Fairfax unfairly valued its gains in Go Digit General Insurance: Muddy Waters Research

The first improper manipulation, Muddy Waters alleges, of Digit's carrying value occurred in Q12021. Digit agreed to raise money at a valuation of $1.9 billion, which implies that Fairfax should have booked a $605 million fair value gain in either Q42020 or Q12021

Forensic-cum-activist investment firm Muddy Waters in its latest report said that Fairfax Financial Holdings “hatched a plan” to take highly aggressive fair value gains throughout 2021 on its investment in unlisted insurer Go Digit General Insurance.

In a report dated February 8, Muddy Waters flagged accounting manipulations by several of its holding companies. Fairfax has been increasing stakes in Indian companies, prominent among them apart from Quess Corp are Thomas Cook and Bangalore International Airport.

Prem Watsa, known as the Warren Buffett of Canada, is the founder of Fairfax Financial Holdings.

“In Q42020 - Q12021, rather than buying back shares, Fairfax put in place Total Return Swaps (TRSes) on its stock. On the surface, TRSes seem like a risky way of returning capital to investors, because if the stock declined, Fairfax would take both P&L and Book Value hits. Plus, it has no anti-dilutive feature such as would be guaranteed to increase shareholder value permanently,” said Muddy Waters.

The first improper manipulation, Muddy Waters alleges, of Digit's carrying value occurred in Q12021. Digit agreed to raise money at a valuation of $1.9 billion, which implies that Fairfax should have booked a $605 million fair value gain in either Q42020 or Q12021.

But Fairfax, which had not yet completed putting its TRSes in place, did not recognise any such gain until the following quarter, which was also when Digit agreed to another financing round at a $3.5 billion valuation. Rather than recognising the valuation gain in one fell swoop in Q2 2021, Fairfax instead took gains gradually over three quarters in 2021: $425 million in Q2, $397 million in Q3, and $668.3 million in Q4, the research house said.

“Assuming that the market valued each dollar of Digit profit at $1 incremental share value, the gains on the TRSes added earnings juice of $160-170 million in 2021,” it said.

Wrong reporting

Muddy Waters also alleged that Fairfax wrongly said Digit was profitable when in reality it reported losses.

Quess used by co-promoter Prem-Watsa owned Fairfax Financial to manipulate profit: Activist investment firm

In its 2021 Annual Report, Muddy Waters says, Fairfax claimed that Digit was "already profitable" in 2021. However, Digit's financials record net losses in its fiscal years ended March 31, 2021 and 2022.

The research house decreased the current valuation of Digit to $1.5 billion against a peak valuation of $3.5 billion in 2021. It also questioned if the company can truly be called an insuretech, given that 1) it allegedly has built “little” of its own software and (b) much of Digit's business is still processed through agents.