Fairfax Financial’s Brilliant Deal to Sell First Capital

In a surprise move, Fairfax Financial announced a deal to sell its Singapore division, First Capital, to Japanese insurer Mitsui Sumitomo Insurance Company for $1.6 billion. First Capital is one of Fairfax’s crown jewels and the biggest property/casualty insurer in Singapore. So, why are they selling it?

In a previous article, I discussed how Fairfax Financial’s insurance operations have markedly improved over time and pointed out that for many years now the company has been expanding to build a global enterprise. First Capital was one of those expansions from 2002. Fairfax Financial paid $35 million for its stake in the company. Both its growth and profitability have been incredible ever since. Premium volume has grown from SGD 26 million ($19 million) in 2004 to SGD 210 million ($150 million) in 2016, all while averaging a combined ratio of 73%.

First Capital’s net premiums written, shareholders equity, and combined ratio from 2004-2016.

Fairfax CEO Prem Watsa regularly heaps praise on Ramaswamy Athappan, First Capital’s leader. In Fairfax’s 2008 annual report he said:

“At this time, I must share with you the record of an outstanding manager that we have been fortunate to attract to Fairfax, Mr. Athappan from Singapore. I first met Mr. Athappan about 15 years ago when he was managing a P&C company called India International. Mr. Athappan took over managing India International, an Indian Government owned company, in 1988 with approximately SGD14 million in shareholders’ equity. Until he joined us in 2006, Mr. Athappan grew that SGD14 million to SGD238 million – with no new capital and having paid SGD28 million in dividends to his shareholder. During this time period, India International had an average combined ratio of less than 90%, almost never had a combined ratio in excess of 100%, and always practised excellent reserving. About 13 years
ago, when real estate prices were very high, Mr. Athappan sold his house and rented, even though the house was owned by the company!! Mr. Athappan is an outstanding investor and is intuitively value oriented. Since he began managing First Capital in 2002, shareholders’ equity has increased from SGD58 million to SGD188 million and the company has made an underwriting profit every year with excellent reserving. With regard to 2007, by which time net premiums written had risen from SGD14 million to SGD90 million, First Capital was ranked fourth in premiums written in Singapore but first in underwriting profit. This is our goal for all our companies – to be first in underwriting profit, not in premiums written. You can see why we are excited about Fairfax Asia’s prospects as Mr. Athappan puts
his stamp on all our Asian operations!”

Fairfax’s pre-tax return on its First Capital investment is close to 29% compounded annually. Mitsui is paying more than three times book value for the insurer and twenty-two times last years’ earnings. The $900 million after-tax profit for Fairfax amounts to $33 per share, which will presumably also increase book value from its current $378 per share to $411 per share.

Mitsui is the largest Japanese property and casualty insurer, owning about a third of the market by writing about $3 billion worth of net premiums each year. Integrated with the larger Mitsui, it’s possible that First Capital could gain efficiency and reduce its expense ratio somewhat. The increased capacity may also mean that First Capital’s business will expand faster. Fairfax will also continue to participate in 25% of First Capital’s business through a treaty share arrangement – the functional equivalent of maintaining 25% ownership in First Capital.

“If First Capital writes $100 million worth of business, we’ll take a quota share of 25 per cent, which will be $25 million and that $25 million will be going into one of our companies,” Watsa explained. “You’ll get 25 per cent of the earnings and you’ll get 25 per cent of the growth, that made it a very unusual and attractive transaction.”

Coincident to the transaction, Fairfax and Mitsui are partnering to write certain lines of insurance on Mitsui’s entire book. That would give Fairfax access to markets it has not already entered, most notably Japan.

Finally, the best part of the arrangement may be that Athappan will continue running Fairfax’s Asian operations.

So, Fairfax was able to lock in an enormous profit on a long-term investment, maintain access to the assets future upside, expand its geographical footprint, and not lose one of their best managers. That is not a bad days work.

Fairfax shares are currently trading at $508 per share, a 24% premium to book value.

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