Interview With Prem Watsa - Gurufocus

[T-bone1]

The thing I'm confused about is how he repeats over and over again that their focus is combined ratios and profitable underwriting... However on this board everyone is constantly talking about how they are a mediocre insurance writing operation, and their real strength is the investing side.  If I remember correctly their recent combined ratios have not been stellar.  How do we reconcile what he says about their focus on underwriting profit, and their lack of underwriting profit??  Can someone more experienced w/ FFH explain this?  thanks..

 

Fairfax and their subs have stated that their expense ratio (the cost of having a building full of employees and actuaries actually writing insurance) is currently 5% too high because they are writing less than 1/3 of the business they could be writing due to the soft market. Both to prepare for the hard market and to make sure that agents are incentivised not to write poor business in a soft market, FFH has not downsized their bussiness to match the decline in premiums written.  This means that an increase in premiums in a harder market will automatically lower the combines ratio by 5% simply by spreading the costs over more business.  This would take the company under a 100% combined ratio.  The loss ratio for business written in a harder market should also be at least 5% lower, making for very attractive combined ratios.  The ratio just looks bad right now because they are preparing for the turn, where they will write much more premiums at lower rates. 

 

In the meantime, FFH still makes more on their bonds (supported by the float) than the float costs them, so the insurance business should have some positive value.  When you add the value of the insurance business today to the optionality of a much larger and more profitable insurance business in the future I think a significant premium to tangible BV is in order.  Prem sounds like he agrees in the interview and I would imagine they are actively buying back their stock today (I am assuming BV is up at least $20 in the quarter).

[Liberty]

From memory, recent CR has been rather mediocre at many subsidiaries, but it starts to look better if you look at the average over the long-term. Much closer to 100, IIRC.

[tnp20]

Not sure if its been brought up before but Prem means "love".

 

As for "Watsa", I am not 100% sure but "Wat" means someone fashionable, or is dashing...."sa" means person who comes from those qualities.

[Viking]

DCG, I also sometimes wonder how Prem evaluates management when making a purchase. Perhaps they take a basket approach (buy a couple different companies) to achieve some basic diversification and really do not try and get too cute with management.

 

Regarding underwriting, yes, FFH says all the right things. However, it takes many years to really know how good a company is at underwriting. At this time, based on past results, I would give FFH an average grade when it comes to underwriting (not terrible and not great). Now that their ship has been righted I would be disappointed if FFH did not trend over the next few years towards being a great underwriter. Time will tell.

[DCG]

My issue isn't so much that they buy companies like the ones I listed (although its partially that), it's more that they bought large positions in some companies like those when there were so many other companies selling for very cheap prices.

 

And he is obviously basing his judgement on past results and not based on what the future looks like for those companies (yeah..I know it's contrarian, but I just question buying those companies compared to every other company out there).

[tombgrt]

Fairfax probably has one of the most contrarian stock portfolio's out there. The fact that those ideas are so unloved makes it possible to get outsized returns if things do work out ... or sometimes get proven very wrong.

 

I doubt they take a basket approach and count on management too much for such big positions. I'm sure they crunch the numbers just as much as with other investments. They are making really out of whack risk/reward bets that others steer away from because of the uncertainty involved.

 

I'm glad they do and that we can benefit from their expertise because I sure couldn't be that contrarian if I had to do it myself.

[Guest valueInv]

My issue isn't so much that they buy companies like the ones I listed (although its partially that), it's more that they bought large positions in some companies like those when there were so many other companies selling for very cheap prices.

 

And he is obviously basing his judgement on past results and not based on what the future looks like for those companies (yeah..I know it's contrarian, but I just question buying those companies compared to every other company out there).

 

The problem is that the management teams succeeded in a very different environment. They face very different challenges now. The real question is if they can change. If they keep doing the same things they did the first time around, they are likely to fail.

[Uccmal]

FFH is not just throwing darts at low PE stocks.  They have a team of analysts.  Take Dell for example, since I refuse to discuss the other any longer.  They have analyzed every part of the existing business, very deeply, and determined that the stock is cheap.  Then they have done a forward analysis on what might happen with Mr. Dell back at the helm.  Analysts, perhaps even Prem himself have likely met and spoke with Dell himself and his management team.  The depth this group is looking to for a large investment is probably deeper than any other analyst in the business.  The "I like the management script" is polite Prem speak for we dont discuss our common stock investments.  With LVLT, they are insiders, and therefore have information not available to the public. 

 

As for the company I wont discuss I can guarantee that Prem knows the co-CEOs personally, and probably quite well, and that some of his team also know them.  Prem is the Chancellor at the U of Waterloo, which has one of of the most highly regarded computer engineering programs, financed in part by the local tech companies.  Recall Buffett interviewing Jack Byrne at Geico, prior to investing.  The same thing is going on here.  They know exactly what they are doing.  I guarantee they have looked at every data point available on every investment.  Of course not all their turnarounds will turn, hence the diversification. 

[Parsad]

FFH is not just throwing darts at low PE stocks.  They have a team of analysts.  Take Dell for example, since I refuse to discuss the other any longer.  They have analyzed every part of the existing business, very deeply, and determined that the stock is cheap.  Then they have done a forward analysis on what might happen with Mr. Dell back at the helm.  Analysts, perhaps even Prem himself have likely met and spoke with Dell himself and his management team.  The depth this group is looking to for a large investment is probably deeper than any other analyst in the business.  The "I like the management script" is polite Prem speak for we dont discuss our common stock investments.  With LVLT, they are insiders, and therefore have information not available to the public. 

 

As for the company I wont discuss I can guarantee that Prem knows the co-CEOs personally, and probably quite well, and that some of his team also know them.  Prem is the Chancellor at the U of Waterloo, which has one of of the most highly regarded computer engineering programs, financed in part by the local tech companies.  Recall Buffett interviewing Jack Byrne at Geico, prior to investing.  The same thing is going on here.  They know exactly what they are doing.  I guarantee they have looked at every data point available on every investment.  Of course not all their turnarounds will turn, hence the diversification.

 

The other thing they do is once they come up with an idea, they have everyone politely tear it apart and tell you why it's not a good idea.  If it stands that test, they make an investment.  The analysts do all the grunt work, but it's the investment committee (six people) that make the final decision.  And that doesn't happen until there is some agreement for the big ideas. 

 

Smaller ideas, the principals are give a certain amount of capital, and they invest accordingly...as do the analysts, but way smaller.  Big ideas like Dell, etc...the group of six has to come to some agreement.  Cheers! 

 

[prevalou]

"How do you avoid bureaucracy in your decision making?

We are very careful about that. On the investment side, we

make sure that on our investment committee of six, each

member makes decisions on a certain part of the portfolio.

Committee members don’t have to get consensus to buy

something that the others like. So if one individual in the

firm buys US$10 million dollars of something, some stock

that he likes, he doesn’t have to get everyone’s permission

to buy. Then the rest of us can add to that and take it up

to US$100 million. But to take it to US$100 million, it

would involve the rest of us doing a lot of work on it ourselves

to get comfortable. So we like this idea of individual

decision making."

From his last CFA interview