Prem Watsa Deep Dive
I finally finished going through Prem Watsa's Fairfax Financial shareholder letters this week and wanted to write a small summary on his rise to investing fame. He is the current Chairman and CEO of Fairfax Financial and controls 42% of share votes via his ownership. He is often referred to as the 'Canadian Warren Buffett' due to his long track record of compounding shareholders' capital in the insurance industry. Later this week, I will publish my scratch notes in a separate post on the site, for those who are interested.
Let's start with a little history shall we? Born in 1950, Watsa attended high school and undergrad in India and later attended the Richard Ivey School of Business at the University of Western Ontario for his MBA. After he worked at Confederation Life for a few years, he started Hamblin Watsa Investment Counsel with his boss Tony Hamblin in 1984. Interestingly enough, Hamblin Watsa (as a Fairfax subsidiary) still manages all of the 'float' generated by Fairfax Financial's insurance subsidiaries.
In 1985, Watsa, with help from outside capital, helped recapitalize Markel Financial, which was a small trucking insurance firm that was near insolvency. From there, he helped grow the business from roughly $10M in revenues in 1985 to $14B in 2017. He compounded book value at 19.5% and the stock value (not including dividends) at 18.1%. What a record! $1,000 invested with Watsa in 1985 would have compounded into roughly $205,000 over 32 years, not including dividend payouts! A constant $1,000 invested annually over his 32 year track record (total of $32,000 invested) would be worth an astounding ~$1.1 million!
While he has made his mistakes (overhedging his equity exposure from 2010-2016 cost shareholders $4B!), he has always written extensively and honestly about the company's operations, choosing to disclose everything to shareholders that he would wish to know, were he in their shoes. I particularly enjoyed his discussions on bubbles, economic risks, and valuation risks in various financial markets over the years (the 1998 letter on the tech bubble, the 2003-2006 period on housing and collateralized debt obligations which exploded later, his call on China's huge debt burdens in early 2010's, and his views on deflation, though they did not come to fruition as expected - or at least not yet!). So what makes Watsa such a great long-term investor? Here are my thoughts after reading through his 32 annual letters:
1. His patience, especially in the occasional years where Fairfax posted a loss.
2. His ability to sacrifice short-term performance for protection. Many times in Fairfax's history, Watsa has chosen to hedge certain exposures due to either financial markets risk (high valuations) or macroeconomic risks (deflation and interest rate risk). This lead to lower short term performance, but also 1) protected the company's investment portfolios from large sudden declines and 2) at times allowed for large one time gains when the underlying risks being hedge against actually occurred - such as the 2008 period when his credit default swaps became worth billions when the financial crisis hit.
3. His ability to issue shares to fund acquisitions at fundamentally sound prices. Issuing shares in acquisitions can be a sign that management does not care about current shareholders more than the current acquisition or it could be a savvy capital allocation move. The caveat is that it takes time and careful observation to know which is the case. It is clear from reading Watsa's shareholder letters - and understanding that he is the largest shareholder - that his acquisitions have been fairly savvy moves using equity as a currency over the long run.
4. His focus on strong deal structures early on in the company's history. I found it particularly interesting how almost all of his insurance acquisitions that he writes about early on from 1985-1995 are contingent on reserve developments. In other words, if the premiums that were written by the previous owners turn out to be badly underwritten, then Fairfax is indemnified (or not on the hook) from those losses. This protects their downside on deals that subsequently go bad, while allowing them full access to the float that has already been generated by the insurance company prior to the acquisition.
5. His focus on profitable underwriting, realizing that this was the key to outsized returns over the long run. This has been a key to Buffett's long-term success at Berkshire and Watsa was wise to understand that he could have capital that was essentially costless or even profitable to invest (combined ratio of 100% or less on the investment float from premiums written).
6. His ability to attract talented individuals to the Fairfax family.
7. His ability not to miss the forest for the trees. Watsa understands how bubbles typically play out, and this is an essential talent for the most successful investors. As Buffett has always said, "if you don't know who's the patsy at the poker table, chances are it is you!"
8. His focus on keeping a clean balance sheet and using leverage at opportune times. Watsa keeps a low debt to capital ratio most of the time, which allows him to both 1) write more insurance premiums and take more risk in this area and 2) lever up if an attractive acquisition candidate materializes.
9. His shameless copying of Berkshire Hathaway's decentralized and insurance-based business model. As Munger has repeatedly said, "we aren't sure why more people haven't tried to copy us." Watsa has done it to great effect.
For those who are looking to learn more about the property/casualty industry, how long-term value investors think, and in general what to look for in an owner-operator like Watsa, I highly recommend reading through these letters. They are like windows into the mind of one of the greatest businessmen and investors alive today.