Value Investing


FAIRFAX FINANCIAL HOLDINGS LIMITED – OPPORTUNITY KNOCKS? by Caleb Gibbons, CFA, FRM– Originally at IBankCoin. Reposted with permission

FAIRFAX FINANCIAL HOLDINGS LIMITED is a Financial Holding Company based on Toronto, Ontario, Canada. Their underlying business is multi-line insurance (property & casualty, life, re-insurance, investment management and insurance claims management). Fairfax is listed on the Toronto Stock Exchange (TSE) under the ticket FFH.TO and has had an impressive run (understatement) under Prem Watsa, 21% compounded annual growth in book value from September of 1985 through present. From C$1.52 to C$700, over 31 years, truly remarkable. As at the end of Q3 2015 Fairfax had C$42bln (US$32bln) in assets. Full results for 2015 will be out mid April. Mr. Watsa is extremely savvy and even though he is young enough to be Buffett’s son at 65, he is often referred to as “Warren Buffett of the North”. Prem Watsa immigrated to Canada from India after completing a Bachelor of Technology Degree on Chemical Engineering and completed his MBA at the Ivey Business School at Western University in 74?.

FFH.TO at C$700 per share is up 8.1% ytd in 2016 but is well off it’s tippy toe highs when it was up 18.6% on February 19, 2016, to C$774, at a time you might recall most thought it was end of days. FAIRFAX FINANCIAL HOLDINGS LIMITED announced a C$735mm bought deal for 1mm shares of subordinate voting shares on February 22, 2016 when the stock was flirting with C$770. It likely seemed to Lead Underwriters, Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CIBC) and Royal Bank of Canada (RBC) that 1mm shares on a bought deal basis at C$735 held limited downside, especially with C$29mm of total fees included. It turns out a bought deal was the way to go for Watsa. The deal closed March 2, 2016 and Fairfax got their C$735mm in gross proceeds (C$706ish net). The deal, as Fairfax typically does, funded growth with the proceeds of this slug of sub voting shares to pay for formerly announced acquisitions, namely 80% of Eurolife ERB Insurance (largest insurer in Greece) and an incremental 9% of ICICI Lombard (taking holding to 35%), India’s largest private sector general insurer.

The most recent bought  deal turned out to be a stinker. About 1/2 was sold at the marketed (i.e. bought) price but with the rest of the wares sitting on the shelf of the deal underwriters, the last shares of the bought deal were re-offfered at $687.50, approx. 6.5% down from the $735 bought price. Obviously, underwriters did not take Fairfax up on the “Greenshoe” option to upsize the deal by up to 15%, that would be more a Kodiak boot than a shoe.

Fairfax’s main ticker is denominated in Canadian dollars. The Canadian dollar at 1.3354 has staged a magnificent 10% rally versus the USD in the last 2 1/2 weeks from the recent low. They have a USD version FFH.U.TO, also listed on the TSE but scant, as in near zero volume I’m afraid making FFH.TO the only game in town. Several hedge funds have listed re-insurance arms. Watsa like prowess costs you 2% & 20% in the USA. Canadian hedge funds typically charge 1.5% and 15%. Fairfax even pays you a consistent dividend.

The complexity ofFAIRFAX FINANCIAL HOLDINGS LIMITED  is a turn off for some investors and there is certainly key man risk, but I’m much more comfortable taking risk on Watsa at 65 than others of similar vintage. He signed on for a decade more as CEO (through 2025) last year for C$600,000 (US$450,000) per annum in pay with no other incentives (pension, share options, car, nada) other than his existing shareholdings in Fairfax. Watsa used to control 80% of the voting rights in the Company and now hold 43%, 41.8% through multiple voting right shares and the residual through subordinate voting shares (identical to the $735mm just raised). Watsa is worth approx. $1bln through his career long efforts at Fairfax and draws two Hillary Clinton speeches worth of remuneration per annum. Serious skin in the game.

Macro overlays. Prem Watsa has shown a very deft capacity to effect macro overlays to the Fairfax business at just the right time. His bet against subprime in the global financial crisis allowed Fairfax to net US$4.6bln on hedges, split somewhat evenly between equity hedges and credit default swaps where Fairfax was a buyer of protection well before the storm hit. The latest overlay, other than 16.5% (US$5.2bln) in cash, is related to a deflation bet Prem Watsa began in 2010. Fairfax now has >$100bln notional in CPI-swaps which pay if key global markets (USA 42% of notional hedges, EU 38% of notional hedges, Great Britain and France) experience deflation over the contract term (typically 10 year swaps, with roll down the portfolio has a average life of <7 years). Part of this hedge is to protect investment returns, but Watsa thinks both bigger and 2 moves ahead of most. Many European insurers will likely be insolvent after an extended period of NIRP right on the heels of ZIRP. Funding growth through opportunistic acquisitions does not come solely from bought equity deals when the sun is sunny.  JCG

Note: At the due diligence stage with this one. No position held in FAIRFAX FINANCIAL HOLDINGS LIMITED. Pref shares in scope, in addition to the common.