FFH vs. ORH vs. ORH.A

[Crip1]

The long post regarding the ORH preferred has compelled me to contemplate this question. I have both FFH and ORH common but it looks to me that of the three, the ORH common is the least attractive investment at current prices. ORH is selling at about 1.2x estimated Y/E book with is closer to the high end of the historic range than the low end. FFH is selling at a lower (to be verified next week) multiple to BV of, my guess, about 1.1x and will be in for significant gains 3-5 years down the road once their cyclical holdings come back. As I hold FFH and ORH in a retirement account, tax implications are not applicable.

 

Would be interested in the opinions of others.

 

-Crip

[zarley]

Long term -- FFH.  But over a shorter period the ORH preferreds may do a bit better. 

 

If called at the end of 2010 ORH-A will return over 60% from current prices.  FFH would need to get over $500 to provide that kind of return.  That seems a little unlikely in the next two years, although it's certainly possible. 

 

Given a 5-10 year time frame though and the earning potential of FFH is much more attractive.

 

I own both, but my position in FFH is 2x my position in ORH-A.

 

FWIW

 

zarley

[FFHWatcher]

I don't see the value in ORH redeeming the preferreds at any time.  8% cost of borrowing seems pretty good and if interest rates creep up, than 8% might be really cheap.  ORH has restrictions in redeeming them and they have to pay $25.+, not market value.  If ORH has an extra $25M lying around, it seems logical to buy back their common and/or invest in some of their stocks and/or increase their dividend.  I too was hoping on the ORH redemption investment thesis.  I read the prospectus and it changed my mind due to the $25. repurchase limitation.  Hey, I could be wrong but that's how I interpreted the prospectus.  I guess their isn't even a fixed redemption date in the future?  Perpetual prefs?  I will re-read it again a little later.

[Myth465]

My vibe is ORH is buying back as much as they can on the open market and when they redeem it they will only have to pay $25 to a small group of holders and it will simplify there reporting structure. Also they hold government bonds paying negative interest so buying these back is well worth it.

 

 

[StubbleJumper]

Yes, ORH-A are perpetual prefs.  Over the past year or so, ORH has had ridiculous amounts of excess capital and has been aggressively repurchasing its common shares for prices close to its trailing quarterly book-value.  In 2010, it will have the option of either continuing with the common share repurchases or it can call its preferred shares.  Depending on the market price of the common shares, it may or may not be in the interest of shareholders to continue the re-purchase program (ie, how much more than BV would they be prepared to pay?  Perhaps 1.1xBV?  or maybe 1.2xBV?).  If a common share repurchase does not increase the intrinsic value per share for the remaining shareholders, then buying back the preferreds instead might make good sense.

 

It is also worthy to note that you need to be careful when comparing the cost of capital for debt and preferreds.  Interest is tax deductible, while preferred dividends are not.  So, the preferred dividend of 8.125% would roughly be equivalent in cost to debt priced at 12% (ie, 8.125% / 1-tax rate).  In that light, would it be in shareholders interest to use excess capital to repurchase the preferreds?  Maybe....or maybe not. It would depend on what alternate uses are available for that capital.

 

The wild card in all of this revolves around the FFH parent.  We have seen ORH aggressively repurchasing shares, thus increasing FFH's percentage ownership.  We have seen FFH make a tender offer for NB.  It doesn't take a lot of imagination to envision FFH buying the remainder of ORH at some point over the next few years.  If this occurs, would the preferreds be repurchased?  I would guess yes.  If FFH took over the remainder of ORH, they could significantly reduce their public reporting costs (annual and quarterly reports), Sarbanes-Oxley requirements and other disclosure costs by not having any publicly traded ORH securities.  Would they continue to incur those reporting and compliance costs just to maintain $100m in preferreds?  Dunno.

 

In any event, it's a pretty good opportunity.  If the preferreds are never called and you hold them forever, it's a nice, tidy return of about 11-12% in dividends per year.  If the preferreds are never called, but corporate spreads narrow, they will probably trade meaningfully higher at some point in the future which would provide an opportunity to sell them and earn a slightly better return of 11-12% in dividends PLUS a modest capital gain.  If the preferreds are actually called in 2010, the return will be spectacular!

 

In all likelihood, a long-term hold of FFH will do better, but ORH-A has very little implementation risk.....

 

SJ

[Partner24]

My vote is on FFH for several reasons, like:

 

- it's cheap

- it will grow it's value over time (forget that with ORH.A)

- it is the most diversified both geographicaly and by product lines

- Fairfax is the holding company, and Prem has most of it's own net worth in this company.

 

[Partner24]

A 12% dividend yield is something interesting. You see both BRK and FFH saying yes in some deals that are giving them a 12% yield.

 

But there is a difference, and this difference is significant. These securities are often convertible into common shares for an interesting price. That's a good "bonus" that you don't have with ORH.A.

 

So guess what? I prefer to invest in FFH and they those juicy deals on a per share basis  ;)

 

Cheers!

[oec2000]

It is also worthy to note that you need to be careful when comparing the cost of capital for debt and preferreds.  Interest is tax deductible, while preferred dividends are not.  So, the preferred dividend of 8.125% would roughly be equivalent in cost to debt priced at 12% (ie, 8.125% / 1-tax rate).  In that light, would it be in shareholders interest to use excess capital to repurchase the preferreds?  Maybe....or maybe not. It would depend on what alternate uses are available for that capital.

 

SJ, the high cost of the preferred is what should drive the redemption call decision. My guess is the ORH pfds were issued when they needed to bolster their capital base. Given their stronger capital position today, they should be able refinance the pfds with significantly lower cost debt (and not just because of the tax effect but also because they should be able to get tighter spreads) once we are out of this credit crunch. So, imo, the odds of an early call are pretty high.

 

Crip, as for the relative merits of FFH or ORH pfds, the fair way to look at it is on the basis of risk-adjusted returns and not pure absolute returns. FFH will likely outperform on an absolute return basis longer term but the pfds will provide a more "guaranteed" return with very low downside risk. Depending on whether the pfds are called in Sep 2010, 2011, 2013 or 2018, the yields to call are respectively 35%, 25%, 18.5% and 14%. I would say that such high "low risk" returns are not easy to beat.

 

My solution: Buy the FFH 2011 Jan 320 Call for $70, buy $250 worth of ORH.PR.A to get the best of both worlds. Your total cost of $320 is what it takes to buy 1 share of FFH. The advantage of the combo is that you get the same upside as buying the FFH share but no downside at all. This is because the $250 in ORH.PR.A will accumulate to $320 by Jan 2011. If the pfds get called next year, you get an extra bonus! (To be fair, you do lose one FFH dividend!)

 

 

[oec2000]

Another way to consider the ORH.PR.A position. One could argue that because of the relative safety of the preferreds, you could use leverage to juice up your returns. Applying 1:1 leverage at 4% borrowing cost, the return purely on a current yield basis would go up to 20%. This does not factor in capital gains resulting from either a redemption call or a reversion to normalcy in the credit markets.

 

Of course, leverage may not be for everyone and you take the risk of rising rates and margin calls.