Fairfax Financial Holdings Ltd. FFH-T defended the ways it values its businesses and its application of accounting rules in a rebuttal to allegations that U.S. short-seller Muddy Waters Research published last week.
Chief executive officer Prem Watsa once again called the report “false” and “ill-informed” and reiterated his confidence in the company on a Friday conference call to report its fourth-quarter earnings.
“We have built our company over 38 years on honesty and integrity, full and complete disclosure in our reports to our shareholders,” he said.
Mr. Watsa also said “the market has already spoken,” as Fairfax’s share price had recovered from its 12-per-cent plunge after the short-seller report was released last week. On Thursday and Friday, Fairfax shares traded above the $1,404.40 Feb. 7 closing price the day before Muddy Waters went public. They closed at $1,374.97 Friday, down 1.8 per cent on the day.
Mr. Watsa and chief financial officer Jennifer Allen said Fairfax does quarterly checks for impairments of its investments through what Ms. Allen called a “robust process.” She said Fairfax’s evaluations typically use models that include cash-flow projections from the management of its operating companies, which the company then corroborates by looking at market prices and sales of other companies.
She also said Muddy Waters’s critique of Fairfax’s application of International Financial Reporting Standards 17, a transformational accounting standard for the insurance industry, was wrong because Fairfax believes the short-seller used an inappropriate peer group and an incorrect financial metric to weigh the impact.
In a report last Thursday, Muddy Waters said it believes Fairfax has overstated its balance sheet by US$4.5-billion because of accounting choices or transactions involving 13 of its investments, subsidiaries or joint ventures, including the IFRS 17 application. All 13 of the items had an impact of at least US$100-million, Muddy Waters asserts. The IFRS 17 application added US$1.24-billion, more than a quarter of the alleged overstatements, it says.
With Fairfax often valued at a multiple of its book value – assets in excess of liabilities – an inflated balance sheet would mean an overpriced stock.
Muddy Waters, as a short-seller, profits when a stock falls. Short-selling is a bet that the share price will drop, with an investor borrowing shares, selling them and repaying the loan by returning new shares, hopefully bought at a lower price.
On Friday’s call, Fairfax took brief questions from Muddy Waters CEO Carson Block. His company asked five detailed questions of Fairfax and said it “remains short” on Fairfax’s stock in a posting on its website.
Mr. Block pressed Mr. Watsa and Ms. Allen to provide additional disclosure on cash invested and returned from associates, which are companies in which Fairfax owns between 20 per cent and 50 per cent, in future financial statements. “Will you be disclosing these associate transactions?” he said.
Ms. Allen responded that disclosure with respect to associate transactions is made “as applicable” in the company’s annual reports, according to the IFRS rules it follows.
But Mr. Block pressed for more. “Obviously you could do the bare minimum but why leave it there?”
Mr. Watsa told Mr. Block that Fairfax has “taken a lot of time to go through the allegations you’ve made.”
“We’ve made the point very clearly that we will not tolerate false and misleading information,” he said, before calling for the next question from an analyst.
Ms. Allen addressed Fairfax’s complex accounting decisions for several investments specifically targeted by Muddy Waters, including its stakes in restaurant company Recipe Unlimited Corp, Dallas-based energy company EXCO Resources Inc., and the sale of a minority stake in its U.S.-based insurance and reinsurance subsidiary Odyssey Group Holdings Inc.
In the case of EXCO, Ms. Allen pushed back on Muddy Waters’s argument that Fairfax has overvalued its investment by carrying it on the balance sheet at US$18.26 a share when it traded at US$8 on the U.S. OTC Pink exchange.
“The OTC Pink market is recognized as one of the lowest tier of the available marketplaces for trading over-the-counter stocks and the OTC traded value is not representative of fair value, as the stock is very thinly traded in an illiquid market,” Ms. Allen said. Fairfax carries the investment at about three times EXCO’s 2023 net earnings, she said.
Mr. Watsa said that the market value of all its non-insurance investments and ownership stakes, in the aggregate, were worth US$1-billion more than their carrying value on the balance sheet. “Muddy Waters highlights a number of these investments in its report, all with carrying value above market value, never mentioning one that is carried below. Clearly, a one-sided argument.”
The Toronto-based insurer and asset manager reported fourth-quarter profit of US$1.67-billion, or US$52.87 a share, compared with US$2.48-billion, or US$91.87 a share, in the same quarter last year. Full-year profit was US$5.1-billion, and Mr. Watsa said 2023 was “the best year in our history, by far.”
David Milstead
James Bradshaw