Saturday, September 19, 2009

Fairfax Financial Holdings (FFH) to Acquire another Subsidiary

A couple months ago, I wrote an article about one of Canada’s main reinsurance companies. Namely Fairfax Financial Holdings Limited, I also elaborated on how the company had been incredibly positioned to benefit from the financial meltdown of 2008. Through the sale of its large credit default swaps portfolio and a recent $1 billion public offering, the company has built an impressive cash position that it has used to invest in numerous ways, mainly by investing in the stock market but more importantly by acquiring the minority interest of two of its jewel subsidiaries.

At the beginning of December 2009, Fairfax Financial made an offer to the minority shareholders of it’s Canadian subsidiary Northbridge Financial Corporation. The details of that transaction were quite simple and very attractive to any single one of the company’s shareholders at the time.

It was an offer to acquire all of the outstanding common shares of Northbridge, other than those shares already held by Fairfax, for $39.00 in cash per common share, representing total cash consideration of approximately $686 million. At the time, $39.00 per Northbridge common share represented a premium of approximately 28.9% over the $30.25 closing
price of Northbridge common shares on the Toronto Stock Exchange on November 13th, 2008, the day Fairfax approached Northbridge’s board of directors to consider the proposed transaction.

As Fairfax’s press release underlined it, the proposed transaction also represents a 31.8% premium over the 30-trading day volume-weighted average closing price for the period ended November 28, 2008 of $29.59 and a 160.0% premium over the May 21, 2003 initial Northbridge public offering price of $15.00 per common share, it was pretty rewarding for long term as well as trading shareholders of Northbridge Financial. At the time, Fairfax owned 30,111,306 common shares or approximately 63.1% of Northbridge’s outstanding common shares.

It seems that Vivan Prem Watsa is striking again; this time with Northbridge’s American sibling, Odyssey Re Holdings Corporation. According to the September 18th press release, the price of $65 per share in cash represents a 29.8% premium over the closing price on September 4, 2009 (the date on which Fairfax publicly announced that it was proposing to acquire all outstanding shares of common stock of Odyssey Re that Fairfax does not currently own for $60 per share) and a 33.4% premium over the 30-day average closing price for the period ending on September 4, 2009. The complete transaction would amount to about $1.8 Billion. Based on Odyssey Re’s initial public offering price of $18.00 per share in June 2001, the purchase price represents a compounded annual return of 17.3% through the date of the merger agreement.

The acquisition of those two reinsurance powerhouses and the investing incredible investment ability of Fairfax’s CEO Prem Watsa reinforce my conviction in the future growth of the company. I remain convinced that even at a price of 398$ per share at market close on September 18, 2009, this company is clearly undervalued by the market.

10-year target selling price: 651$

Disclosure: The author is long FFH.TO

Thursday, September 10, 2009

The High Yield Royalty Trust

During the past five years, Canadian legislation has been pretty rough on companies that have decided to convert to income trusts. In the past, this had been a very advantageous situation for them, since distributions were not taxes by any government, whether it would be federal or provincial.

Royaly trusts tend to work a lot like income trusts, except that they must operate in the oil and gas business. Their most appealing similarity is that almost all of the income generated by their assets is distributed, on a monthly or quarterly basis and at a very advantageous 10% tax rate, to unitholders, thus generating a very interesting form of income.

As it happened for income trust, legislation has been passed by the conservative government to fully tax realty trusts starting in 2011. Depending of the result of the next federal elections, investors still have about a year to still take advantage of the their incomes from realty trusts.

The one that has charmed to me the most is Provident Energy Trust, which is, according to their financial statements, an open-end investment trust created to hold, directly and indirectly, all types of petroleum and natural gas and energy related assets, including without limitation facilities of any kind, oil sands interests, electricity or power generating assets and pipeline, gathering, processing and transportation assets. The Trust’s business activities are conducted through two business segments: Canadian oil and natural gas production (Provident Upstream) and Provident Midstream. Provident Upstream includes exploitation, development and production of crude oil and natural gas reserves. Provident Midstream includes processing, extraction, transportation, loading and storage of natural gas liquids, and marketing of natural gas liquids. The Trust’s oil and gas production business segment operates in Canada, and Midstream business operates in Canada and the United States.

With a 0.06$ monthly distribution and a unit price of hovering around 6$, this gives this trust a yield a little bit over 12%, which is a very reasonable rate of return in the current economic conditions. In the past, the unit price change has matched the changes in the distribution amount, always keeping the distribution yield between 10% and 13%. As the economy recovers and energy consumption increases, I expect to see the distribution amount raise back to historical levels, consequently making the yield even more interesting.

10-year target selling price: 13$

Disclosure: The author is long PVE.UN