FFH 13F for 6/30/09

[ERICOPOLY]

Thanks Cardboard, that definately helps!

 

O.K. so let's speculate that ORH won't be taken over then...

 

1. Andy felt that buying another 10% of ORH public shares in 3 months (1.7M shares of approx 17.2M available) was a just a good deal and....

 

2. Paul and Brad needed to shift $240M worth of ORH shares to some other subs just because they could OR they really needed to shore up some massive adverse development at one of the non-US subs, but decided not to disclose this in the Q2 or conference call and....

 

3. Prem felt that $880M of holdco cash was just a bit too light, and needed to boost it to $1.3B in the worst credit environment since WWII so they can cover $180M of debt 4 years from now....

 

OR

 

They've collectively decided that it's prudent to take $500M - $1B flyer of (25% of shareholder equity BTW) of their company on a Chinese acquisition

 

OR

 

They are buying the rest of ORH.

 

...c'mon!

 

 

 

 

That's what I think too, but then like I said once I switched to the ORH bench yesterday I've been a huge fan of a premium buyout  ;)  Maybe it's affecting my judgement.  Wow, after taking FFH for a ride in recent weeks... to get the ride back-to-back from ORH will be amazing.

 

[Cardboard]

Ok, so TIG Insurance Company held the same number of shares on June 30 as it did on December 31. The actual percentage of ownership of ORHC (Odyssey Re Holdings Corporation) on December 31 was 17.8% and 18.2% on June 30 (NAIC filings). It did increase due to Odyssey Re share buy-back program.

 

This is well above the 7.8% ownership mentioned by Odyssey Re on December 31 in its 10-K. That is because this percentage was only for direct ownership of ORHC by TIG Insurance Company. TIG Insurance Company also owns 97.5% of ORH Holdings Inc., a holding company whose only assets is ORHC shares and has no liability. Hence, 7.8% + 10.3% x 97.5% = 17.8% or ORHC shares as of Dec 31.

 

As I mentioned in my previous post, Crum & Forster still held its Odyssey Re ownership as of June 30 as confirmed by its carried value on June 30 in its 10-Q. Actually, there is still so much cross-ownership within Fairfax, that it is no wonder that we have so much trouble getting good ratings. A big drag on loss ratio and on flexibility as to what we can do with investments.

 

Finally, TIG Insurance Group owned around 25 million shares of ORHC on December 31 and is the last possible group that could have created such a change in the 13-F (4,600,600 shares), but there is no way to tell. This company, a holdco, is the parent of TIG Insurance Company and is 100% owned by Fairfax (probably via some other structure). It is probably not that important to figure out since Fairfax in its 2nd quarter report told us that they held 71.9% of Odyssey Re, meaning that no share would have been sold since December 31.

 

The 13-F is filed for Hamblin Watsa Investment Counsel and Prem Watsa. It means that they have investment discretion over the shares listed. What seems to be happening here is that 4,600,600 shares of Odyssey Re still held by Fairfax cannot be sold anymore. They have become like "restricted cash" for some purpose between March 31 and June 30.

 

A key piece to understand is that 18.2% of Odyssey Re shares is a significant asset to TIG Insurance Company and they carry it discounted to market value at $314 million on their balance sheet. A 27% discount and it was the same discount percentage on December 31. If you remove this asset, then Fairfax Inc. guarantee to the California Department of Insurance that TIG Insurance Company would maintain a net statutory reserve to surplus ratio below 3 and a capital level 200% above the authorized control level falls apart. Remember that TIG Insurance Company is in runoff.

 

Also, the Odyssey Re stake is discounted since they are a "publicly traded affiliated entity". It is a discount required by NAIC resulting from the large percentage or ORHC's outstanding shares controlled by Fairfax.

 

To understand what may be going on, I found interesting to look at what happened at Crum & Forster when Northbridge was bought out:

 

“On December 23, 2008, the Company sold its 15.7% interest in Northbridge to nSpire Re Limited (“nSpire”), a Fairfax affiliate, for $248,066 and received a Fairfax Inc. note held by nSpire of equal value. Since Northbridge was accounted for at fair value, no gain or loss was recorded on the sale. “

 

“In December 2008, the Company sold its 15.7% investment in Northbridge to an affiliated foreign company, which resulted in tax benefits of approximately $51,605 attributable to the utilization of foreign tax credits. “

 

I don’t believe that the 13-F contains a typo and I also believe that the reduction of 4,600,600 shares is too close to the direct ownership of Odyssey Re by TIG Insurance Company to be a simple coincidence. The discounted value of Odyssey Re shares on TIG’s books, tax implications and the fact that Odyssey Re would no longer be traded (can’t be easily liquidated to pay runoff claims) may have forced some kind of internal transaction explaining the discrepancy. It does not prove Odyssey Re’s buy-out theory, but shares have been "pledged" to facilitate some “restructuring” and very likely at TIG Insurance Company to satisfy the California Department of Insurance.

 

We will have to keep speculating since it is the first disclosure that something is going on with these 4,600,600 shares and there is nothing else in any filing indicating what happened to them as of June 30. Also, Odyssey Re did not receive an offer from Fairfax for sure as of July 29 since they disclosed having bought back shares up to that point. At Northbridge, they established a special committee on November 13 as they received the offer and then announced and made the recommendation on December 1. Could not have bought back shares during that timeframe. 

 

Finally, regarding "Fair For Acquisition", please read the "Background to the Offer" in the Northbridge directors circular on the SEDAR website. Effectively, Watsa was trying to make a low ball offer at $36. He only raised it to $39 after a fair bit of arm wrestling. Again, the walk and talk are not totally aligned.

 

Sorry for the long post  :-[

 

Cardboard

[Daphne]

Cardboard, I think your walk the talk comment was unfair to say the least.  Prem would have to balance his fiduciary responsibility to FFH shareholders while attempting to be "fair" to NB shareholders.  I can't imagine that it would ever be an easy call.

 

d

[Cardboard]

I have no problem at all defending my comment.

 

$36 or 1.2 times book is about the lowest multiple that Northbridge shares had traded at over any reasonable period of time from the IPO. So called the crown jewel of the Fairfax empire. A company along with Odyssey Re that has allowed Fairfax to get out of the hole (survive?) during the very difficult years. IMO, a very very low offer to a friend who has helped you when you were down. On top of that, done at a time when Northbridge was seeing a very soft market and was trading at a very low valuation.

 

I also have a very hard time with the following comment:

 

"On November 19, 2008, Mr. Watsa had a discussion with Mr. Smith during which he advised Mr. Smith that Fairfax would not be willing to sell its Shares if another party made an offer for Northbridge. On November 20, 2008, Mr. Watsa met with Mr. Smith to share his views on the appropriate valuation metrics for the Shares. During that discussion, Mr. Watsa expressed his view that an appropriate premium for the Shares would be 20% above the most recent 30 day volume weighted average trading price (which represented approximately $36.00 per Share)."

 

You don't need to mention stuff like that to a "friend". That was understood. You make an offer that is acceptable and if it is, a sincere hand shake will ensue. $36 was not a fair offer. There is not a single Northbridge shareholder who would have been happy with such offer. $39 was not great, but it felt fair.

 

Cardboard

[20ppy]

If $39 sounds fair, it seems to me that Prem's walk and talk is aligned.

[Vinayd]

Thanks Cardboard for the great investigative reports.  Everything you've posted continues to strengthen my view that FFH will imminently make an offer for the balance of ORH:

 

1. FFH is a complicated structure, with many intermediary holding companies and investment companies riddled between the actual insurance/reinsurance operating subs.  

 

2. the $880M of cash at the FFH holdco, is likely not ALL held in one US holding company, but various amounts held in various intermediary holding companies and comprised of various international currencies (e.g.: US$, CDN$, Pounds, Euros).  With the $US weakening substantially these past 4-5 months, it may be beneficial to tap into these international currencies within their holdco cash to make part of the purchase.

 

3. The transaction of buying out ORH will likely trigger tax implications accross at least some of the companies that are holding ORH shares -- and therefore a need to ensure the transaction is tax efficient.  Therefore a movement of some ORH shares out of TIG group to perhaps NB or Advent may support this thesis (...my speculation:-))

 

4. Cardboard, your posts on NB's special committee discussion reveals that like many large conglomerates -- getting internal alignment requires posturing, and some level of strong arming. In the end, these are leaders of large corporations who know how to play the politics of their internal organizations to their benefit. Moving NB shares around may have been more than just getting a tax benefit at C&F before takeover, but to ensure Prem's existing shares of NB were in the 'correct' intermediary holding companies to ensure internally his votes were lined up.  

 

5. FFH cannot feasibly make an offer for ORH until they actually have the cash from the $400M debt offering.  If this closes on Aug. 18th, then FFH can only make an offer after this date.  Until then, ORH has no need to form a special committee and it's status quo on share buybacks.

 

6. The payment of $50M US for the balance of Advent last month aligns well with the notion of an ORH buyout, since FFH may need to gain full control of Advent's float to gain access to more foreign currencies and a strong posture of where ORH shares are held in relation to voting ability.

 

7. ORH bought back another 500 K shares in July, and likely more in August (...my speculation again).  These share buybacks at below book, along with more mark-to-market gains in ORH's investment portfolio are putting upward pressure on the stock price. and book value -- and ultimatelya final buyout price.  It is imperitive that Prem not have ORH release another Quarterly report so he can harden the $51.90 as the latest book value and as a plausible valuation metric.  

 

8.  Although Andy has done a fabulous job operationally at ORH, it is Hamblin Watsa's investment prowess that equally (...if not more so) contributed to ORH's gain in intrinsic value and book value. So, a buyout valuation of 1.15 - 1.30XBV range is very reasonable given current soft markets and historical trading range of ORH and likely be considered 'fair' by any valuation committee formed at ORH although somewhat be-grudgingly.

 

Buying out ORH, unlike buying out NB, is a substantially larger endeavour.  It requires FFH to move funds around to maximize currency translation.  A need to ensure the buyout minimizes tax consequences and potentially maximizes tax gains where possible.  A need to secure $400M in debt for prudent cash management -- to manage upcoming debt maturities at the holdco and ORH sub in 2012-2013 as the buyout will cost $$850M - $950M now. And finally, will require a strong posture internally so that Prem can fend off any potential internal power struggle at the sub level.

 

An ORH buyout puts the continued ORH share buybacks, Advent purchase, $400M debt offering, large ORH share movements and even the recent renewal of Andy's contract into proper context.  All of these elements are required to make a successful offer.  Without an imminent ORH offer, the above moves actually create some cause for concern (e.g.: what the heck do you need $400M for now??, and why the heck are you buying the rest of Advent for such a premium??).

 

cheers,

Vinay

 

[ERICOPOLY]

8.  Although Andy has done a fabulous job operationally at ORH, it is Hamblin Watsa's investment prowess that equally (...if not more so) contributed to ORH's gain in intrinsic value and book value. So, a buyout valuation of 1.15 - 1.30XBV range is very reasonable given current soft markets and historical trading range of ORH and likely be considered 'fair' by any valuation committee formed at ORH although somewhat be-grudgingly.

 

Fully agree.  Somebody earlier said that because of ORH's 20% ROE, then it's worth some massive multiple.  Well, there's no way that Fairfax should have to pay for HWIC's talent given that they already own HWIC.  So you have to back out HWIC's talent from ORH's ROE, then value it.

[Redskin212]

Great Point Ericopoly!!

[Smazz]

I dont see why when they can continue to buy the company back at 10% tranches should they jump ahead and pay a premium. As Prem said when he was asked again about not buying more of the subs his comment was:

"well, we get the float anyway"

 

I really dont see a huge need for a complete buyout here.

 

We've all (at least I know I have) benefitted greatly from bad times turning into good times and picking our spots. I would like them to hold off on aquiring more debt util such time that the debt we offer are at more attractive rates (for us - shareholders).

If Prem has a MUST HAVE company out there - who knows, perhaps there is a non public company none of us has on our radar - an Iscar if you will - but the proceeds of what he is investing in best be paying back in multiples.

 

All that being said, Im eager to see whats up the sleeves.

[ERICOPOLY]

I dont see why when they can continue to buy the company back at 10% tranches should they jump ahead and pay a premium. As Prem said when he was asked again about not buying more of the subs his comment was:

"well, we get the float anyway"

 

They don't get the float anyway is more like it -- we're talking about buying the part that they don't own.

 

[ERICOPOLY]

Perhaps I just didn't understand Prem's comment.

 

Anyhow, he might have misspoke because he bought NB, despite having the float anyhow as he put it.

 

Perhaps when you want to acquire a company, you don't tell people ahead of time.  Something about tipping your hand maybe?

 

[Smazz]

I dont see why when they can continue to buy the company back at 10% tranches should they jump ahead and pay a premium. As Prem said when he was asked again about not buying more of the subs his comment was:

"well, we get the float anyway"

 

They don't get the float anyway is more like it -- we're talking about buying the part that they don't own.

 

No his comment was something to the effect that they get the float and Im assuming he means control of the float.

[ERICOPOLY]

I dont see why when they can continue to buy the company back at 10% tranches should they jump ahead and pay a premium. As Prem said when he was asked again about not buying more of the subs his comment was:

"well, we get the float anyway"

 

They don't get the float anyway is more like it -- we're talking about buying the part that they don't own.

 

No his comment was something to the effect that they get the float and Im assuming he means control of the float.

 

Ah, HWIC is in charge is his point.  That's true.

 

However in the past they have grown their float in soft markets via acquisition.  That's what they get from a buyout.

 

 

[returnonmycapital]

I mentioned the ORH premium due to high ROE.  I also mentioned, perhaps more poignantly, that if an insurance\reinsurance business can generate no cost float, the value of that float should be treated just like shareholders' equity.  In effect, ORH's true book value is = float + common shareholders' equity, which comes close to $8 billion.  Also meaning that ORH is trading below 1/2 true book value. 

I also mentioned precedent with this type of math in the GenRe acquisition by BRK. 

 

I understand that it's nice to see a quick pop in a takeover target's stock price.  But, as they say, then what?  I would much rather leave my capital in ORH generating tax-deferred returns of 20% per year than have a quick 30% pop and have my capital prospectively diluted by less desirable businesses generating less attractive overall returns on my capital for years to come.  If a takeover of ORH should happen, it should reflect such a difference for future years.  Prem, of course, knows this.  Does no one else?

[valuecfa]

I would be satisfied with 1.3x current book value as an ORH shareholder acquisition price. In the meantime, I would like to see more ORH buybacks in the $40-$70 million range per quarter as long as it stays this undervalued, assuming excess captial at ORH is available.

[benhacker]

Amended 13HR... ORH shares properly listed at 42.4m.

 

End of Discussion.

 

Ben

[Cardboard]

Looks like that Fairfax has redone its math and has now restated their 13-F to reflect the correct Odyssey Re share ownership.

 

http://www.sec.gov/Archives/edgar/data/915191/000095012309035828/0000950123-09-035828-index.idea.htm

 

That is very interesting to me. Odyssey Re share number has never changed on all 13-F ever filed by Fairfax (started in 2nd quarter 2007 for some reason): 42,399,400 shares held. This is also the first time ever that they issue a restatement to their 13-F.

 

What has created the error? If this was a new holding or one that changes frequently in # of shares it could be a simple typo. Based on history, it is not like they have fat fingers since they have never filed a restatement and their other holdings in common stock vary significantly. It is also hard for me to believe that no one is auditing the 13-F for potential errors before submission.

 

I suspect that something has occured internally preventing the share count to end up the same as in previous quarters, some transaction, something. They wrote the correct number based on some assumptions in the original file and then after a few called IR today, they realized the potential for speculation regarding ORH and have corrected the "error".

 

Cardboard

[ERICOPOLY]

I mentioned the ORH premium due to high ROE.  I also mentioned, perhaps more poignantly, that if an insurance\reinsurance business can generate no cost float, the value of that float should be treated just like shareholders' equity.  In effect, ORH's true book value is = float + common shareholders' equity, which comes close to $8 billion.  Also meaning that ORH is trading below 1/2 true book value.   

I also mentioned precedent with this type of math in the GenRe acquisition by BRK. 

 

I understand that it's nice to see a quick pop in a takeover target's stock price.  But, as they say, then what?  I would much rather leave my capital in ORH generating tax-deferred returns of 20% per year than have a quick 30% pop and have my capital prospectively diluted by less desirable businesses generating less attractive overall returns on my capital for years to come.  If a takeover of ORH should happen, it should reflect such a difference for future years.  Prem, of course, knows this.  Does no one else?

 

 

After the quick 30% pop, put it in FFH.  That's what.

 

Regarding your treatment of float as equity.  Fairfax has more float per share, you should be happy with the switch.  Truly though, I think your reasoning there is highly flawed -- what about a life insurer with a much higher float/equity ratio?  Float is not equity.

 

 

[Parsad]

Cardboard, we work with junior mining companies at Quantum, and you wouldn't believe how many times things are refiled...including stuff that the auditors have signed off on.  It looks like a simple mistake in accounting.  I don't know what the reasons are for the debt issued, and it still may have something to do with ORH, but the 13-F filing seems to just have been an oversight.  They filed the corrected 13-F after noticing the problem from all the different shareholders inquiring about it.  Cheers!

[Cardboard]

Sanjeev, this is no junior mining company and when I mentioned audit, I had in mind internal audit.

 

This is a large company that was just freed from an SEC investigation and that admitted to lack of internal control in some derivatives accounting a few years ago. I would think that any document filed with the SEC would be seen by them as a very serious matter. I suspect that the employee who made the error (or accidentally let some information slip?) had a bad day at work today.

 

There is still a possibility that it may have been a simple error. It is still intriguing that the error matches direct ownership of Odyssey Re shares by TIG Insurance Company.

 

Time will tell as to what is going behind the scenes. When there is smoke there is usually fire. IMO, they are working on something big for sure.

 

Cardboard

[Parsad]

Hi Cardboard,

 

I didn't mean to imply anything with the junior mining comment.  Just that refilings are very common, and occur with some frequency from small-caps to large-caps.  Most companies naturally prefer not to have refilings, but mistakes do happen from time to time, and a refiling is necessary.  The controls Fairfax put in place were primarily to do with accounting controls...intercompany transfers, etc.  I don't believe the controls were particularly directed at things like a simple 13-F filing.  Cheers!   

[Myth465]

As an internal auditor i can tell you we dont have much to do with SEC reporting. At least not at the companies I have dealt with.

[valuecfa]

Good Stuff. The amendment now shows the same number of ORH shares owned by Fairfax. We all knew there was something screwy going on there (with no sales disclosures in the Q's and no corresponding SEC filings showing an ownership change), and good to see it has been cleared up. Let the speculation resume. :D

[FlyingArrow]

 

After the quick 30% pop, put it in FFH.  That's what.

 

Regarding your treatment of float as equity.  Fairfax has more float per share, you should be happy with the switch.  Truly though, I think your reasoning there is highly flawed -- what about a life insurer with a much higher float/equity ratio?  Float is not equity.

 

 

 

Eric, you've convinced me. Somewhat.

 

After a good pop in FFH already I've sold some (15%) and put it in ORH. Mostly common and a handful of Feb 45 calls.

 

As with you if we get a pop due to a buyback/privatization I will put it right back into FFH. I'm doing this transaction in my registered accounts. I hate friction and I hate paying the taxman too soon. If it doesn't happen I'm perfectly content owning these ORH shares for quite some time. They are a great value regardless.

 

I hope to end up owing you a beer.

 

Cheers.

[returnonmycapital]

Eric, FFH has averaged high cost float over quite a few years.  ROE at FFH has averaged 14% for just as many.  That is why I mentioned dilution by less desirable business returns; both ORH and FFH share the same investment returns (more or less).  Add to that $400 million of reasonably high cost new debt capital at FFH and the struggle continues.

 

As for life companies; please name me one that produces a combined ratio below 100%:  Suggesting a cost to their float.

 

I'm not entirely sure it is my logic that is flawed, but no insult intended.