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Prem Watsa And His Early Problems With Short Sellers

March 06, 2011 | About:
Josh Zachariah

Josh Zachariah

36 followers
Prem Watsa’s ascent to guru status was not without its bumps. In the mid 2000’s he was the center of much short selling including some done by Jim Chanos. This article and the book “Selling America Short” more thoroughly profile the events surrounding the short selling, but I’ll give a brief synopsis of the events.

The late 90’s was a period awash in rich valuations for the stock market, but it was also a period of “soft pricing” in the reinsurance market. As the name implies the softness relates to a diminished pricing in premiums as insurers jump over each other for business. Watsa’s Fairfax Financial had purchased two struggling businesses in 1997 that would later falter. One of the companies, Crum and Foster, suffered huge losses on claims after the 9/11 attacks. Its combined ratio shot up to 131%, pulling the combined ratio for Fairfax up to 121%.

Conditions eventually improved and the combined ratios dropped for both Crum and Fairfax. But later in 2002 a report was released showing Fairfax did not adequately cover its reserves (which cover future insurance claims). The reserve shortfall was estimated by some short sellers around the order of $3 billion. Fitch would later downgrade Fairfax bonds to junk status and Fairfax would retaliate by barring Fitch from analyst briefings. Another red flag pointed to the asset “recoverable from reinsurers” which ranked 2 in size on Fairfax’s balance sheet. The recoverables were 28% of all assets and this figure was much higher than the industry average.

Fairfax was shorted by one of the most well known short sellers in Jim Chanos and he was quoted as saying “We think this [Fairfax] is a zero.” In 2003 just over 11% of the outstanding Fairfax stock on the NYSE was being shorted. Fast forward to 2005 and Hurricanes Katrina and Rita both drop a bomb on reinsurance balance sheets. Fairfax survived the claims, but took a $220 million loss in the 3rd quarter and was forced to issue new shares at below book value.

Watsa has since transcended these troubles as Standard & Poors in 2009 upgraded Fairfax’s Crum & Forster insurance units to A- from BBB+. That same year Watsa also made the decision to delist Fairfax from the NYSE. His claim was that the markets were sufficiently liquid and their shareholders and employees would not require the additional listing. That may be so, but not being under the microscope also offers its own benefits.

Disclosure: No Holding In Fairfax

Josh Zachariah

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 3.5/5 (6 votes)

Comments

brianbook
Brianbook premium member - 3 years ago
Fairfax has a $8 billion lawsuit now pending against Third Point & SAC, as reported by Bloomberg News on 3/5/11.

jonmonsea
Jonmonsea premium member - 3 years ago
Interesting! Thanks!
batbeer2
Batbeer2 premium member - 3 years ago
Wow !

Prem Watsa and Francis Chou own a chunk of Overstock and Biovail (now Valeant) and join those companies in suing the hedge funds for manipulating stock. Patrick Byrne (CEO of overstock and former CEO of a Berkshire subsidiary) no longer fights this fight alone.

Interesting indeed.

rncarpio
Rncarpio - 3 years ago
a nitpick: patrick byrne was not a berkshire CEO, but the son of one (john j. byrne)
AlbertaSunwapta
AlbertaSunwapta - 3 years ago
We digress, but nonetheless, the whole thing would make a fascinating soap opera...


Elliot Spitzer and Jim Chanos apparently have a fascinating connection(s)...

http://www.benzinga.com/life/movers-shakers/10/12/666518/the-naked-truth-patrick-byrne-ceo-of-overstock-com-part-2


As for the Byrnes, the father Jack Byrne was at GEICO and White Mountains. I believe Buffett spoke very highly of him and for a bit the father was also on the board or something or other with Overstock.

Mark Byrne another son, is involved with Flagstone Re. Since I have a bit of it as well, I recently noticed that Chou has/had Flagstone in his portfolio.
batbeer2
Batbeer2 premium member - 3 years ago
a nitpick: patrick byrne was not a berkshire CEO, but the son of one (john j. byrne)

You are of course right, but the one does not exclude the other ;-)

John "Jack" => Geico

Patrick => Fechheimer Brothers, manufacturer of uniforms.
rncarpio
Rncarpio - 3 years ago
ahh I did not know that, thanks for the correction.

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