Fairfax's Watsa prepares for the worst
FINANCIAL SERVICES REPORTER
Fairfax Financial Holdings Ltd. CEO Prem Watsa says he's sticking with his incredibly bearish bet against the stock market, which paid off for the first time in the latest quarter.
The Toronto-based insurance and investment conglomerate reported second-quarter profits of $95-million (U.S.) after markets closed Thursday, following two consecutive quarterly losses stemming from the bet.
Mr. Watsa's pessimistic outlook on everything from the political crisis in Europe to the real estate markets in China and the United States prompted him to hedge Fairfax's stock portfolio to the tune of roughly 105 per cent by the end of last year. The company is essentially betting that markets will go down, and it's willing to give up the gains it could make from rising stock markets to protect itself against a potential nosedive in the markets.
It's a risky gamble. Fairfax's investment portfolio bled $914.9-million in the final three months of 2011, mostly because of that bet, causing the company to post a $771.5-million loss. And the firm reported a $1.3-million loss in the first quarter, as the hedges essentially erased what could have been more than $700-million in stock market gains.
The company still lost money on stocks this quarter, as the gains from its hedges failed to match the losses from its stocks (hedging is not a perfect science, and the firm doesn't directly hedge each stock it owns but rather broad indexes). But it was much better off with the hedges than it would have been without them. Its stock portfolio would have lost more than $580-million in the latest quarter, but its hedges brought in about $390-million.
"We continue to maintain our equity hedges as we remain very concerned about the economic outlook over the next few years," Mr. Watsa stated in a press release.
Fairfax has a history of making large bearish bets that take time to pay off, including ones it made prior to the U.S. subprime mortgage crisis in which it bet that a number of major financial institutions would suffer.
The company's core property and casualty insurance operations posted an underwriting profit of $34.8-million, turning around the loss that they posted in the same period last year when the firm was hit by losses stemming from tornadoes in the U.S.
Fairfax will host a conference call for analysts and the investment community on Friday morning, and Mr. Watsa is likely to be asked about his decision to increase Fairfax's stake in Research in Motion Ltd. to 9.9 per cent, a move that Fairfax revealed in regulatory filings on Monday.
The stake makes Fairfax the largest shareholder of the BlackBerry maker, which has been struggling to convince the market that it will be able to take on its rivals in the increasingly competitive world of smartphones and tablet computers. Mr. Watsa joined RIM's board in January. In an interview he suggested that Fairfax is not betting on a takeover of RIM, but rather believes in the company's ability to turn around over the next three to five years.
Fairfax also announced a series of management promotions on Thursday, as chief financial officer John Varnell becomes vice-president of corporate development, clearing the way for current vice-president of financial reporting David Bonham, who has been in that role for eight years, to become the new CFO.
Brad Martin becomes vice-president of strategic investments while Paul Rivett, the current COO of Hamblin Watsa Investment Council, takes on the additional role of vice-president of operations at Fairfax.
Fairfax Financial (FFH)
Close: $380, up $3.43
WHY FAIRFAX IS BULLISH ON RIM
Prem Watsa spoke to The Globe and Mail earlier this week about Fairfax's decision to become the largest shareholder in Research In Motion Ltd., the struggling BlackBerry maker. These were his comments:
"We believe in [RIM CEO] Thorsten Heins and we firmly support him and the entire BlackBerry team working tirelessly on the new [BlackBerry 10] platform ... He's got the experience and the passion for it, and he's going to get it done. He is on a mission."
"As John Templeton said 'the best investments are made at the point of maximum pessimism.' We don't know if RIM has reached that point, but we figure it's pretty close."
"This company has a tremendous brand name that is recognized worldwide. It has 78 million users, 56 million BlackBerry messenger users, patents and a worldwide network."
"When any company gets this cheap it could be taken over, but we believe this is a great Canadian company with a tremendous future. I joined the board to assist in any way I can."
"We've never seen a technology company, with assets and talent of this calibre, come down as cheap as the stock of this one has. The marketplace seems to be pricing the stock as if the company might simply close its doors shortly ... It's not like this is a start-up venture capital company. There is a worldwide following, significant capital, tremendous talent and singular focus on innovation."