A Toys 'R' Us store is pictured in Toronto on March 15, 2018.Carlo Allegri/Reuters
After Toronto-based Fairfax Financial Holdings Ltd. prevailed with its $300-million bid for the Canadian subsidiary of Toys “R” Us Ltd. on Monday, you may have wondered if this was a deal to applaud or question.
Welcome to Fairfax, a property- and casualty-insurance holding company that is better known for its substantial investment portfolio − and its head-scratching bets.
To name a few: It is the biggest investor in Torstar Corp., the struggling owner of the Toronto Star; it is the second-biggest investor in BlackBerry Ltd., the struggling mobile communications company, and Intrepid Potash Inc., which has suffered three straight years of losses.
Add in some Greek real estate and a bet on International Business Machines Corp., where operating revenue has declined 20 per cent since 2010, and it’s clear that this isn’t an index-hugging portfolio.
Long-term investors who stand by the investing acumen of Fairfax’s chief executive officer, Prem Watsa, may have no reason to worry about these eccentric investments as they flock to the company’s annual general meeting on Thursday.
They know that Fairfax’s annual profits can be lumpy, which is why the company’s performance is usually based on changes in book value. And book value per share has risen 19.5 per cent annually since 1985.
The share price has tagged along. It has gained more than 18 per cent a year on average, far exceeding gains by the S&P 500.
If Fairfax now sees value in Toys “R” Us, a retailer whose U.S. parent filed for bankruptcy protection in September, then investors will no doubt stick along for the ride. But their patience may be tested.
Fairfax’s approach to investing has changed recently. Prior to the financial crisis, it held large hedges against market downturns – a prescient move that paid off during the financial crisis. When the S&P 500 fell 38 per cent in 2008, Fairfax shares rallied nearly 36 per cent.
Those hedges are now gone: Mr. Watsa is upbeat about current economic conditions and the new U.S. administration’s focus on cutting taxes, reducing regulations and investing in infrastructure, which he expects will drive corporate profits higher.
“So we are back to playing offense again,” Mr. Watsa said in his recent letter to investors.
But his enthusiasm means Fairfax is positioned for either an ongoing bull market or a shift toward the deep-value style of investing he has long favoured.
It could happen. The stock market has been favouring growth and momentum styles of investing in recent years, leaving untapped bargains that might shine.
As Mr. Watsa pointed out, the value of Fairfax’s stock portfolio doubled between 1999 and 2001 − even as the S&P 500 plummeted when the tech bubble burst − illustrating how unpopular bets can pay off in the long run.
As well, Fairfax sees another approach to success: Driving value through deals. For example, it expects that Toys “R” Us will fit in with its other retailing operations, such as Golf Town and Sporting Life Inc., creating operating efficiencies.
It won’t be easy, though. Fairfax has been less successful at increasing its book value in recent years. Sure, book value rose 22 per cent in 2017. But that was after selling two insurance operations during the year, which added $2-billion in gains.
Excluding these unusual gains, book value would have fallen in 2017, according to Paul Holden, an analyst at CIBC World Markets. Since the end of 2009, he added, book value per share has compounded at just 2.5 per cent a year.
For Fairfax to achieve its target of increasing book value by at least 15 per cent, Mr. Holden estimates that the return on equity of its investments must be at least 25 per cent. For perspective: The S&P 500’s return on equity is 13.9 per cent, according to Bloomberg.
In other words, Fairfax’s investments must outperform the market in a big way for the share price to do well. Let’s hope those oddball holdings pay off.
David Berman