How Prem Watsa Built the "Berkshire Hathaway Of Canada" | The Fairfax Way w/ Kyle Grieve (TIP783)

Summary

Kyle Grieve breaks down how Prem Watsa and Fairfax Financial compounded for decades through disciplined value investing, …

Transcript

So, why has Fairfax been so successful despite having no obvious competitive advantages? Watson wrote, "The actual business of insurance is not that differentiated. What differentiates us is culture." And when you break down culture, he would guide you to some specific qualities such as trust, fairness, humility, and long-term thinking. These areas of its culture are its moat, and they are very, very hard to replicate. >> [music] >> Hey, real quick before we jump into today's episode. If you've been enjoying the show, please hit that subscribe button. It's totally free, helps out the channel a ton, and ensures that you won't miss any future episodes. Thanks a bunch. We're going to discuss a highly underrated insurance-like conglomerate and it's outsider type CEO. Don't worry, it's not Birkshire Hathway. It's a lot more unknown. The company is Fairfax Financial Holdings and the CEO is Prem Watza. So Prem Watza today I think is an investing legend. He's often cited as Canada's Warren Buffett and it's easy to see why. Fairfax has compounded at 19% since it IPOed back in March of 1980 which is absolutely spectacular results. Now the reason that Fairfax doesn't get much attention, I think it's pretty simple. The business isn't in AI. It isn't glamorous. It doesn't do anything particularly flashy and is therefore rarely considered a market darling. But Prem Watza is a value investor at heart. And what he's done with Fairfax has clearly worked very, very well for investors. Now, as a quick side note here, I'm going to be citing a lot of information today from this great book that I was sent called The Fairfax Way written by David Thomas. Now, let's begin here with Prem's background. Watson was born in Haidider, India. Prem was fortunate to write the Indian Institute of Technology or IIT exams and was accepted into a chemical engineering program. But once he began studying engineering, he realized something very very profound. And that was that he didn't want to be an engineer. So after graduating as an engineer anyway, just to appease his father, he decided to further his education in other areas that he personally found a little more interesting. So he applied to the Indian Institute of Management, Amedabad. Now after failing to be accepted on his first try, he got in on the second attempt. Prem's father thought that India just didn't really offer too much upside for young people like his son. So he advised Prem to move elsewhere for more opportunities and Canada would be that place and Prem would get his MBA from the Ivy School of Business. Now this would edge him towards investing. But as you can clearly tell, investing wasn't really something that seemed to be an obvious path for the young Premata. When asked about his attitude towards money and wealth when he first came to Canada, Prem replied, "I didn't have one. Nothing. Zero. At first, I didn't know a stock from the hole in the ground. I learned I could do pretty well with investing, so I basically just ran with it. When I arrived in Canada, I was mostly hoping for a good job and to make a good life for my family. I had no conception of building wealth and zero plan to build a big company. Now, the light bulb moment for Prem that really helped him understand better investing was in his second year at Ivy. So, his professor told the class to look at this company called Alcan Aluminum. Now his professor at this time was named Fred Jones and he wanted the students to look at the business through the lens of an analyst and not through the lens of an academic. This concept of analysis really helped develop Watson's love of analyzing specific companies. Now another key lesson that Prem learned from Jones was the importance of delineating between speculation and investing. The average investor approaches stock investing very speculatively. Simply trying to find an investment that other people are going to pay for more at some point in time in the future. Now, Jones, like Benjamin Graham, tried to teach his students the value of a business and how focusing on that end was truly what distinguished an investor from a speculator. Once Prem completed his MBA, he began applying for jobs. Two suitors caught his eye. The first was 3M, which was looking for a financial analyst to work in London. Now, London was intriguing for Prem because his brother lived there and worked there, and the second option was as an investment analyst for Confederation Life in Toronto. He chose the latter because him and his wife thought that Toronto being the largest city in Canada was a great place to be and it would give his wife Nolini many opportunities to work as well. Now, it's interesting how many great investors are born out of the insurance industry. Warren Buffett and Shelby Davis come to mind as people who entered the insurance industry from very different backgrounds. Now, while I've always pushed away from insurance, maybe that's a mistake as there seems to be just so many knowledgeable and very very successful investors who work within the industry. Now, the problem with the insurance industry during Prem's time was just simply a problem of remuneration. Confederation life wasn't offering the highest pay, but it provided something that was intangible and that was incredibly valuable to Prem, and that's an expansive and free education that was subsidized by his employer. A man named John Watson was the vice president and head of investments at Confederation and was a very key influence on Prem. Watson taught Prem about the powers of being a good person, having high standards, and integrity. Watson also introduced Prem to Benjamin Watson by dropping off a copy of Security Analysis by Benjamin Graham and David Dodd. Prem learned a lot from Graham. The first big lesson from Graham was that reason and rationality were a great winning combination. While of course it didn't guarantee a win, it really just tipped the odds in his favor. He also learned the importance of rigorous research and patience, which he felt would offer better outcomes than being speculative and being in a rush. The book also taught him some simple value investing lessons such as the margin of safety. Prem learned so much from Benjamin Graham that he told his wife that if they ever had a son, he wanted to name him Ben, which he eventually did. Now, Watson ended up staying at Confederation for 9 years, then decided to look for a higher paying job. After getting hired at another investing shop, Watson eventually decided to just start his own company. And this company was called Hamblin Watsa Investment Council or HWIC or I'll probably call it Quick, which he started with his former boss at Confederation Life. Prem headed the equity segment of the business. Quick was doing really well, having been handed several accounts worth north of $50 million. But Watso was something of a hustler and, you know, he was always looking for other deals that he could do. One such deal came onto his desk after his colleague and great investor Francis Chow helped explain how Warren Buffett made so much money. Now, it wasn't just because of the great investments that he made, which most people would say. No, the reason was that he was able to make these investments in the first place because specifically he had this access to an insurance float that he could use to invest. Now, the idea here is simple. You just run a separate business, utilize the float to generate additional returns, and keep enough cash on hand to pay future claims. Seems simple but not easy. Now, his first target was a near bankrupt Canadian trucking insurance owned by Markel. The deal would cost over $5 million. Now, since Watts had been managing money for others for nearly a decade, he was able to secure about $2 million from his network, but the rest was proving very, very difficult to obtain. Markeel ended up accepting the $2 million and extended the remainder of the fee by about 6 months. So, as that 6 months began rolling around, Prem was getting very, very nervous. So one day near the end he was driving down the highway and he pulled over to use the pay phone and contacted his old employer Confederate. So his first mentor Tom Watson was still there and he actually liked the deal that Prem explained to him. To close the deal though he told Watson that he needed some skin in the game. He needed to come up with about 100K. Now Watson raised this money by draining his entire retirement account. In the insurance business Prem looked to two legends of investing to learn on how to run a great company. The first pretty simple Warren Buffett. The influence that Buffett had on Watson was regarding the investing part or you know what to do with the insurance float. Second came Henry Singleton who managed this incredible business called Teladine and created immense value for shareholders. From Singleton, Prem learned how to optimize M&A and utilize buybacks intelligently. Now back to Buffett here. Prem also modeled Buffett's goal in his letters to his partners, which was to provide them with information that he would want to know if the roles were reversed. So, in his first letter, he explicitly laid out how his performance should be judged. He said the average Canadian company earned about a 13% return on equity or ROE, and he thought that he could beat that benchmark by a pretty generous margin, so he settled on 20%. Now, for anyone curious about the ROE equation, it's very simple. It's net income divided by shareholders equity. He said these targets were crucial to put on paper and share because they helped guide him to future decision-m. So here you can really see that Prem really understood incentives and long-term thinking very very well just like Buffett did. Now it's not easy to go the route that he took because it's a very challenging goal that he created for himself. And since Prem was a very honest and transparent person, there was just no hiding from this goal if things didn't work out as he set out to. And in the insurance industry, which is notoriously cyclical, it becomes nearly impossible to beat that goal every single year. Now, another vital point that Watson made clear to his shareholders was that the company would never be sold at any price. So, management intended to maintain a strong controlling stake in the business at all times. Management had these specific shares that carried additional voting rights. So he said in the extremely low probability event that the company was sold, all these shares, even the shares that had significantly more voting rights would be treated equally between the shareholders of the ordinary shares and the more technically valuable ones. Now I'd always wondered why Fairfax got its name Fairfax. It's kind of a strange word. So I was really pleased that David Thomas, the author of the Fairfax way, helped uh explain it. So the fair part comes from the expectations that the business will treat its customers and employees fairly as well as the management and employees of potential acquisition targets. The second F simply stood for friendly. Wata doesn't believe in hostile takeovers. So he made sure that that was part of the company's DNA via its name and the AX is just simply an ode to acquisitions. Since Fairfax is an inquisitive company, it made sense to have that as part of the business highlighted in the name. Now, it's crucial to understand that Fairfax today is increasingly leaning towards the Birkshire model. Yes, its core is definitely still insurance, but it's branched out to avoid significant earnings volatility that's very inherent to the insurance industry. And we'll go over this evolution some more as the story unfolds here. But during the first years at Fairfax, they were laser focused on just adding more and more insurance companies to increase the size of their float, which they could then invest. Also, in Fairfax's early days, they would do a lot of these joint ventures with Markeel. Now, why was it that Wata loved insurance companies outside of just the float? So, there are a couple reasons. First, simple. They were cheap. Often, he could get them selling far far below intrinsic value. And since he viewed Graham in reverential terms, it was very, very logical to buy these heavily undervalued businesses. So, for the first 3 years of Fairfax's existence, they were absolutely crushing their ROE KPI. They had an ROE of 26% versus their benchmark ROE of 11% for the first 3 years. But as I mentioned, insurance is very, very hard work and it's cyclical. That's just the way it is. So, one of their businesses, Mortyn and Hellwig, wasn't doing very well. Watson labeled their performance simply as a disappointment. Another insurance company was consolidated in to Mortyn and Hellwig, and he told shareholders that he expected improved profitability from the operations. But by 2004, Watson was no longer able to cheer that company on and admitted to shareholders that the company's stewardship had just been unsuccessful. Now, part of the reason for this loss was just simply the quality of the business. In Fairfax's early days, they weren't flushed with cash. And Prem being allin on these kind of value plays was looking for extremely cheap companies. And once you invest for a little while, you realize that cheap businesses are rarely worth it because they just lack those special qualities that really make ownership just feel like a breeze. The problem with M&H was that it required Fairfax to put money into this company once it appeared to turn a corner, which it never actually did. So, they ended up putting about $28 per share into the business, which actually never provided ample profits for shareholders. So, another deal from 1989 illustrates an interesting attribute of Fairfax and its M&A approach. So, Federated Insurance Holdings of Canada was a property and casualty PNC insurer with farming and commercial accounts. The business's chairman, Chuck Buxon, had grown tired of translating financials into French for Canadian regulators. Once they spoke, Watson named the price that he was willing to pay for the business. Chuck accepted, knowing that Fairfax only had about 8 million in cash on the $28 million price tag that Prem had quoted. So, they ended up getting the money. Then, they use these two $10 million notes, which they could pay off with future cash flows from the acquisition. Fairfax, very interesting, just doesn't walk away from deals after they've been finalized. nor will they alter agreed upon terms, a fact they're very, very proud of. So, another lesson in culture was learned by Fairfax when it wanted to acquire this business called Commonwealth Insurance, which is another Canadian-based insurer. So, the problem with this deal was that Markeel was just not interested in making it. Markeel originally planned to sell to Wata to exit the Canadian markets, but their founder, Steve Markel, was very, very much enjoying the deals that he was making with Prem. But unfortunately, the time finally came when it was time to part ways. Now, what was the main reason for this? It was simply that Fairfax and Markeel, while they shared many cultural similarities, there were still just enough differences between them that it just made the most amount of sense to separate. The most significant barrier in culture was the way that each company exercise control. So, Markeel was great at controlling its businesses in a more centralized manner, and they've done wonderful things with that strategy. So, you know, nothing wrong with it. But Prem wanted to go to a more decentralized route, which didn't really mix well, unfortunately, with what Markeel was trying to do. So, they separated a few of the insurance companies with some going to Markeel and others going to Fairfax. Now, with the proceeds from that split, Fairfax purchased Commonwealth for $58 million, which was about $10 million below book value. Now, the early 1990s turned out to be pretty tough for Fairfax's operating businesses. While Fairfax booked profits of $23 million that year, all of it came from the sale of assets to Markeel. the underlying companies just didn't have a good year and the stock ended up falling by about 40%. Now, while this isn't the most fun thing for a CEO to see, there's obviously a silver lining. So, I already mentioned that Wata considered Henry Singleton as one of his biggest influences. And part of what made Singleton just so good was that he knew how to use shares of his businesses as currency to add value and when to use cash from his company to buy back stock. So, with prices down 40% and cash in a pretty good place, Watts ended up purchasing 25% of the outstanding shares of his float. Now, I absolutely love this. One thing that really irks me is seeing a business have its share price pounded and be in a very, very secure financial position when you look at its balance sheet. If you have a lot of spare cash lying around and nothing to do with it, you're really just losing that money to inflation by keeping it in a bank account. Why not buy shares in your company when the shares are undervalued? Far too often I see companies announce that they have board approval for buybacks and then they just buy back a negligible amount of stock. Why not buy back enough stock to significantly impact your company's per share value? There were two micro caps this year that I sold where this lack of decisiveness really helped me sell my own shares. So they both had very prominent cash positions, very steady business models that continued to add more and more cash to the balance sheet and probably most importantly very very minimal M&A experience. So, the fact that they refused to buy their own stock despite it being just incredibly obvious that the shares were cheap was very, very frustrating. Now, I wouldn't advocate for using all the cash on your balance sheet for buybacks. You need to obviously make sure that you have enough money to stay safe. But if you know your businesses well, which I assume the CEOs of the businesses that I invest in do, then they should know that there is a significant amount of cash that can and should be deployed into buying back their own stock. Now, like with many public businesses, Fairfax went through cycles of being both loved and hated by the market. And leading up to the tech bubble, the company was getting all sorts of love from the market. But as we know from understanding cycles, what goes up eventually comes down. And in Fairfax's case, their temporary downfall didn't come purely from their operating businesses beginning to kind of fizzle out, but from short sellers. Interestingly, the shorts on Fairfax didn't just attack them in a single year, then back off. This was a multi-year campaign that really, really tested Watson and Fairfax. The timing of this short makes some sense when you consider what was happening to Fairfax. The insurance markets were soft. The tech bubble had just popped, causing a massive market crash. There were several large catastrophes. Fairfax had to restate their accounts and hedge funds were obviously looking for blood. So, let's start here by looking at Prem's shareholder letter in 1999. At this point, Fairfax stock had decreased precipitously. Watsa, who rarely discussed stock prices in his letters, decided to break precedent due to this specific event. And he made his point very, very clear. Fairfax was willing to accept short-term volatility in its earnings, which would of course impact its share price as long as it was in the best interest of the long-term results of the business. And even during this period, when earnings weren't strong, he reminded investors that book value was continuing to grow and that the share price would track that KPI over longer periods of time. But, you know, he also wasn't trying to deflect blame at that time. He took full responsibility in 1999 with the net income dropping about 68% which created about a 55% drop in the stock price in just one year. He told investors that the year was a disaster for almost all of our underwriting operations. There's no other words for it. I'm embarrassed by these results and I apologize for them. So, 1999 was a very horrible year. One of my most hated reasons for poor businesses is blaming it on the weather. But in this case, Prem probably could have done it and chose not to. So the average year for Fairfax was about two catastrophic events. And in 1999, they had 10, which siphoned off hundreds of millions of dollars of potential profits. And 2000 wasn't any better. In 2001, book value dropped an additional 12% and the shares slid another 28% down. Now, all this combined to really harm shareholder loyalty that had been very, very strong leading up to the end of the 1990s. Watson noted that Canadians have a long memory for stocks that harm them given just how small the market is. And if you owned Fairfax after 1999, for the next few years, you probably didn't have a very, very good experience. So, here's where Wall Street started getting involved. Since Fairfax had very large operations in the US, they decided to list their shares on the New York Stock Exchange, which of course would massively increase its exposure to US investors. After the stock listed on the New York Stock Exchange with very little fanfare, an analyst named John Gwyn published a research report claiming that Fairfax had inadequate amounts of reserves and a mounting level of debt. Now, keep in mind that nobody at Fairfax had actually ever heard of this guy before. So, the DD that he was doing must have come from far less reliable sources. Gwyn would go on to write another 60 plus research reports on Fairfax over the coming years. Now, this negative report had hedge fund managers circling Fairfax like sharks, identifying blood and looking to short the business. Investors like Steve Cohen, Jim Chenos, and Dan Loe all started generating interest in potentially shorting this uh company. Chainos thought that Fairfax was a zero and he wanted to take the ride down. But as with many shorts, short sellers often go out of their way to just sabotage businesses that don't deserve it. Now, don't get me wrong, some businesses deserve to be shorted, but Fairfax just clearly wasn't one of them. Here's an excerpt from the book, The Divide: American Injustice in the Age of the Wealth Gap. The Fairfax fiasco was a tale of harassment on a grand scale in which the cream of America's corporate culture followed executives, burgled information from private bank accounts, researched the Canadian sexual preferences for blackmail purposes, broke into hotel rooms, and left threatening messages, prank called a stricken woman in the middle of the night, and even harassed the pastor of a state Anglican church where the Canadian CEO worshiped on Sundays. They worked tirelessly to scare away investors and convince rating agencies to just denounce the firm and in general spread so many lies and false rumors to so many people using so many different false names that they actually needed a spreadsheet to keep track of all of their aliases. Gwyn was eventually fired for sharing his reports with hedge funds before he released them to the public. Gwyn focused on deficiencies in reserves, goodwill, shareholder equity, tax obligations, revenue shortfalls, reinsurance, recoveries, and other issues. But in reality, Gwyn just didn't understand the company very well, and he overlooked the fact that it had very wide ranging abilities to generate profits. Now, with all the negativity surrounding Fairfax, they just decided to fight back. They hired legal counsel to help write the ship. Now, a few clear lessons were learned at this time. The first was that having no relationship with the press actually harmed Fairfax more than it helped it. In this case, the press was all negative simply because they had no allies to give their side of the story. Another interesting tidbit from this story was just how level-headed Wata was at this time. His wife actually said that he was still just sleeping like a baby. This showed his ability to deal with the truth because if I were in his position, I don't think I would necessarily be sleeping like a baby. For instance, his wife was accosted by random people who questioned her and left packages insinuating that Wata was engaged in fraud. They'd leave strange voice messages, leave random books in his hotel, surveiled his house, and even Watts's assistant was harassed. So, as part of their strategy to fight back, Fairfax launched a claim seeking about $6 billion in damages. Now, as part of their suit, they laid out details for the false accusations against them in extreme detail. As a result, the shorts all just died off, having lost money because buyers began coming back into the business. So, one area of the company that Fairfax management thought could have protected it against this type of short attack was to have a fortress balance sheet. David Thomas writes, "Today, Fairfax has annual operating earnings of around 4 billion and also keeps a rainy day cash of about 2.5 billion on hand, plus a few billion in untapped lines of credit. It also has a long record of reserve redundancies. the hedge funds never would have taken a run at them with that kind of strength. Now, I mentioned earlier that his wife noticed that he was sleeping like a baby, but it wasn't just his wife who noticed that he was very, very calm under all of this pressure. One of Fairfax's senior executives recalls seeing Prem go into the office and could never actually tell that there was anything wrong. And Prem really used the whole short situation as a lesson, not as some sort of horrible event that would spiral out of control and destroy his company. Another potential lesson was that they just shouldn't be listed in the US anymore. And so in 2009, they delisted from the New York Stock Exchange. Now, just like the hedge funds shorted Fairfax, Fairfax itself wasn't actually afraid to use shorts in their own investing portfolio. Everyone listening has probably heard of Michael Bur for his famous short during the great financial crisis, which was outlined in the big short, but his outcome was actually only a quarter as profitable as Fairfax's. Now, to make sense of this, we need some context. So, first of all, Fairfax didn't actually view its investment into collateralized debt swaps, which I'll just refer to here as CDS, as a macro trade. It was simply a catastrophe insurance on the financial system. Fairfax was obviously an insurance company, and it had to protect itself against rare disasters. Now, owning insurance via the CDS was a way to survive a disaster that they thought was becoming increasingly more likely. Now, since many of Fairfax's reinsurers had invested in these mortgage back securities, it was vital that if these mortgage back securities went south, which Fairfax thought they would, Fairfax could be protected because if their own reinsurers owned a lot of these derivatives that would eventually lose a lot of money, Fairfax needed a way to protect itself. So, they began buying CDS's on AIG, Swiss Ree, and Munichree. The problem was that they started repurchasing them in 2003 and the GFC still had a few more years until things really started to break down. Now, before we continue the story, let's briefly cover what a CDS is. So, a CDS is basically cheap insurance on a company's failure. If nothing happens, you just lose a little bit. It's just like paying an insurance premium. But if things go badly, you stand to gain a ton. So, since they had these CDS's since 2003, investors were kind of viewing them as cost that was unnecessary. And in some ways, it's true. You know, it was insurance against the credit markets that really could just destroy Fairfax's balance sheet. Fairfax would have to continually dish out money for these CDS's when nothing really bad was happening for a time. This action generated criticism from shareholders and analysts who didn't understand why they were increasing these CDS's over time. Now, between 2003 and 2006, Fairfax lost $500 million on these investments. But during this time, they were seeing that the asset that their reinsurers had just weren't durable. So, while Wata had to endure these years of losses, he knew he had to keep them on as long as his reinsurers were at risk. And it was the right call as they made $4.6 billion in 2007208 as a result of these investments. So, Premata and Fairfax learned many valuable lessons from this period. First, the protection that they had purchased generated more than purely economic profits. It also bought them time, credibility, and optionality that very few other firms had the luxury of. When the great financial crisis hit, Fairfax was not a force seller. They had billions in capital when nobody had any, and they could calmly deploy capital into the best possible opportunities rather than worrying about staying solvent. Second, they learned that systemic risk is highly correlated, and this correlation can happen when the majority least expect it. Under Fairfax's modeling, they understood that the asset prices were likely to fall together. As a result, counterparties would also unfortunately fail together. And as these events happened, insurance claims would spike. So the CDS's were protection against this correlated failure and not just from a single asset class. Third, during the great financial crisis, even though Fairfax came out looking much better than nearly everybody else, it showed that risk must be monitored at all times. Fairfax actually became even more conservative after the great financial crisis. They use this time to maintain liquidity and protect their downside. I think the big lesson here for investors and business owners isn't that we should focus necessarily on making money from a crash. It's that we should focus on investing in businesses or building businesses that can't die when one inevitably comes because that's a lesson investors will only learn once if they're lucky. Now, I just spoke here about the key lessons that Prem and Fairfax learned after the great financial crisis. And as you'll see in the period immediately following the GFC, they really took these lessons to heart, perhaps even to their own detriment. So Fairfax continued to hedge equities as another form of insurance after the great financial crisis. The problem with this was that this time there was just no event like the great financial crisis on the horizon. And as a result between 2010 and 2016, the insurance hedges wiped out 100% of operating income. During this period, the company's investment portfolio returned negative 7% while the S&P returned nearly 15%. Wasa admitted that this strategy was done for protection, but that the protection was just getting too costly. One of the main drags on this was from shorting the S&P 500 and Russell 2000 indexes. After losing $2 billion on the strategy, Prem concluded that they would no longer short, which I think is a great strategy. Prem felt that shorting got away from Fairfax's wheelhouse of value investing, which is just, you know, finding good businesses at great prices. So his first investment following this maxim was a private insurance business called Zenith National Insurance which ensured workers compensation. But since Wata is a value investor, the company did not come wrapped up very perfectly. It obviously had some hair on it. For instance, it had been hit very very hard by the floods after the great financial crisis and was working on turning its business around from that despite having this incredible 30-year track record of an average combined ratio of just 95%. During the first year of ownership, Zenith's combined ratio was an uncharacteristic 137% and it lost $24 million. But Fairfax was actually correct about the quality of the business. Although it took about 3 years for the combined ratio to drop below 100% which it has stayed ever since. The post GFC period was also when they began diversifying their operating businesses beyond just insurance. For instance, they bought businesses such as funeral homes, retailers, golf, and sporting good retailers, and assembled a portfolio of successful food chains. The food chains were eventually spun out into an IPO as Recipe Unlimited, which was ultimately taken private once again by Fairfax. Now, I mentioned here that Fairfax had mainly been playing defense during that 2010 2016 period. But since 2017, Fairfax has really gone back on the offensive. First, in 2017, the entirety of Fairfax showed that it was starting to kind of turn a corner. Even though there was a catastrophic event which ate about 1.3 billion, Fairfax still achieved a new all-time high in profits. And even if we fast forward to CO, which theoretically should have been a very bad year for insurers, Fairfax still did well. In 2020, CO hit Fairfax for about $670 million, yet again, they had record profits. So, the business had clearly evolved and was still able to return a profit despite the presence of these super cats. But let's stick with 2017 for now because that was the year that Fairfax made its largest acquisition to date. This was an insurance business called Allied World and its price was $5 billion. Fairfax was clearly continuing to run up the ladder of quality businesses. Allied World was founded in 2001 and had an average combined ratio of just 91%. Now, given the business's insurance operations were clearly very well-run, what exactly did Fairfax see in the company? The float. Allied World's investment track record yielded only about 4% returns. And if those returns were then transformed through better investing that Fairfax could clearly offer, their average performance would have been far superior 7% and Alli's actual returns would have been 20% rather than 12%. So taking a page from Henry Singleton, this deal was financed by equity issuance. The problem was Fairfax's shares weren't trading nearly as expensive as Watson would have liked. So Fairfax shares were only trading at about a 6% premium to book value and they used them while purchasing Allied World at an actually 32% premium to book value. Since the deal was large, it increased Fairfax's shares outstanding by nearly 25%. But it was still worth it as it boosted premiums written, the investment portfolio, and the book value at a much higher rate than the dilution would suggest. So, what was even more important to this deal was Prem's negotiations. I've mentioned many times on the show that the best M&A should be a win-win for the buyer and the seller, and Prem designed the deal that way. Using Fairfax's decentralized structure, he told Alli's management that he wanted them to stay and keep their employees because they were just doing such a good job. So there wasn't really this kind of fear among Allied owners that they'd have to fire a large percentage of their workforce after the merger was completed, which is a huge bonus for sellers who really care about their workforce. And another beautiful part of Allied World was its organic growth. Between 2017 when it was purchased and 2024, its gross premiums written more than doubled, demonstrating very very strong organic growth. Now let's get to CO here. So the unfortunate strategy that many businesses were forced to adopt during COVID to reduce expenses was just to unfortunately fire large parts of their workforce. But as you can probably guess, Fairfax did not subscribe to that. WASA said we have a responsibility for looking after employees and I must say with much gratitude to our presidents, we met it. The other problem during CO was that many companies were stress tested as the world shut down. But the strategy that Fairfax took of bolstering its balance sheet really, really paid off here. Most of its emergency funds didn't even need to be touched. They had cash and marketable securities worth about $2 billion, no debt maturities until 2022, and an unused credit line of $2 billion. So, while of course this was a tough time for Fairfax, they came out very, very strong, showing how crucial its strategic shift on the balance sheet form really, really was. Another winning investment Fairfax made was what Davis Thomas called the big long. Now, this wasn't one investment, but a series of value adding investments that allowed Fairfax to really just cannibalize itself. The base investment was simple, buyback shares. But Fairfax came up with some very interesting ways to help raise funds to do buybacks on steroids. To show confidence in the business and its low price, Wata backed up the truck in 2020, personally purchasing $150 million worth of shares. But this investment by Watsa didn't actually have the effect he was hoping for in the short term as sentiment just didn't really change that much. But as I think I made abundantly clear, Watson is a very long-term thinker. So in 2024, he ended up selling about half of the shares that he bought back to Fairfax for cancellation purposes. So he originally purchased the shares at about $400 per share and ended up selling them at $1,500. Now, this worked for all parties because even at that higher price, Fairfax only buys back shares when they're trading at a discount. So both Prem and the shareholders made out well from this deal. Next, they invested in these things called total return swaps or TRS's, which are this form of derivative. The TRS allows a buyer, in this case Fairfax, to access the upside of its stock, but it doesn't actually own the shares. It just gets the right to extend the trade if it chooses to do so. The $700 million investment in 2020 returned about $2 billion in 2024. Another strategy to buy back even more shares was to just sell parts of the business. Fairfax ended up selling off about 10% of its crown jewel, Odyssey Group, to raise cash for buybacks. Now, here's where it gets interesting. So, this 10% stake was sold to two Canadian pension funds, which provided Fairfax with a billion dollars to buy back its own shares. But the important part is seeing the details here. So, they sold that 10% in Odyssey at 1.7 times book value to buy shares at Fairfax at only 0.9 book value. Now, the final area of growth I'd like to mention here was simply on international investments. an area of investing that I find fascinating and take part in. By 2019, Fairfax had insurance companies all over the world with exposure in Eastern Europe, Latin America, South Africa, Asia, Ukraine, Vietnam, Greece and India. But they also started buying up operating companies internationally and some of them grew into these very huge and successful companies. So in India, they own a stake in Bengalaru airport which is controlled by Fairfax India. They own Digit, an online insurance company, and Quest, a staffing and workforce solutions provider. Outside of India, they have Key Financial, a specialty insurance company based in the UK. Eurobank, one of Greece's largest banks, Kennedy Wilson Partnerships, a global real estate platform. The list goes on. They also own businesses in other industries such as seal production, energy, and shipping. So Watts is someone who very clearly thinks about intrinsic value not just as a valuation tool but as a guiding light for capital allocation decisions in mergers and acquisitions, organic growth and share purchases. What Watson understands just as well as Warren Buffett is value. And because of that he has on several occasions tried to keep investor sentiment positive when the intrinsic value was up but the share price was down. So let's go over some of the thinking concepts that Watsa leans on while running Fairfax. The first is one that all value investors are going to be very familiar with, which is the margin of safety. Now, early in Watts's career, he focused on this with laser-like precision. But as he gained more experience, he realized that intrinsic value wasn't exclusively found on a company's balance sheet. Intangible assets located inside the people running the business were even more critical than the tangible capital that many businesses have. For this reason, Watsa placed a greater importance on a company's management quality than on a low price, even when the value of its intangible assets could be very low or even negative. One of Watson's influences on management was the legendary investor Philip Cray. Wata added a Kare quote in a few of his letters. Good management is rare at best. It is difficult to appraise and is undoubtedly the single most important factor in security analysis. Find the company whose boss is heart and soul dedicated to profitable operations and even more interested in the profits of 5 years hence than those of today. If he has sound business judgment, skill in selecting the other members of the team and the rare ability to inspire them to superior performances as well, the company's stock is worth investigating. There is no substitute for buying quality assets and allowing them to compound over the long term. Patience can produce uncommon profits. The following key that Wata focused on was time. As Kare mentioned, you want businesses that get better over time. And to accomplish that, you must have patience. If you want to understand the power of compounders and time better, please check out my episode on the book The Compounders on TIP72, which I'll link to in the show notes. But the general gist is that good businesses that compound and reinvest profits become just so much more valuable over time. Often more valuable than the market gives them credit for. Are you looking to connect with highquality people in the value investing world? Beyond hosting this podcast, I also help run our tip mastermind community, a private group designed for serious investors. Inside, you'll meet vetted members who are entrepreneurs, private investors, and asset managers. People who understand your journey and can help you grow. Each week, we host live calls where members share insights, strategies, and experiences. Our members are often surprised to learn that our community is not just about finding the next stockp, but also sharing lessons on how to live a good life. We certainly do not have all the answers, but many members have likely faced similar challenges to yours. And our community does not just live online. Each year, we gather in Omaha and New York City, giving you the chance to build deeper, more meaningful relationships in person. One member told me that being a part of this group has helped him not just as an investor, but as a person looking for a thoughtful approach to balancing wealth and happiness. We're capping the group at 150 members, and we're looking to fill just five spots this month. So, if this sounds interesting to you, you can learn more and sign up for the weight list at thevesspodcast.com/mastermind. That's thespodcast.com/mastermind. or feel free to email me directly at claytheinvespodcast.com. If you enjoy excellent breakdowns on individual stocks, then you need to check out the intrinsic value podcast hosted by Shaun Ali and Daniel Mona. Each week, Shawn and Daniel do in-depth analysis on a company's business model and competitive advantages. And in real time, they build out the intrinsic value portfolio for you to follow along as they search for value in the market. So far, they've done analysis on great businesses like John Deere, Ulta Beauty, AutoZone, and Airbnb. And I recommend starting with the episode on Nintendo, the global powerhouse in gaming. It's rare to find a show that consistently publishes highquality, comprehensive deep dives that cover all of the aspects of a business from an investment perspective. Go follow the intrinsic value podcast on your favorite podcasting app and discover the next stock to add to your portfolio or watch list. To focus on the long term, Watson knew that he had to fight the inner battle against short- termism. Wata regularly focuses on the intrinsic value of Fairfax, which has risen very, very steadily over time despite a volatile share price. If you look at a chart of Fairfax's book value per share and its share price, it's eerily similar. Another hallmark of great businesses is the long-term use of value producing KPIs to evaluate management. Warren Buffett used book value per share for Birkshire. Fairfax has gone through two kind of primary KPIs, but with very good reason. So when the business was in its early days, they focus on return on equity and set the benchmark at 20%. As the company scaled, they were forced to reduce that number to 15%. And as of late, they've actually just ended up following Buffett's footsteps and focus more and more on book value per share. Since good management teams want to be held accountable, it also needs goals and targets. Watts has four guiding principles in which he feels that he should be evaluated. One, compound book value per share at 15%. Two, focus on the long-term increase in book value and not on short-term earnings. Three, remain soundly financed. And four, provide complete disclosures to shareholders on an annual basis. He also believes that management should never take advantage of shareholders via superior voting shares. So the plan in Fairfax was that existing management should always maintain control of the business. For that reason, they had multiple voting shares, some of which carried more votes than others. In some businesses, managers would sell these shares at a premium to the price of the ordinary shares, which Wata felt was very unfair. Watson cited a case study in which a business called Ashawa Group was bought out and that a disproportionate share of the sale price went to holders of the multiple voting stock rather than the subordinated shareholders. The value per share was $116 compared with only $36. Another abuse that management can do is take very large salaries. It shouldn't come as any surprise that Watson currently has a fixed salary of $600,000 with zero bonuses. Most of his income comes from his holdings in Fairfax stock, which pays him now about $19 million in dividends per year. Now, when it comes to M&A, Fairfax has a very particular set of rules that it lives by. The acquisition credo follows four principles. Number one, buy companies with good management in place already. Number two, only by companies that can hit a target of performance. Number three, companies will be run independently and performance will be measured against the same target. And number four, Fairfax stock is as good as cash when the stock is issued. Fairfax will be sure to get as much value as it gives. Now, as their name implies, M&A will always be fair and friendly. So, they have never had to take part in a hostile takeover. And since they have this value investing background, they also refuse to participate in any auctions. So once they make an offer, it's simply take it or leave it. This is a brilliant strategy because once you get into bidding wars, you only really win the deal by losing out and accepting the lowest possible returns. Now, I really like the types of M&A deals that were outlined in this book. So he had a few different kind of buckets that he put them in. So the first were startup place. Fairfax, of course, isn't really known for engaging too much in venture capital, but it actually has been a relatively early investor in a few companies and created a few spin-offs. The next are turnarounds. Blackberry as an example. But to be fair, the results have been kind of mixed on this with a few failures and a few successes. Then you get into commodity plays. Fairfax partnered with Wilbur Ross in International Coal, which has been very successful. Stelco was also a great success that recently sold for $2.5 billion and doubled Fairfax's initial investment. Another is asset management and infrastructure, real estate and private equity where they've dabbled a little bit but it doesn't make up a significant share. And the final one that I find really interesting is the cannibal buyup. So this is simply buying pieces of businesses that they already own but don't own 100% of. For instance, if they couldn't afford maybe the full purchase price of an insurance business, they might have searched for a partner to help cover the remaining costs and once they're in a better financial position, they simply just buy out the partner. This has happened on Allied World, Eurolife, and Singapore Reinsurance. Now, if you could listen to my episode on what I learned in 2025, one of the central learnings I had was with the importance of culture. The main point being that culture is upstream of fundamentals. If you can find an incredible culture reasonably early, then you're looking at a business that is being underappreciated by the market. And this book is really a manifesto of Fairfax's incredible culture, which has all the ingredients for a business that will succeed for a long time to come. The interesting thing about Fairfax is that as a business, it doesn't have one specific crown jewel that carries the entire company. Insurance itself isn't an inherently mody business. I did a quick search and while no concrete numbers exist, the range of insurance businesses worldwide is massive. So, I'm getting numbers between 7,000 and 1.9 million worldwide. So if you own an insurance business, you're likely to have multiple competitors. So why has Fairfax been so successful despite having no obvious competitive advantages? Watson wrote, "The actual business of insurance is not that differentiated. What differentiates us is culture." And when you break down culture, he would guide you to some specific qualities such as trust, fairness, humility, and long-term thinking. These areas of its culture are its moat, and they are very, very hard to replicate. So, let's go over culture in some more detail. Trust is absolutely vital to Fairfax for a few reasons. First, Fairfax is well known for its strong relationships with business partners, which it has cultivated over time, and it really just starts with treating people well. Just because business is a cut-throat industry does not mean you have to be a horrible person to succeed. Watson says that being kind to everyone he interacts with has had two major bonuses over his entire career as a CEO. The first one is that it creates outperformers inside of Fairfax. And second, people outside of your company have a higher degree of trust in you rather than in others. Now, putting the analyst cap on here, if you're looking at a business and trying to find the trust that's outlined here by Fairfax, it's pretty difficult to really see it. You know, there's nothing tangible out there for you to look at. But there are some raw data points that you can use as well. For instance, a great culture leaves some clues that any investor can really find. The first is that a good culture will generally have good economic performance. That's very obvious given how Fairfax's book value per share has grown over the years. Second comes employee turnover. That number being low is a very powerful sign that people enjoy working there, are being well compensated, and are generating shareholder value. Fairfax measures its retention in decades, not years, which tells you a lot of what you need to know. The problem with culture is that it can change as a company scales. When Fairfax was young, their strong culture was evident. They worked incredibly hard and they stayed out of the limelight. But today, Fairfax employs 57,000 people. So, getting that many people to buy into a single culture is just not that easy. The way Fairfax has gotten around that issue is by integrating companies that already have strong cultures and are very intentional about how they built their own cultures. This just kind of goes back to trust, right? There was a study cited in the book that showed kind of the biggest reasons that people leave a company. And the top reason was actually not being treated with respect or dignity. The second was being prevented from making an impact on the organization. Third, not being listened to. And fourth, not being rewarded with more responsibility. When you have management teams that you can trust and know that are aligned culturally, you can just trust them to do the right thing, which often has been the case during Fairfax's existence. Another way Fairfax builds trust is by attracting the right talent. They always hire from within. So employees know that if they outperform, there's a very good chance that they're going to be fasttracked to a higher position rather than having someone from the outside being brought in. This also helps keep morale very very high. There was a fascinating person that Watts study to better understand culture and that person is Mike Abershoff, a former US Navy captain. So Abershoff studied why people left organizations and found that trust was paramount. So here's what Abershoff said. I assumed that low pay would be the first reason, but in fact it was the fifth. The top reason was not being treated with respect or dignity. The second was being prevented from making an impact on the organization. Third, not being listened to, and fourth, not being rewarded with more responsibility. Abershaw's big statement was that businesses with employees who take ownership of their own decisions will beat the socks off of their competitors. And it's quite clear that Fairfax has taken the statement to heart and tried to engineer a culture that will survive and thrive for many years to come. I want to divert away from culture here and discuss a part of Fairfax's growth that I think many businesses go through. A company I own is called Technon, which my co-host Stig pitched, which I'll share in the show notes. So, it's a business where it CEO Johan Steen has said that many of the early mistakes that he made in the business were from just buying cheap businesses, which turned out to be, you know, lowquality. And Watson came to the same conclusion very early in his career. The problem with buying cheap companies is that there's often a very, very good reason that they're cheap. Sure, the market can completely mispric something, but a lot of time cheap businesses are cheap because they deserve to be. When Fairfax began consolidating insurance companies, they had a good mixture of wins and losses. The commonality in their losses was that they would often buy them cheap, but that cheap price was because the assets tended to be broken and managed by broken managers. Wata was fortunate to find his version of a G Jane in a gentleman named Andy Barnard. So part of Fairfax's competitive advantage was in talented individuals such as Barnard and his protege Brian Young. Barard is now the chairman of the Fairfax Insurance Group while Young is a president. Barard helped Wata to a very high degree in learning which way to steer Fairfax's insurance engine. It was Barard who wanted to lean on reinsurance and commercial lines which now make up over 90% of their insurance book. But Watson needed a talented person like Barner to head these divisions as they are insurance lines that can be very lucrative when properly managed but also have significant downside volatility when not managed properly. So personal insurance like home and auto insurance has outcomes that are based much more on probabilities which also have the added benefit of extensive backup data. This makes outcomes much more easier to predict on a yearly basis but it also gives just kind of lower returns. Commercial lines who are Fairfax focused have much larger premiums but much fewer transactions. So when claims have to be paid, the coverage is very extensive which can make the business a little more dangerous. Now on commercial and reinsurance, you're covering a liability that could be 10 to 15 years into the future which is obviously very very difficult to underwrite for. Since WASA helped create this kind of long-term focus in the management of Fairfax, it also helped its own executives maximize their own learnings from mistakes. Here's what Brian Young said about employees who bounce around too much or leave after a merger is announced. They work somewhere for 4 to 5 years and miss the period where claims finally come in and they end up not learning from what they did to see how to do it better in the future. I spoken a lot about culture here but now let's shift to another key element of successful long-term businesses which is decentralization. So in my episode on the great book the compounders I mentioned that decentralization was evident in all businesses covered in that book. So, it shouldn't come as any surprise to learn that Fairfax is a business that is built on decentralization. The plan for Fairfax as it grew was to deploy excess capital into more opportunities. But once they slowed down on M&A, they wanted to empower management of their insurance companies to grow organically, which when it really comes down to it is yet another capital allocation decision. But to make that strategy work, you need the right people in place who can help carry a business forward. Watza, like one of his heroes, Henry Singleton, believed that success comes from pushing decision-m towards people closer to the customer. When you did this, you shifted responsibility elsewhere and reduce centralization and bloat that centralized businesses experience. The beauty of decentralization is it allows upper management to focus on areas of that business that require their immediate attention. That might include individual business segments that need some attention, how to optimize new acquisitions, whether to pursue M&A, whether shares are priced so that buybacks make sense, or whether, you know, more debt should just be retired. Basically, it allows upper management to focus on what can create the most value for the business and leave a lot of the other very important work, but to people who are just better equipped to make those decisions on their own. Another area of decentralization I think has a wide range of effectiveness concerns synergies. Companies like Berkshire or Fairfax have operated with the focus on completely ignoring synergies and so far it's worked incredibly well for them. Watson believes that pursuing synergies would negatively affect the current business model that Fairfax operates. Watson wants managers of their subsidiaries to feel like they're running their own business unit inside Fairfax even though they do have a parent company. And if you try to achieve synergies, you kind of lose that feeling of individuality for managers. So my thoughts on this is really that it kind of depends. Some businesses that have very little ability to see synergies make sense to run in that fashion, but some businesses are decentralized just to a certain degree where synergies can still create a very very large amount of value. So an example of that is a business that I own called Terabvest Industries. It's decentralized with several different segments and presidents of those segments inside of the business, but it still creates numerous synergies within the business which offer very very big value. So since Tervees can source steel directly from the mills in large quantities rather than through dealers, it can save up to 30% on steel costs. They've also consolidated manufacturing facilities which helped save significant costs by moving two businesses into a single manufacturing facility. They can reduce lead times and carry more inventory. They can insource custom parts for their products which leads to shorter lead times and higher margins. And all of these are really just designed to increase EBIDA for their acquisitions. So even if they purchase an acquisition at say five times EBIDA, once they go in and optimize margins, it's not unusual for that EBIDA multiple to drop by half. Now back to Wata. Since he came to Fairfax from an investor point of view, he looks at his investments in a different light. Many managers are highly familiar with the industry they are in and laser focused on a company's operations. That's all well and great, but the role of the CEO really is multifaceted. They must be an operator, but they're also in charge of allocating capital inside of the company. And this is where many CEOs fail to impress, as it's not really a priority for operators when maybe the business is smaller or when they're in a role with zero capital allocation responsibilities. In Prem's case, it was the opposite. He was a capital allocator above all. He just happened to be a capital allocator in insurance similar to Buffett. Lua Glaciius, the president of Allied, one of Fairfax's insurance subsidiaries, had glowing words regarding decentralization and capital allocation. Allocation is what the Fairfax team is so great at. They figure out buybacks and when to increase ownership stakes, the best ways to do financing and the whole investment side. They don't spend their time managing insurance companies and pretty much leave us to run those assets. And the companies have very clear objectives. Since Fairfax wants to increase its book value by 15% annually, the managers will have a pretty clear idea of what kind of profit objectives need to be achieved. And since different insurance and non- insurance businesses operate in different fields, they're probably going to have different KPIs to help add to shareholder value. These might be things like underwriting profits, overall business performance, contribution to long-term shareholder value, and maybe even some more subjective measures such as leadership, judgment, and adherence to Fairfax's culture. Now, I want to transition here and go over some case studies from Fairfax's history. We'll cover some very interesting acquisitions and examine the best lessons to be gleaned from Fairfax's mistake, which have helped them improve. The first one is some of the early lessons in Markeel financial holdings. The issue that Fairfax had with Markeel was something that I already briefly touched on. Markeel at that time was a smaller company and was much more focused on centralization compared to Fairfax. But Fairfax had to learn this the hard way by making mistakes. And the issue with Markel Financial Holdings was simply that the management in place misread the risks and failed to pull back when market pricing just kind of turned against them. The book has two great lessons that Fairfax learned about insurance. The first is to decentralize. There were just too many managers that were reporting back to Prem Watson in the early days. Instead of dealing with all them individually, he ended up handing off the responsibility to Rick Salsberg, which helped them kind of find this middle ground. The second one was that some companies unfortunately just aren't quick fixes. Markeel took nearly a decade to fix due to the poor underwriting. It require time and energy just to get it right. This was time and energy that could have been used for other more profitable things. The key point is that even if you are decentralized, there must be transparent reporting. The mothership needs to know what's going on and whether or not it needs to, you know, hit the panic button before things spin out of control. Another lesson in decentralization occurred when Fairfax tested in its investments outside of insurance. So, they were part of an investment group that invested in a business called Midland Wallwin, which was in the investment banking industry. Fairfax believed it had the right leader in Tony Urel to run the business, but similar to Markeel, it just didn't have the right cultural fit. Management of Midland Class with Fairfax. And because Fairfax held only a 37% position, it was unable to take a more activist role in getting Midland on board with Fairfax's culture. They also learned that Bay Street tends to be just too short-term focus, which is completely antithetical to Fairfax's business model. They learned pretty quickly that investment banking was not for them and ended up taking up a loss just to exit the business. The third case study on decentralization was fascinating. So there was actually a time that Fairfax had to tinker with centralization and because of this diance into trying centralization out. It helped them become a lot better longterm because they understood the power of being decentralized. So obviously this is a very risky experiment as it could clear a very very significant move away from the core value of decentralization which is highly valuable in a business. So anyways let's just go over what happened. So in 2009 Northbridge was reprivatized and owned by Fairfax. During this time, Fairfax was separated into four decentralized segments. You had Markel Financial Holdings, Lombard Insurance, Commonwealth Insurance, and Federated Insurance Holdings of Canada. The issue was that each of these segments had different market segments, experiences, and cultures. Fairfax wanted to get the subsidiaries a little more aligned, but it just didn't go as well as expected. Andy Barard said the change made it harder for individual business heads to lead and sort out accountabilities. The task of fixing this issue was handed to Sylvia Wright who was promoted to CEO. She decided to bring all four segments together and consolidate them. This was a centralized move. So it was very hard for Wata to accept but it turned out to be the right strategy at that time. This taught Wata and Fairfax that centralization can be necessary to improve your ability to run a decentralized [clears throat] organization. First, it allowed Fairfax's guiding principles to be adopted by all subsidiaries. This then allowed the subsidiaries to gain more freedom to execute in their own way while abiding by the guiding principles. Now I want to transition here to three case studies that helped WASA understand the powerful effects of quality businesses. So this lesson was learned through large amounts of pain that Fairfax had to endure which forced it up the quality curve to help make it into the enduring business that it is today. The first example was with Odyssey Group. So Odyssey began as kind of this mortgage board of broken assets. Many of these assets were purchased when Fairfax shares were expensive and the assets were cheap, allowing Prem to go on an M&A buying spree. The Odyssey Group proved that patience was vital to Fairfax's long-term success. Patience was critical at this time because Fairfax had to wait and see how the insurance assets would perform as part of Odyssey, and the outcome was very good. First, they added two large acquisitions, Scandia America and CTR. This increased the segment's net premiums to $1.4 billion. A few years later, that number increased at 2.5 billion. As the numbers above show, the business started slowly but was able to show strong growth as it improved its insurance book. And even though some of the assets that were rolled into Odyssey were kind of unsalvageable, the parts that were kept proved to be very, very good at creating a ton of value over the long term. The next case study was sort of this melting ice cube situation called Crumb and Forester. So, this was a business that took over a decade and four CEOs to turn around. Between 1998 and 2013, it had an underwriting loss in all but 2 years. The melting ice cube part was that they had to reduce the number of policies they wrote from about 33,000 to 6,000 over just a 3-year period. Luckily, these strategic shifts helped it improve the value of their premiums. It wasn't really until they hired this guy named Mark Addie that the benefits started to acrue. He increased Crumb's premiums from a billion to 5 billion. One of Mark's biggest initiatives was to help build a pet insurance business with incomerum that was eventually sold for $1.4 billion. Another big lesson for Wata here was regarding his preference for doing the right thing. Yes, he could have shuttered these businesses, which would have meant firing a large number of employees, but since he wanted to do the right thing, his focus was on ensuring the assets were performing well with the people that he already had. If management had it had this long-term outlook and focus on doing the right thing, Crumb would never have survived or would be a fraction of the size that it is today. Reflecting on the acquisition of Crumb, Prem admitted that he would never do another acquisition with the problems that Crumb had when they purchased it. Judging by the CEO carousel, you can see how much this experience taught Prem about having the right long-term management in place when making an acquisition. If you're forced to keep finding new people to turn around a bad asset, it's just not worth owning in the first place. This was a lesson on quality that I think Prem really learned. Speaking of quality, let's discuss one more case study on a business called Zenith National Insurance. So, Zenith was part of Fairfax's move to purchase 100% of a business having started as a minority shareholder. This acquisition was interesting because while it was a high quality asset, the fact that it was high quality wasn't really a hidden attribute. And because of that, the purchase price was at a pretty big premium to book value, which was very uncharacteristic for a value investor like Prem. And the timing wasn't the best either. So, Zenith had to retrench about 50% of its premium writing following the great financial crisis. As a result, the combined ratios for the first 3 years were 136%, 128%, and 116%. And this resulted in a cumulative loss of hundreds of million dollars for Fairfax. But, as I think you understand now, Prem is a very long-term thinker. he would have had a very good idea that things were probably going to go south in the short term with brighter days ahead and soon after the combined ratios dropped to 90%. Prem purchased this business above its intrinsic value for a few reasons. First, he thought that Zenith's culture was a great fit with Fairfax. They both believed in treating people well, doing the right thing, and rejecting people with large egos. Prem also figured that once the short-term pain was over, Zenith was well set up for organic growth, which was a great place to put excess capital to work. And the best part of this deal, it all worked out. Zenith is now one of Fairfax's most profitable companies. The final section of this episode will discuss succession as it's an essential part of business. So Prem is only in his 70s and doesn't show any signs of slowing down. But when you have a CEO who's approaching, you know, typical retirement age, you must always make sure that the business is set up to continue to perform well once they leave. Now, because Fairfax is a decentralized company, there could theoretically be corporate raiders that are interested in taking an activist position at Fairfax once Prem is gone. Certain back-end operations between the businesses could theoretically be synergized to save costs, which I think probably would have PE licking their lips. But Fairfax has refused to go that way in its history because they think it would damage their culture. So Watson has set up his will to ensure that his shares in Fairfax don't fall into the wrong hands. His holdings will all be maintained by his family. And in the event that shares need to be sold, they must be sold with another one of his executives consent. None of his childrens can take an executive role in the company, but they do have board seats and understand their roles as stewards of shareholder capital. So who might be the next president of Fairfax? The book's author thinks Peter Clark, who has experience in both investing and the insurance sides, would make a great leader of Fairfax. That's all I have for you today. If you'd like to continue this conversation, please follow me on Twitter at irrational Mr. KTS or connect with me on LinkedIn. Simply search for Kyle Grief. I'm always open to feedback, so please feel free to share how I can make this podcast an even better experience for you. Thanks for listening and see you next time. Shareholder value is created when a company earns a return on capital that exceeds its cost of capital. That is all you really need to know to purchase a business that can generate value for shareholders. The problem is that most businesses just struggle to do this. The forces of capitalism erode returns on capital as more fighters enter into the ring. Generally speaking, over a multi-year time period, the cost of capital is exactly where returns of capital are drawn to like a flame to a moth. Only businesses with competitive advantages can stave off competition long enough to generate