Fairfax Financial Holdings Limited Announces C$431,000,000 Bought Deal Financing

[Guest wellmont]

 

I don't think anyone here finds that you're an "easy" target, certainly not me.

 

But you know that Parsad was way more critical than I was. yet you chose to come at me. interesting. I'll make you a deal. we could do a Do over. pretend it never happened. I will check to see if you chose to modify your post and I will reciprocate.

[A_Hamilton]

I wonder how the underwriters will sell this stuff now that share prices are below the bought deal..

 

Gross proceeds of CAD $431 million. You don't know what fees they are getting...

 

A single institution is purchasing 30% of the $431mm (presumably at the $431/share), so only 700,000 shares to be sold to the public where the brokers are actually taking price risk.

 

On the public tranche there is a 4.0% fee, and on the committed inst'l tranche there is a 1.0% fee. So total fees between the two tranches will be $13.4m, or roughly $19/share of fees on the public risk tranche. So the brokers' "cash breakeven" price on the shares is around $412/share.

 

Any source for the above? Thank you.

[berkshiremystery]

I just have to gawk at some opinions. It might not make sense for shareholders/owners that are concerned about dilution percentage wise relative to their stakes in FFH. BUT Fairfax sells their newly issued shares extremely above book value, and THIS is what's counts, so mathematically it makes pure sense. It's the real thing. Like it or don't like it, but it makes pure logical sense to me if someone thinks about this non-linear on different scales. ;D 

 

+1

[T-bone1]

I just have to gawk at some opinions. It might not make sense for shareholders/owners that are concerned about dilution percentage wise relative to their stakes in FFH. BUT Fairfax sells their newly issued shares extremely above book value, and THIS is what's counts, so mathematically it makes pure sense. It's the real thing. Like it or don't like it, but it makes pure logical sense to me if someone thinks about this non-linear on different scales. ;D 

 

+1

 

I agree.  I've been complaining lately that I don't think FFH is cheap here, so in order to be consistent, I must applaud this offering.

[nestorius]

Any source for the above? Thank you.

 

From a term sheet I received this morning from BMO, text of which I pasted here: http://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/ffh-at-multi-year-high/msg139809/#msg139809

[A_Hamilton]

Any source for the above? Thank you.

 

From a term sheet I received this morning from BMO, text of which I pasted here: http://www.cornerofberkshireandfairfax.ca/forum/fairfax-financial/ffh-at-multi-year-high/msg139809/#msg139809

 

Thanks for that. Was looking at my BB terminal and scratching my head.

[PED]

share out BRKA (period 92-13):

1,1M -1,6M

 

shares out FFH ( period 95 -13)

8.9M - 20M +

 

PW managed to issue FFH shares when fairfax was trading at 3-4X BV. (97-98)

An opportunistic move which in-fine had a great ( I did not made the maths) positive impact on the compounding BV/per share performance.

Time will tell why he decided again to dilute his shareholders and if like in the past it was the right move.

 

 

 

[giofranchi]

  And there may be more to come...One of the reasons why Prem Watsa may want to raise cash now is because he sees something very bad coming down the road...remember that practically all the statistical indicators for the US stock market say that there is a high risk of crash.

 

he sees something? lol. the whole discussion the last few days has been about how he missed 4 years of bull market. he has been seeing something "very bad" for 4 years now. Did we not learn anything from this entire discussion? He's raising cash because he is investing in bbry. And there is no statistical indicator for US market that says there is a high risk of a crash. none. oh and one last thing. There is no deflation. Inflation is baked into our system.

 

ps: perspective from a non owner: some of the fairfax shareholders are a "wimpy" bunch and are Short Term investors. pw is not going to give you a smooth ride. but he will get you to your "destination" in style. :)

 

right I agree 100%. Nobody knows when it is going to happen. That makes it Unpredictable. Right? So those "indicators" are useless as predictors of market crashes.

 

wellmont,

I agree.

Just be careful to not infer too much about the future from the past... Here is what I think:

 

The more time passes and the more stocks (and asset classes in general) rise, the higher the probability Mr. Watsa will finally be proven right and the closer we get to that day.

 

giofranchi

 

[thefatbaboon]

Generally I don't much like end of world deflation bets.  Statistically it isn't a bet I'm comfortable with - after all it's not like it happens very often! Also, in a world of fiat currencies one really has to wonder whether central banks would let a general price level deflation follow through.  Septmenber/October 2008 would have resulted in a massive systemic price deflation but the Fed was able to step in with an enormous amount of repo and discount window transactions.  Today the US banks are well funded, they sit on absurd amounts of Treasury and Agency paper, so even if the Fed was less energetic now I don't see price deflation coming through a bank run.  Where do the FFH investors see deflation coming from?

 

 

[txitxo]

right I agree 100%. Nobody knows when it is going to happen. That makes it Unpredictable. Right? So those "indicators" are useless as predictors of market crashes.

 

  I don't think they are useless. You cannot use them for accurate market timing within a single market, but I think they are very valuable as a way of choosing which market to be invested in. 

 

The last times the EU Shiller P/E clearly punctured the current level (15) going upwards were in 1983 and 2009. Very good years to be long. On the other hand, the last two times the US Shiller P/E broke this level (24.4)  going upwards were 1928 and 1996. Very good years to be hedged.

 

  So the way I use the Shiller PE (and other indicators) is by trying to avoid the US market (although couldn't stop myself from picking up some SHLD in late August when it was below 40$) and putting most of our money in Europe. In Italy, for instance, the Shiller PE is about 66% below its long term average. In Spain it is 50% below. If the Euro didn't break up last year, it will never break up. So at some point Europe will have to do QE with a vengeance. 

 

 

 

 

[giofranchi]

Where do the FFH investors see deflation coming from?

 

Practically all the inflation we experienced since 2008 is in the form of higher asset prices. If and when asset bubbles form, if and when asset bubbles burst, it will then be very difficult for central banks, which have already gone all-in, to contain them. Please, read the 3 questions Mr. Einhorn asks in Greenlight’s Q3 2013 Letter. Their answers make me nervous about what could happen… if and when asset bubbles form, if and when asset bubbles burst.

 

giofranchi

 

[thefatbaboon]

Gio,

 

I understand the imbalances - although I'd say that their main causes are the post-communist labor pool and the various free trade agreements still being worked through 20 years on.  The often uneasy but mutually dependent Labor & Capital partnership in the various developed countries changed with post-communism globalization.  This has been exacerbated by tax inequities: it's much better to be capital than a wage-earner.  We are 20 years into digesting this imbalance,  a worker of the post communist labour pool started out earning more than twenty times less than developed country labour.  For 20+ years developed labor wages have flatlined, while developing has been inflating nicely.  I think labor and capital will fall into a better balance in 5 - 15 years when the global labor cost discrepancies are better balanced.  (obviously technology is a bit of a wildcard here).

 

It's true that developed country labor has participated in economic prosperity a lot less than it's historic share, but let's not therefore say that there hasn't been prosperity.  Indeed, I would even argue that one of the reasons that these decades have gone by with so little voter rage is because while labor's wage has gone nowhere the costs of many of their goods and services have also gone nowhere.  Their car costs, phone costs, TV and entertainment costs - many of these have seen minimal price changes over the past decades - and we have also seen the availability of many free goods develop.  This has softened the inequity - and is probably the reason we haven't seen real voter reaction.  But obviously the lions share has gone to capital, has gone to profit margins, has gone to the so called 1%.

 

We have been living in the midst of massive and unprecedented deflationary forces for two decades.  Of course we have bubbles - humans always have bubbles - Nasdaq, Property, and now I'm sure there will be something else as Einhorn intimates.  But so what?  Why try and time this?  The overall trajectory even in the context of a massive 20 year, +1bn labor pool deflationary force has been tremendous overall prosperity and asset growth (with typical bubble formation and crash cycles).

 

I would also question your statement that the central banks have already gone "all in".  Early in 19th century England their central bank took debt to GDP up to 240%, like the Japanese have today, and in the decades after England's wealth grew massively.  I cannot look at the Eurozone or America today and agree that they are anywhere near "maxed out".  Indeed, I would go even as far as suggesting that America's borrowing power, should they wish to use it, is nowhere near exhausted.  Now whether there is the willingness (see Germany) - is another question.  But my guess is that faced with the prospect of price deflation - as in the past - there will be the willingness.  No voter elected politician allows price deflation without a fight to the death.

 

To me this bet on deflation wining the day just looks like a cyclical bet on the next boom/bust cycle.  Structurally speaking, nothing looks different to me here than at any other time in the last 20 years we have been working through the deflationary effects of the the global workforce rebalancing.

[giofranchi]

Gio,

 

I understand the imbalances - although I'd say that their main causes are the post-communist labor pool and the various free trade agreements still being worked through 20 years on.  The often uneasy but mutually dependent Labor & Capital partnership in the various developed countries changed with post-communism globalization.  This has been exacerbated by tax inequities: it's much better to be capital than a wage-earner.  We are 20 years into digesting this imbalance,  a worker of the post communist labour pool started out earning more than twenty times less than developed country labour.  For 20+ years developed labor wages have flatlined, while developing has been inflating nicely.  I think labor and capital will fall into a better balance in 5 - 15 years when the global labor cost discrepancies are better balanced.  (obviously technology is a bit of a wildcard here).

 

It's true that developed country labor has participated in economic prosperity a lot less than it's historic share, but let's not therefore say that there hasn't been prosperity.  Indeed, I would even argue that one of the reasons that these decades have gone by with so little voter rage is because while labor's wage has gone nowhere the costs of many of their goods and services have also gone nowhere.  Their car costs, phone costs, TV and entertainment costs - many of these have seen minimal price changes over the past decades - and we have also seen the availability of many free goods develop.  This has softened the inequity - and is probably the reason we haven't seen real voter reaction.  But obviously the lions share has gone to capital, has gone to profit margins, has gone to the so called 1%.

 

We have been living in the midst of massive and unprecedented deflationary forces for two decades.  Of course we have bubbles - humans always have bubbles - Nasdaq, Property, and now I'm sure there will be something else as Einhorn intimates.  But so what?  Why try and time this?  The overall trajectory even in the context of a massive 20 year, +1bn labor pool deflationary force has been tremendous overall prosperity and asset growth (with typical bubble formation and crash cycles).

 

I would also question your statement that the central banks have already gone "all in".  Early in 19th century England their central bank took debt to GDP up to 240%, like the Japanese have today, and in the decades after England's wealth grew massively.  I cannot look at the Eurozone or America today and agree that they are anywhere near "maxed out".  Indeed, I would go even as far as suggesting that America's borrowing power, should they wish to use it, is nowhere near exhausted.  Now whether there is the willingness (see Germany) - is another question.  But my guess is that faced with the prospect of price deflation - as in the past - there will be the willingness.  No voter elected politician allows price deflation without a fight to the death.

 

To me this bet on deflation wining the day just looks like a cyclical bet on the next boom/bust cycle.  Structurally speaking, nothing looks different to me here than at any other time in the last 20 years we have been working through the deflationary effects of the the global workforce rebalancing.

 

Well, if I have understood you correctly, it seems to me that your view belongs to a 25-50 years time horizon, instead Mr. Watsa’s view belongs to the next 5-10 years. Both can be correct! I have no doubt that in due time we will prosper greatly, but I thought you have asked why Mr. Watsa expects deflation in the next 5-10 years. As far as central banks are concerned, I was thinking more about their balance sheet than about developed countries debts: it seems to me unquestionable that they have already expanded their balance sheets in an unprecedented way… They could go on expanding them, but, if asset bubbles burst, to no tangible avail: when and if financial asset prices come down, confidence in central banks will be broken… And I don’t see how more of a medicine that has ceased to work might do any good…

 

If, on the other hand, I haven’t understood you correctly, sorry: I have a date tonight, and my mind is already there! ;D

 

Gio

 

[thefatbaboon]

Date night in Milan - I'm jealous!!

 

I laid out the generational deflationary thesis - rather tediously, sorry!  But I did this because I think that that deflationary argument has some reasonable support.  But my conclusion is that if we've been able to offset it for the two decades when it was most intense then why not for the next decade?  I think we're agreeing in a way:  that this bet of FFH's is on a 5-10 year boom/bust cycle and not on some generational deflationary thesis.  I just think it's crazy.  Not because we won't have a bust - I think it's guaranteed that we will - but counting from the '09 low it was never clear whether the next bust would come in 3, 4, 5, 6, 7, 8 years.  This interest rate policy - Greenspan 9/11, Bernanke 08- - is pretty much guaranteed to stimulate bubbles.  But the other uncertainty is where.  So the when and the where is unpredictable.  Why hedge the equity index when you don't know when and you don't know where?

 

Personally - if the central banks stay with low interest rates (and why wouldn't they) -  I don't see over valuation today.  Are Apple, Exxon, BP, Microsoft, BRK, JP Morgan, Pfizer, Sanofi, Total, Wells Fargo expensive?  I find it very hard to come up with big cap equities that are at anything resembling bubble valuations.  Are bank balance sheets over extended? No.  The bond market?  Well that depends on the central banks.  The bonds spreads aren't too tight.  The absolute yields are low of course but you can't say it's overvalued without basing your belief on central banks raising rates (which I simply do not see).  So where is the bubble?  The only place I see potential overvaluation is in rich man stuff: Art, London, NY, HK, etc property.  But rich man stuff has been booming for years, and has nothing to do with sub prime or it's aftermath, it's because rich people have been and continue to be getting richer at a hell of a clip.  Is that going to stop?  Well that comes back to the macro generational thing - the rich are getting richer because they control marvelously profitable Capital.  It will stop when Labor has a better bargaining position to negotiate more of the incremental prosperity away from Capital.  Until then billionaires and millionaires will compound and the prices of their toys with it.

 

Honestly I don't get it.  I would love to understand more because i think of myself as a careful and conservative person and it makes me uncomfortable to see asset-price bearishness among smart people and to not see it myself.

 

 

[A_Hamilton]

share out BRKA (period 92-13):

1,1M -1,6M

 

shares out FFH ( period 95 -13)

8.9M - 20M +

 

PW managed to issue FFH shares when fairfax was trading at 3-4X BV. (97-98)

An opportunistic move which in-fine had a great ( I did not made the maths) positive impact on the compounding BV/per share performance.

Time will tell why he decided again to dilute his shareholders and if like in the past it was the right move.

 

I think it's pretty obvious why they raised capital. Read the rating agencies' reports on the company. They want FFH to be at <30% Debt to Capital. At the end of the Q they were at 28.4%. Now they have extra BBRY loss post Q, thanks to the brilliance of equity accounting FFH will be taking a large hit next Q to its carrying value in RFP (RFP had a massive writedown of its DTA this quarter), and the company's bond portfolio is very volatile with its long duration in a low rate environment.

 

Add to this the fact that FFH told the rating agencies no more capital in BBRY, and the agencies issued statements saying no change in FFH's rating based on this statement, and the rating agencies were likely pissed when FFH added $250 million to the name.

 

Notice S&P only issued its affirmation/no credit negative on the BBRY deal after FFH announced the offering? I doubt the timing was a coincidence.

 

This is all a bummer because FFH doesn't need more capital and our earnings power took a modest hit because the rating agencies can have major detrimental effects on FFH if FFH doesn't adhere to  what the agencies want them to do.

 

Look at other items and you'll see it. Rating agencies demand $1 billion in liquidity at hold co., agencies demand that there be a centralized risk figure so FFH buts Andy Barnard in that position (though he was probably doing some of this anyway). Who knows maybe some of these things are good, but this capital raise was definitely a submission to the rating agencies.

[SharperDingaan]

Think of what would happen were China to experience material banking disruption. All those new built empty cities, debt financed, with no visible CF to service that debt ..... so just how exactly is the magic being maintained, & what are the limits.

 

Almost all financial flows with the outside world pass through a few, & tightly controlled, portals. Counterparty risk is concentrated, & controlled centrally. Most would argue that the financial risk, net of forfeited western deposits, is actually being borne by the outside world. The net risk may be small ... but it is net of extreme gross upside and downside volatility should China have a blowout. And every expanding trade nation suffers a blowout at some point ....

 

Remove a good chunk of the demand from a commodity & its price will drop. Do it on a lot of commodities .... & at the same time; & you get contagion. Over the short term, the replacement cost of virtually everything falls like a brick (deflation), loan collateral evaporates, banks fail. Over the medium term; cash on corporate books flows to new equipment purchases, & the old equipment (plus the people who operate it) gets scrapped. Significant & material disruption for an extended period.

 

China can close the wall again at any time, it is a communist country, & you are not going to be foreclosing on any Chinese assets in China. Crocodiles basking at the watering hole are playing the waiting game - & eventually those jaws snap on something.

 

SD

 

 

 

[thefatbaboon]

SD,

 

What is the West's counterparty exposure to China?  (I don't mean potential effects on the countries that export raw materials into China.).   

[ERICOPOLY]

it's because rich people have been and continue to be getting richer at a hell of a clip.  Is that going to stop?  Well that comes back to the macro generational thing - the rich are getting richer because they control marvelously profitable Capital.  It will stop when Labor has a better bargaining position to negotiate more of the incremental prosperity away from Capital.  Until then billionaires and millionaires will compound and the prices of their toys with it.

 

 

It's also just plain common sense that there will be more wealth disparity as the boomers get older.

 

Demographically, who are millionaires?  People over 55.

Where is the age group of the boomers?  Oh yeah, people over 55.

 

So should we or should we not have more wealth disparity with the boomers being over 55 versus 20 years ago when it was merely 35 year olds?  Damn right we should!

 

[SharperDingaan]

Wests counterparty exposure:

 

To do domestic business in China you have to do it with a partner. Either an entity that is state controlled in some fashion, or with state permission (ie: in an economic zone), or via a corrupted state mandarin giving you cover. No different to Russia.

 

You start out with Chinese Assets, & Western Debt. Moving through time the Chinese books accumulate retained earnings that support new Chinese debt on a 1:1 basis; those Chinese debt proceeds then repay the Western debt.

 

Western exposure is all cumulative investment less all cumulative debt repayment. Chinese exposure is all cumulative BV write-offs that have not yet occurred. The more corrupt the environment, the higher those unrecognized BV write-offs are, & the smaller the Western debt repayments. Assuming no additional investment - Western financial exposure declines over time, & Chinese exposure increases. Standard investment procedure for high risk locations.

 

The commodities impact is not just pricing. If business is booming you open new plants closer to your buyer, & you justify the loans based on those higher commodity prices. Total investment increases, & China gets new P&E on the ground – in China. The experienced will make their state-of-the-art investments in the West, & only invest their old & used equipment in China. As much of the investment in-kind as possible.

 

The expectation is that the music will stop, & that you will lose the entire Chinese investment.

 

In the meantime at the company level, you book higher EPS, try to keep your payback period as short as possible, invest in commodity sellers (via the treasury portfolio), & hedge the index. When the music stops, your share price collapses, & the cash gain on the index finances your share buyback. Standard operating procedure.

 

At the state level, you issue as much paper as practical to the Chinese, & try to lengthen the maturity as much as possible. When the music stops, you seize the paper as compensation for the lost Chinese investments. You stop paying interest, & defease the debt. Standard operating procedure.

 

The net impact is mild, but the gross impacts are extreme & offsetting. Obviously the state level gaming is extreme, but it is nothing new (oil, arms, drugs, etc.). It is also one of the realities that hedgers do not like to remind people of.

 

SD

 

[thefatbaboon]

Thank you for the detailed reply.

 

I guess I'm trying to understand what makes the China situation a massive deflationary risk for the West.  Don't get me wrong - it's not that I have confidence in China - but I struggle to see why the aftermath of a bust is more than a nasty bust (Nasdaq, Sub prime, Euro periphery) - which, with a certain amount of political will,  the central banks are able to deal with.

 

America's late 1920s collapse had major and lasting ramifications for Europe.  But America was already the world's biggest market; Britain had massive outright exposures to America's equity and debt markets; and Germany, post-Versailles, and Europe post WWI generally, were seriously weakened.  When I go through the West's main stores of value today, their property, their finance, their IP, I see China contributing cheap government and GSE finance, a fair amount of corporate growth delta, either directly or indirectly, but I also see China on the COGS side of many corporate income statements, overall I don't see why the possibility of a China crash (indeed, certainty at some point) would lead to the desire to hedge 2010 asset prices as done by FFH.  To hedge 2010 seems like hedging the 1930 bounce in preparation for 1932-37.  Wouldn't it make more sense to short a few commodity/heavy construction countries and companies if "China crash" is the thesis?  Rather than the West's general equity indexes in a world full of politicians and fiat currencies? 

 

 

[SharperDingaan]

You have to be able to enter/exit the hedge in scale, quickly, easily, & discretely. Equity indexes are preferred as they are also the instrument of choice for all kinds of other long/short strategies (ie: ETF's, market guaranteed rate deposits, etc.); your trades look like all those others, & nobody is any the wiser.

 

Keep in mind they also have an oversized position in the restructured asset heavy RFP (one of a few), & a commodity collapse will trigger massive write-downs. As you cannot short your own stock, or industry sector in this case, equity indexes are the next best choice  ;)

 

They are in a box, & are executing fairly well - but are getting punished because it is too difficult for most to get their heads around. It is really an indication that they need to restructure their business into simpler, easy to understand, components. Unfortunately, we just do not see it happening any time in the forseeable future.

o

SD

 

[thefatbaboon]

I understand the advantages of hedging using indexes!  But I don't like the bet - even if one takes as given that China is going to have a bust at some point - and I especially don't like it at 2010 price levels.  To go and short Indexes in 2010 when the timing of China's bust is uncertain and interest rates are zero and the Indexes are dominated by reasonably priced companies with low leverage…I don't like it.  The FFH equity portfolio is not so massive - why not take more focused short positions against truly China-vulnerable companies/countries?  That way, if the timing is off, and it takes 6 years for China's bubble to burst you're not stuck effectively shorting XOM, AAPL, MSFT, GOOG, JPM, WFC, JNJ, WFC….against long positions in JNJ, WFC…for 6 years!

[Guest wellmont]

he really should just hold lots of cash when he is negative and wait.  8)

[ERICOPOLY]

This hindsight hedger says that he should have just bought an at-the-money index put and rolled it.  That would have cost a lot less.

 

Similarly, any private owner of FFH shares that didn't like the hedges could have done the same (purchasing at-the-money calls to offset the onslaught of losses from the look-through index shorts).

 

Next time he hedges, and you disagree, just buy index calls to put a max cap on your share of the potential hedging losses.

[Ian L]

This hindsight hedger says that he should have just bought an at-the-money index put and rolled it.  That would have cost a lot less.

 

Similarly, any private owner of FFH shares that didn't like the hedges could have done the same (purchasing at-the-money calls to offset the onslaught of losses from the look-through index shorts).

 

Next time he hedges, and you disagree, just buy index calls to put a max cap on your share of the potential hedging losses.

 

For a more exact hedge, you should just buy the product that prem shorts. Otherwise, if the equity price stays the same, you would lose on your calls (the time component) and break even on the index.