At A 32% Discount, Fairfax India’s Arbitrage Opportunity Can Be Exploited By Investors – Fairfax India Holdings Corporation (OTCMKTS:FFXDF)

Fairfax India Holdings Corporation (OTCPK:FFXDF) recently announced that shareholder equity, or book value, was up 24% for fiscal year 2019 from $13.53 to $16.89. The stock has continued to trade at a discount to the recent shareholder reports. Since the report was compiled on 12/31/19, the public stocks that Fairfax India owns have appreciated by $190 million. This increase means that today’s book value of $16.89 is under reported by $1.37, representing a significant value opportunity for investors.

Due to Fairfax’s ownership of a large number of public stocks, one can approach Fairfax India like an India ETF where about 40% of the underlying equities are trading daily. Today, there is a significant discount between Fairfax’s share price and the underlying equities. The reported P/B as of 12/31/19 was $12.50/$16.89 or .74x. The recent equity increases in the underlying stocks means that the current P/B is $12.50/$18.26 or .68x. The stock is trading at a 32% discount. Investors would be wise to get in on this company and its underlying bet on India.

Sourced from company 10k reports

2019 Fiscal Year Report Overview

Fairfax India’s total book value increased from $2.12 billion in 2018 to $2.58 billion in 2019, representing an 18% increase. The company’s book value per share also increased by 18% over the year from $13.86 to $16.89. The increases were due in part to the shrinking of outstanding shares from 153.1 million to 152.6 million over the year. The majority of these increases were due to Fairfax’s strong net earnings per diluted share (EPS) of $3.30 compared to the fiscal year 2018 (EPS) of $0.63.

According to the recent financial release, the “net change in unrealized gains on investments was $530.4 million.” In the financial release, the company attributed this change to “an increase in the fair value of the company’s investments in the private companies,” particularly BIAL. The recent report highlighted the following companies for their contributions to “net change in unrealized gains” on investments since the end of 2018. I have organized them for readers based on public and private and then further segmented based on gain or loss contributions.

Private Holdings Unrealized Gains

  • Based on a recent sale of part of Fairfax’s interest in Bangalore International Airport (“BIAL”) to Anchorage Infrastructure Investments Holdings Limited, positive operational developments and the finalization of BIAL’s real estate development plan, Fairfax reported a net change in unrealized gains of $751.5 million for BIAL according to the financial release.
  • Fairfax redeemed its bond holdings of Sanmar for $425.5 million and reinvested $198 million for a 42.9% equity interest in the company. These equity holdings have reported unrealized gains of $23.1 million.

Private Holdings Unrealized Losses

  • Fairfax saw its holdings in National Collateral Management Services Limited (“NCML”) decline by a reported $41.6 million in unrealized losses from $165 million a year ago. There was no note as to why this investment recorded losses.

Publicly Traded Holdings Unrealized Gains

  • CSB Bank reported a $60.9 million gain.
  • Fairchem reported a $33.4 million gain.

Publicly Traded Holdings Unrealized Losses

  • IIFL Finance reported a $196.0 million loss.
  • IIFL Securities reported a $40.9 million loss.

These changes all combined for the net unrealized gains on portfolio investments of $580.4 million. In this period, the company also repaid $50 million to a Canadian bank. Fairfax India’s public holdings are where the value opportunity for this company can be better understood.

Arbitrage with Fairfax India’s Public Holdings

5paisa (5PAISA.NS), CSB Bank (CSBBANK.NS), IIFL Finance (IIFL.NS), IIFL Securities (IIFLSEC.NS), IIFL Wealth (IIFLWAM.NS), and Fairchem (FAIRCHEM.NS) are all publicly traded on India’s stock exchanges. Using these companies’ stock prices from 12/31/19 to 2/13/20, investors can determine their change in value and can estimate the updated book value today. Investors can then determine the book-value-per-share increase by taking the total unrealized gain appreciation of these stocks and dividing this appreciation by the total number of outstanding shares. As noted in the table below, the stocks have appreciated together for a total of about $210 million. This means an increase of $1.37 from the book value reported today of $16.89, a 32% discount to the current stock price of $12.50.

Table created by the author.

Fairfax’s Public Stocks Analysis

The following information on the public stocks should help investors better gauge these stocks’ potential. Please note I used INR 1 = $0.014 USD for market capitalization.

  • IIFL Finance is a US$370 million market cap financial loan company in India that owns an 82% stake in India Infoline Finance. It currently trades above its 200-day moving average even though EPS as of 12/31/19 was reported down from the beginning of the year. The company’s future seems positive.
  • IIFL Securities is a US$260 million market cap brokerage service and serves over 4 million customers. The stock currently trades near its 52-week high. The company’s future seems positive.
  • IIFL Wealth is a $1.3 billion USD market cap wealth management firm with over $24 billion AUM and 13,250 families’ assets. The stock is currently trading near its 52-week high. The company’s future seems positive.

The IIFLs are all spin outs of IIFL Holdings. The below chart showcases that they are separate companies.

  • CSB Bank is concentrated in the south of India and has over 1.3 million customers. It is currently trading near its 52-week low probably due to the decline in total deposits this past quarter. An investor presentation can be found here. The company’s future looks negative until deposits improve.
  • Fairchem is a US$300 million market cap Indian industrial company focused on purifying waste products from oil and manufacturing them into consumer products. Fairchem is trading near its 52-week high and recently reported a positive 1.84 EPS up from 1.71 EPS a year ago. The company’s future looks positive.
  • 5paisa is trading below the midpoint of its 52-week price range. 5paisa is a US$70 million market cap fintech company that provides various technology driven brokerage services and APIs for investors. It has crossed over 2 million customers and had a 185% customer growth rate from 2018 to 2019 while tripling revenues. The company’s future looks positive.

Underlying growth trends in India’s middle class that these companies cater to means that Fairfax’s public holdings can continue to appreciate, and book-value/shareholders’ equity will follow.

Takeover Potential

With the current discount, some investors may be wondering if this stock is currently at takeover price. Buffett admirers will comment on this deal’s seemly uncanny resemblance to his Sanborn Map Company deal. However, using a rough enterprise value model, I have determined that the stock is currently not at takeover price, but getting close if an investor were to consider the publicly traded stocks like cash and to hold a strong belief in management’s valuation of the private holdings.

Making a rough theory, an investor could acquire the company at its market cap of $1.9 billion. That investor could sell off the underlying public stocks for a $961 million. Added to Fairfax’s cash and bonds, this would mean an investor would have about $1.1 billion in cash. Using this cash to pay off the current $667 million in liabilities on the balance sheet, the investor is left with the private holdings at current market valuation of $1 billion and about $400 million in cash for a total value of $1.4 billion. If the investor believes management’s book value for the private holdings of about $2.28 billion, then the investor owns a total of $2.28 billion in private holdings and $400 million in cash for a total of $2.68 billion. Based off the $1.9 billion purchase price, this works out to a 141% return for the takeover. For Icahn-like investors, this may seem like an opportunity. However, investors must understand that the large part of this takeover value is due to the belief in management’s valuation of private holdings. Activist investors will be disappointed to realize there are 30 million shares controlled by management which have significant voting rights.

Fees and Risks

Investors will note that Fairfax’s historically high fees continued for 2019. A performance fee of $47.9 million was accrued to the benefit of Fairfax Financial Holdings. In proportion to total book value, this represented a 1.8% expense ratio.

Due to Fairfax India’s large ownership of private companies, investors are taking on the underlying risk of management’s estimates of these companies’ valuations. Fairfax also is not in mainstream index funds and ETFs and therefore doesn’t receive the benefits or scrutiny of ETF-held stocks. Fairfax is held though by an A-team of mutual funds. Franklin Templeton, Fidelity, and John Hancock all have holdings in Fairfax.

Conclusion

When approaching Fairfax India, investors should think of it as a public venture capital fund. The company invests privately or directly into India’s companies, nurtures these companies to success and then releases them into the public markets. As Fairfax continues to grow its stake in India and develop more and more companies releasing them into the public markets, the opportunity to check these prices against reported book value and play this arbitrage game will be available for investors. I recommend holding this company and adding to your stake over time as the book-value-per-share growth trend since 2015 is an excellent sign and the company continues to trade at an enticing discount to book value.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The content of this post is not meant as investment advice as it is the expressed opinion of the author. The numbers and statistics were developed using public information from involved companies and may as all analyst work contain errors. Any decisions or actions made by readers or actors of this article are the sole responsibility of the readers or actors themselves and have no legal or financial responsibility or bearing on the author.

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