Muddy Waters is short Fairfax Financial Holdings Limited (TSE:FFH) because we find that Fairfax hasconsistently manipulated asset values and income by engaging in often value destructivetransactions to produce accounting gains.
More GE Than Berkshire Hathaway
We believe a conservative adjustment to book value should be ~-$4.5 billion or ~-18% lower than reported. We see Fairfax as far more akin to GE than to Berkshire Hathaway.
Likely in response to significant insurance losses in 2017, including at its just-completed “transformational” acquisition of Allied World, Fairfax began pulling levers in 2018 to produce paper profits. We see Fairfax continuing to pull levers in 2019, and then greatly amping it up in 2020 in what seems to have been a near-panic at Fairfax. By 2021, Fairfax seems addicted to this behavior, and its financial engineering goes “gonzo” throughout 2021 and 2022. We expect that 2023 will ultimately prove to have been similarly egregious.
Another Fairfax reality is that for years, it has been badly missing its long-term target of compounding Book Value at 15%. Before adjusting for accounting abuses, from the GFC (December 2008)through 2022, Fairfax’s own numbers have it compounding Book Value at only ~9%.
Acquiring Allied World in 2017 Seemingly Put Financial Pressure on Fairfax’s Insurance Operations
- Allied World grew FFH assets and liabilities by over 40%.
- Even after the catastrophes of 2017, insurance business profitability has lagged since the acquisition.The Combined Ratio averaged 97.3 from 2018-2020, versus 91.5 from 2013-2016.
- We believethis underperformancepressured Fairfax into becoming aggressive in pulling accounting levers starting in 2018.
~60% of Fairfax’s Book Value Increase Since 2017 Is the Product ofAbusive Accounting Often From Value Destructive, Non-Substantive Transactions
Fairfax Touts its 15% Book Value CAGR and Tells Investors it Blows Through It
Since the GFC, Fairfax’s CAGR (Including Dividends) Has Fallen Well Short of 15%
2018-Present: Recipe
Historically Mis-Marking Recipe and thenAcquiring it to Avoid Taking Losses, We Adjust Book Value Downward by $251 Million
Recipe — Introduction
Since Recipe (a chain of restaurants) went public in 2015, Fairfax has consistently overvalued its Recipe equity,carrying it ata premium to the observable market price. From 2015 – 2021, the delta between the public price and Fairfax’s carrying value increased. Despite the deteriorating macro conditions for restaurants, Fairfax took the business private at a 53% premium, paying C$20.74 per share (slightly below where Fairfax carried it). We believe this allowed Fairfax to avoid taking $251 million in losses in 2022. Fairfax has continued to carry Recipe above its estimate of fair value, while the business’ operating income has continued to shrink. Nevertheless, Fairfax has taken no impairment.
Fairfax’s 2021 financials, which are audited by its long-standing auditor PwC Toronto, showed Recipe’s goodwill and intangibles at a level 1.9xthat of Recipe’s own financials, which KPMG audited. We suspect this to be an example of Fairfax exercising an aggressive approach to valuation / impairment at the parent level.
Read the full report here by Muddy Waters.
