FAIRFAX FINANCIAL HOLDINGS LIMITED Initial Thoughts On The Muddy Waters Report
Conclusion: Our take is that the short report encourages investors to
entangle themselves in the minutiae of accounting treatment applied to past
transactions, while overlooking the substantial build of earnings power that
has occurred over the past few years. Based on the intraday share price,
Fairfax trades at a P/E of 6.3x (using 2024 consensus EPS) versus U.S.
peers that trade at 14.7x on average. The integrity of underwriting margins or
investment income is not in question. In our view, quibbling about the
perceived variance between fair value and carrying value of balance sheet
assets overlooks the significant expansion of earnings power that is clearly
not getting the same degree of recognition in the public markets as peers.
We expect that Fairfax will address the short report on its conference call
next Friday.
Key Takeaways
Muddy Waters has released a short report on FFH: The report is fairly
lengthy and entails a large number of allegations that mostly center around
what they perceive to be aggressive accounting treatment of past
transactions. The crux of the short thesis is that book value has been
overstated (by ~18% in their estimate).
The report contains a substantial volume of content: The report lists a
large number of transactions that it perceives to be aggressive or
unjustifiably beneficial to book value. The assertions laid out in the report will
take a large amount of time for investors to untangle and either corroborate
or dispel (while seeding the market with doubt in the interim). It will take a lot
of time for investors to review the detailed chronology of events, the
accounting treatment and other claims made in the report.
Unfortunately Fairfax can be vulnerable to this type of attack: Fairfax is
arguably one of the more complex P&C insurers. Historically, the company
has engaged in investment activities that involve acquiring large equity or
control positions in businesses that necessitate equity accounting or full
consolidation for financial reporting purposes. This element of complexity can
make the company vulnerable to this type of attack from certain actors that
have incentive to seed doubt in the market.
If book value is overstated it means ROE is understated: In our view,
even if any of these allegations had merit, they would not impact the earnings
power of the entity today. Furthermore, if book value was overstated but
earnings were not, it implies that ROE would be understated (theoretically
justifying a higher P/B multiple).
We expect Fairfax to address the short report on its conference call:
Given the severity of today’s market reaction (down 12% at the time of
writing) we suspect that management will seek to address the content of the
report on its conference call (Friday, February 16).
Price Target Calculation
Our price target of $1,700 is based on 1.2x our one-year forward BVPS estimate, which is a positive re-rating reflecting our expectation for a gradual convergence of FFH's valuation with peers.