning Fairfax (i.e., the intrinsic value) is the tangible book value (plus the addition of any "hidden" tangible assets, such as ICICI Lombard's fair value) you get with every share multiplied by some multiple (positive or negative) to account for the expected, risk-adjusted ROE you expect the company to achieve on that tangible equity.  By accounting for, for example, the high quality of Zenith's underwriting ability in the multiple, I believe it is easier to compare across insurance companies.

[ERICOPOLY]

How much was ORH worth if you strip out the fabulous returns of HWIC?  You then only have underwriting profits and growth in float to value it.  Is it still worth 1.3x, or much more than that?

 

I know people were valuing it based on the 20% growth, but I think HWIC's hand had a lot to do with that growth.  The more gains they make investing, the more insurance they can write.  Strip out the outsized investment gains, and then you only have underwriting profit to juice the rate at which you can build capital to grow.

 

[Nnejad]

A majority the goodwill comes from the Zenith acquisition.  I think its approximately $600 million there, 200 at ORH, 100 mil at NB, and the rest is the other recent international acquisitions.

[Guest ValueCarl]

And, you're very good at it, talking stocks, that is,  Bronco!  ;D No harm no foul! Speaking of talking stock, here's MY CALL on Fairfax. You aint' going to see US $350 again! That's why I recommended picking it up in the WAKE of the QUAKE rather than WAIT for the NEWS!  ;)

[StubbleJumper]

Not sure that I quite understand today's price action.  Down $10 at the bell, that makes perfect sense, but it reverses and is up $1 at lunch?

 

BTW, thinking back to spring windstorms circa 2004 or 2005, the windstorms in tornado alley over the past couple of days could have a 9-digit impact on FFH....  Probably won't find out until August.

 

 

SJ