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Fairfax Financial: Why We Bought a Chunk of Stock

Fairfax Financial: Why We Bought a Chunk of Stock

Here's why we added the Canadian insurance holding company to the Junto investment portfolio.
Fairfax Financial annual meeting reception
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Yesterday, we added a Canadian stock to the investment portfolio.

This stock is the insurance holding company run by Prem Watsa, Fairfax Financial.

And there’s a great reason why we bought a sizable chunk of it. But first, let’s talk a bit about Prem Watsa himself.

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17 Responses

  1. Nice write up Oliver. Definitely an interesting story. I’ve been going through the Annual Report last few days by coincidence and think its interesting at current levels as well. A couple of issues I’ve had trouble getting comfortable with:
    1. It seems like fairfax earnings power ex mark to market gains/losses is closer to 3-400mm
    2. The bonds/stocks/pfd portfolio of about 21bn as of year end down about 25% would drop book value to about the current market cap as you mentioned in your write up. A significant portion of the portfolio was likely fully valued or even overvalued given the bull market of the last decade and a 25% decline is probably insufficient.
    3. Prem is much more of a salesmen then a realist in his annual letter. His claim that he is monetizing private investments such as APR at attractive prices is intentionally misleading since he really just sold it into a company that Fairfax has funded (Atlas). Chuck Ferry, APR’s CEO subsequently resigned and Atlas disclosed that APR was running operating losses at the time of acquisition. In general, Prem’s statements and lack of disclosure in a press release of a major change in governance such as the resignation of APR’s CEO by Atlas raises questions regarding the ethical standards at Fairfax.

    Would love to hear your thoughts

    1. Thanks a lot. Those are good points. Here are my thoughts:

      1. Well, I think that sounds a bit penalizing. Seems like you took pre-tax income before net gains on any investments. Value creation above the cost of capital in the P/C industry occurs when insurers know when to write a lot of policies and when to write less depending on financial market opportunities. Excluding such opportunities in determining Fairfax’s value creation would, in my opinion, be a fallacy.

      2. Almost agreed. I think labeling a 25% decline insufficient is too penalizing as well, given that Fairfax surely has (and is) taken advantage of lower asset prices, either for new or existing holdings or through share repurchases. And, common stocks are comprising only $5.3 billion of that $21 billion while bonds are conservatively positioned with short durations. I think 25% is closer to the upper bound.

      3. I agree that Watsa has his way of writing letters. But I wouldn’t couple that with an inverse relationship between being a salesman and a great investor/leader. I don’t entirely agree with your statement of him intentionally misleading investors. Since APR went from being a private company to become a subsidiary of a publicly-traded company, monetizing is not a wrong expression. And operating losses shouldn’t be a surprise. One can simply open the annual report on page 68 to figure that out (and page 59 in the 2018 report).

      Thanks for some great considerations!

  2. Thanks for your responses and fair points. I would encourage a google search on resolute forest products and fibrek related to Fairfax. While the judgment was small I didn’t see it disclosed in the annual report, putting aside the ethical issues

  3. Thank you Oliver for the nice research and WillKim85 for the comment. Prem mentioned in the report that he invested in Seaspan / Atlas mainly because of the outstanding records of David Sokol. What are your thoughts on Atlas as an investment, currently (at $7 /sh) selling at about 0.5 x BV, PE of about 4, DY of 6.7%. The company seems to have improved a lot over the last couple of years since Sokol, Bing Chen, and Ryan Courson have been in charge.

    1. Thank you, Andrew. I don’t know much about the nuts and bolts of the business other than the big picture. But I would expect Atlas to be a significant driver of shareholder value over the very long term. It’s worth to factor that Mid-American under David Sokol compounded earnings at more than 20% over a 20-year period. And I don’t know much about the reputational risk of the specific management, although I know it’s there.

  4. Atlas has made a lot of progress since Sokol joined as Chairman and I am hopeful on its prospects as an investment vehicle. While new mgmt has made progress deleveraging, it still remains highly leveraged at about 4.5x. In addition, the real PE is closer to 7x as they had a 1x gain of 227mm from a contract modification. It also took on a money losing operation ahead of the coronavirus pandemic which will probably weigh on earnings and the CEO of APR abrupty resigned this month (without a press release from Atlas).
    On the positive side, Sokol will probably continue to improve capital allocation, there are 4b+ of contracted revenues (although this may be under pressure due to a reduction of global trade during the pandemic), and Fairfax will likely continue to fund the entity if it needs more liquidity through the exercise of its 25mm warrants. I would personally wait until they provide more clarity on the strength of their contracted revenue during the downturn and some visibility into APR’s numbers, but definitely one to keep an eye on.

    1. Hello! Is the Sokol you mentioned the same David Sokol that Buffett kicked out from Berkshire after he engaged in insider trading? I tried to Google, and realised the Sokol that is running Atlas is “David Sokol” too.

      1. That is correct, Ser. Despite the fact that there might have been some lack of judgment of character, Sokol is a very smart executive. Not that I want to dabble in the Lubrizol case; but, “by seeking and blundering we learn.”

  5. I guess now he’s refusing to mark some assets to market on publicly traded stocks to inflate his book value. About a $1bn hit to book (atlas, eurobank, resolute)… Marking to market I get about $330/share in tangible book, would you agree?

    1. They’d already disclosed that Eurobank had moved to equity accounting and it’s the biggest reason for the discrepancy you mentioned. It’s an accounting rule and not a refusal. I agree with your estimate if everything is valued at market as of the specific date on March 31. Now obviously, that is not static. Simply looking at it from a look-through book perspective would put that value upwards of $430 per share.

  6. Interesting post. Thank you. What are canadian regulations regarding what insurers can invest the float/liabilities in? With lower fixed income yields, how much can be invested in equities etc.
    Thank you
    David

    1. There’s no limitation in terms of allocation to equities, be it float or equity. But obviously, they can’t risk statutory surplus or liquidity, so I wouldn’t bet on an equities allocation being substantially more than book value at any time. There’s been a bigger allocation to high-yield corporate bonds (out of government bonds) throughout the first quarter.

  7. Do you know the approximate liabilities faced by Fairfax from Covid19 business interruption

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