Fairfax Financial Holdings, backed by noted Indian-Canadian investor Prem Watsa, has come under the scanner after forensics-based activist investment firm Muddy Waters Research flagged the company’s accounting practices.
In a report released on February 8, titled the ‘GE of Canada’, the US-based firm said it has shorted the stock, pointing out accounting inconsistencies. Muddy Waters said FFH “consistently manipulated asset values and income” by engaging in “value destructive transactions” in order to show accounting gains. It added that the conservative adjustment to FFH’s book value should be around $4.5 billion or 18 percent lower than what was reported.
Also read: Fairfax fully committed to Bengaluru airport investment, says BIAL CEO Hari Marar
Fairfax Financial Holdings is a Toronto-based company founded by Watsa, whom some call the Warren Buffett of Canada. Fairfax India has stakes in companies such as Thomas Cook, Quess Corp, and Bangalore International Airport Ltd, among others. Fairfax has refuted all allegations.
The allegations
Taking a dig at Watsa’s reputation as the Buffett of Canada, the Muddy Waters report said Fairfax was “more GE than Berkshire Hathaway”. It stated that in 2018, Fairfax holdings began pulling levers to produce paper profits across investments in response to significant insurance losses it had incurred in 2017, including the acquisition of Allied World. Paper profit refers to a value that appears in financial records but does not add actual cash value to the company. This, according to the report, was continued and “amped” up in 2020. Muddy Waters believes that this “manipulation” would continue into 2023, “proving to be similarly egregious”.
Another allegation in the report is that Fairfax has been badly missing its “long-term target of compounding book value at 15 percent”. Fairfax’s own numbers from December 2008 through 2022, before adjusting for accounting abuses, was at only around 9 percent, the report says.
"Manipulation across investments"
The report highlights similar book-value manipulations across 15 investments, including Quess, Recipe, Fairfax Africa, Go Digit, Riverstone, APR Energy and Gulf Insurance.
According to the report, since restaurant-chain Recipe Unlimited went public in 2015, Fairfax has overvalued its equity, “carrying it at a premium to the observable market price”. Additionally, despite a decline in macro conditions for the restaurant segment overall, Fairfax Holdings, in order to avoid making losses to the tune of $251 million in 2022, took the business private at a 53 percent premium. Since then, Fairfax continues to “carry Recipe above its estimate of fair value, while the business’ operating income has continued to shrink. Nevertheless, Fairfax has taken no impairment”.
Similarly, the report says that an investment in Gulf Insurance will generate around “$300 million in questionable gain to book value for Fairfax in Q42023”. According to the report, in December 2023, Fairfax bought out an additional portion in Gulf Insurance at a higher multiple of around 2.4x book value, thereby taking a $300 million gain on existing shares. Previously, Fairfax Holdings owned 43.4 percent in Gulf Insurance.
Also read: Fairfax Financial refutes Muddy Waters' allegations, affirms strong financials
In a February 12 release, Fairfax Financial Holdings said that it "categorically denies and refute all false and misleading allegations". According to Fairfax, Muddy Waters may have "woefully misjudged the strength of Fairfax’s financials and prospects and we are confident the marketplace will reflect our strong fundamentals,"
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