Chatter around Fairfax’s FBD intentions didn’t hurt Canada’s Warren Buffett
Turnaround at insurer saw stock surge 25% past year under Muldoon’s leadership
Fiona Muldoon, CEO at FBD. Photograph: Alan Betson
FBD’s stock surged by 25 per cent in the past year, buoyed by better-than-expected profits and mounting speculation that the insurer could become a takeover target as the punt by Canadian group Fairfax Financial Holdings on the Irish group approached a key milestone.
It has delivered a handsome payday for Fairfax, founded and run by Prem Watsa, known as Canada’s answer to Warren Buffett.
The Indo-Canadian billionaire entered the frame with a rescue investment in FBD three years’ ago to shore up the finances of the then heavily loss-making firm – just as others were scuttling towards the exit. It saw Fairfax buy €70 million of bonds in the Dublin-based company. These carried a 7 per cent annual interest rate and entitled Watsa to convert his investment into equity at €8.50 a share from March 2019.
Fairfax has been in the money since last October, when FBD shares breached that price, having traded at about €6.20 apiece two years earlier.
FBD, headed by chief executive Fiona Muldoon, surprised the market last Monday by announcing that it had agreed to take out Watsa’s €70 million of convertible notes for €86 million in cash. This captures the gain that Fairfax would have made had – as was likely – the bonds been swapped for a 19 per cent stake next year.
FBD’s recovery has been remarkable since Muldoon took over as chief executive of the then shaky company in 2015. The former top Central Bank regulator has presided over heavy restructuring at the insurer, including the sale of property investments, hiking motor premiums, scaling back on the use of insurance brokers and closing the company’s defined benefit pension plan to future accrual among other cost-cutting measures.
FBD paid its first dividend since 2014 earlier this year on the 20th anniversary of its flotation on the Irish Stock Exchange. That was after pre-tax profits surged last year to a better-than-expected €49.7 million from €11.4 million in 2016.
FBD’s consensus-busting performance for the first half of this year saw profits jump more than 50 per cent to €18.4 million. Both results delivered impressive return on equity figures, a key measure of a company’s profitability.
Shares in FBD jumped almost 4 per cent on Monday as investors cheered the bond buyback deal. They were boosted further the following day as Muldoon managed to raise €50 million of subordinated debt to help finance the transaction. The interest rate – or coupon – on the new notes is two percentage points cheaper than the old bonds, resulting in an automatic earnings boost.
Analysts generally agreed that the transactions removed major uncertainty and the prospect of “overhang” in the market of a Fairfax equity stake. It has also averted a situation where current shareholders, led by Farmer Business Developments’ almost 25 per cent holding, having their stakes diluted.
However, some of the surge in FBD’s value over the past year has been down to market chatter that Fairfax would use its investment either to take over the company (which, in fairness, seemed remote, given the insurer’s size and exclusive focus on a small market) – or engineer a merger with another company.
Belgian-owned KBC Bank Ireland had long been suggested as a potential suitor.
Fairfax did nothing to encourage the speculation. But it has certainly benefitted. The focus is now likely to return to FBD’s fundamentals. Profits in the 18 months through June were heavily flattered by one-off events. These included the release of €21 million of reserves that had previously been set aside for expected losses on insurance claims, and a favourable 2017 Supreme Court ruling on who should carry the cost of the collapse of Malta-based Setanta Insurance. That freed up a further €5.6 million of FBD provisions.
Last year’s profits are not expected to be matched for the foreseeable future, according to the most recent forecasts of analysts who cover FBD, including UK-based at Shore Capital – which, it has to be said, remains bullish on the stock.
Aside from an expected €16 million earnings hit this year to reflect the cost of the buyback premium on the Fairfax notes, investors will also likely have to scale back their dividend expectations.
The use of FBD’s own funds to help redeem the bonds has prompted Davy analysts to conclude that the insurer will only pay out 30 per cent of underlying profits to shareholders, compared to the 50 per cent pay-out ratio they had previously expected.
The prospectus document drawn up by FBD to market the new bonds highlights all manner of risks you’d expect. These include: Brexit, with more than half of FBD’s income coming from the agriculture sector; uncertainty over claims costs in a rapidly-evolving legislative and policy environment; and the growing sophistication of insurance fraudsters.
It also notes that there is a risk of the company being unable to retain staff that are key to the business, as competition for such people is “intense”.
The document doesn’t mention the large level of turnover at senior levels in the group in recent years. Of the eight senior managers at FBD, only two, including Muldoon, were in their positions 2½ years ago. While most of the changes are what you’d expect of a distressed organisation being turned around, some of the new hires didn’t lasted long.
The hope is, however, is that FBD’s days of upheaval are behind it.