Fairfax India

Which country in Asia has the longest runway for growth?

We have an position in this constituting around 1.5% of our portfolio. At this point of time, we have a queue to purchase shares to our ideal 5% stake.

We intend to hold this position for the long term (5 - 10 years).

This position forms part of our Unrecognised Growth portfolio.


Optimism in India:

India almost became the growth economy after China is opening up in the 70s and 80s. Decades pass them by and they still remain stick in the rut. Now, with every other economy sputtering, the demographic of India is coming through (just look at the number of Indian CEOs in the Fortune 500). The one thing that is holding back the Indians is their politics.

Lets hear from Prem Watsa - Chairman of Fairfax Financial

In May 2014, India’s political climate changed dramatically for the better with the election of Prime Minister Narendra Modi with a resounding majority. For the first time in 67 years, India has an unabashedly business friendly government. The ineffectiveness of India’s previous governments is seen by the fact that Canada’s economy at approximately $2 trillion with 35 million people is about the same size as India’s economy with 1.2 billion people. Mr. Modi has had great success in Gujarat, a state with 65 million people which he governed as Chief Minister for 13 years (elected three times). Gujarat had real economic growth of over 10% per year during this period while bringing water and electricity and providing child education to virtually every household. We think Mr. Modi can transform India, particularly if he gets re-elected for two more terms, as we think he will. He has an excellent track record, is incorruptible and is business friendly. We expect Mr. Modi to be the Lee Kuan Yew of India!

-Prem Watsa

We are not that optimistic as Modi being the Lee Kuan Yew as India is much more diverse than Singapore but anything better than previous administration is a huge bonus.

Investing in India:

Let’s move into the investing in India. If you have the capability to invest in India, it is one of the most dynamic exchange on the market. Every week, we seem to hear a demerger, some corporate restructuring. Investing in India looks tough with many good and professional investors coupled with mom and pop investors. Valuation tend to overshoot dramatically and then revert. Unlike the Hong Kong and the Chinese market, where some sleuthing could be done with a few call, we are totally helpless in India.

Thus if we are to invest in India, we will

  • need to plant some boots on the ground in India

  • and/or find someone who is well verse in India and work with him

  • and/or buy with a huge margin of safety

These are tough criteria to meet until the pandemic came along. The company we will be talking about today is FairFax India.

Fairfax and Prem Watsa:

For the uninitiated and Prem Watsa was once mentioned at the same breath as Warren Buffett. He is commonly known as Warren Buffett of Canada. To give you the perspective of long term investing in Fairfax, let us quote from the Motley Fools Canada.

Over the long term, Prem Watsa is an absolute legend. From 1985 – when he took over Fairfax Financial (TSX:FFH) – to the end of 2018, the company’s book value per share grew from US$1.52 to US$432.46. That’s a compound annual growth rate (CAGR) of 18.7% per share. And remember, Fairfax has paid a US$10 per share dividend for years now, cash out the door that has restricted the growth of book value.

Shareholders have been the beneficiary of this excellent record, with an investment in Fairfax growing at a CAGR of 17.1% per share from 1985 to the end of 2018. And that’s even after a somewhat lacklustre performance over the last few years.

-Motley Fool Canada

To give you an idea, if you had invested USD 10,000 in Fairfax in 1985 and hold it, you would have gotten USD 1.8m in 2018. That itself is the beauty of long term compounding.

Fairfax had underperformed since 2014 and that is reflective of most value investor throughout the world. If we are to bet on a trend reverting, we would have bet that Prem would have equal his record in the years ahead.

Instead of betting on Fairfax, we prefer Fairfax India (FI) as the company who

  • is operating like a private equity fund through

    • buying both private and public investment

    • working as an activist to create value through

      • merger and acquisition

      • demerger

      • listing of private entities

  • has the tailwind from the growth of India

  • has a set of managers

    • who are acting like entrepreneurs

    • whose incentivise is aligned to shareholders

    • knows the Indian market intimately

  • has Prem Watsa looking after the shareholders’ interest

Downside:

The downside of investing in FI include that it

  1. is listed on the Toronto Stock Exchange

  2. traded in USD

  3. has USD 500m debt denominated in USD

  4. has asset denominated in Indian Rupee

So there is some form of currency and debt risk, for we could not discount the possibility of a serious depreciation of the Rupee against the dollar.

If you can get past the above, then lets continue on to the investment thesis below.

Valuation of the “Quality” parts::

FI is not so easy to value. There is private and public investment. For public investment we can take the market value. As for their private holdings, we are at a loss on how to value them. We could use their valuation methodology but even we feel that that the auditors are too optimistic.

This is time when the the quality of businesses and the margin of safety come into play. We will be using the quality of the business to justify that there is indeed a margin of safety in the valuation.

We will tackle this report on 2 level through an activist playbook

  • Merger and Acquisition (M&A) + Initial Public Offering (IPO) listing

  • Demerger (or Spinoff)

M&A and IPO:

FI’s merger and acquisition is done through Fairfax and Fairbridge (a subsidiary of Fairfax).

Fairbridge’s proximity to the investment opportunities in India and its immersion in the Indian marketplace, the Fairbridge team, along with its extensive network in India, is expected to identify many of the investment opportunities for the Company and conducts, together with the Portfolio Advisor (Fairfax)

Over the years, they had been able to access deals which could not be accessible by the average investors. That include private stakes in

  1. Bangalore Airport

  2. Catholic Syrian Bank (CSB) and National Stock Exchange of India Limited (NSE)

  3. Fairchem Speciality

Bangalore Airport:

We like airport infrastructure. They are basically toll gate for planes and passengers. The value of airport had been bid up in recent years as passenger volume continues to grow. Leverage had been piled on these asset as well. Since the pandemic, airport asset had been in the doldrums. While all airport concession will be hit, we must differentiate the different type of airport. Airport can be seen as

  • Transportation Hub

  • Tourism Airport

  • Business Airport

Transportation hub like Singapore’s Changi airport is an extreme example where there is no domestic routes to talk of and that all their traffic are international in nature.

One example of tourism airport which relies heavily on international tourism to drive traffic would be the airports in Cambodia. Their domestic population do not fly and the airport mainly serves international tourists.

Another form of tourism airport is Hainan Airport which serves the domestic population of China. They might be less affected as domestic tourist could still travel within China.

Business airport usually reside in a major city in a large country having both domestic and international routes and domestic and international customers. The elimination of international routes and customers mean that they could still serve the domestic customers. It also helps that India is the second most populous country in the world and there is ample domestic demand to tap into.

Bangalore International Airport Limited (BIAL) is a private company located in Bengaluru, India. BIAL, under a concession agreement with the Government of India until the year 2038 (with the right to extend the agreement for an additional 30 years), has the exclusive rights to carry out the development, design, financing, construction, commissioning, maintenance, operation and management of the Kempegowda International Airport Bengaluru (KIAB) through a public-private partnership (the concession agreement). BIAL is what we will classify as a business airport.

During 2017 and 2018 Fairfax India had invested aggregate cash consideration of $652,982 (approximately 42.7 billion Indian rupees) (inclusive of $74,202 of costs incurred, approximately 4.8 billion Indian rupees) for a 54.0% equity interest in BIAL.

The question is how do we value the BIAL. Using the latest 20202Q commentary, we know that FI will hold an effective 49% stake in BIAL after the pre-IPO restructuring. FI is planning for an IPO in December 2021 at a worst case scenario of 70.3 billion Indian rupees which make their stake at 34.447 billion rupees (USD 464m).

Catholic Syrian Bank (CSB):

FI started to negotiate for a stake in CSB in 2016. They finally took a stake in Feb 2018 after a long protracted process. In Nov 2019, they managed to complete the IPO of the firm with a 49.7% stake in CSB. Now, that is speed despite some hiccup!

Their 49.7% stake is worth USD 262m

Fairchem Speciality:

To give you a further flavor on how FI continue to do some financial engineering to their private investment, let me introduce you to Fairchem Speciality.

In March 2017, the merger of Fairchem Speciality (Fairchem) - which is listed and Privi Organics (Privi) - which is private was completed, resulting in FI owning 48.8% of Fairchem. FI had earlier separately owned controlling interests in both these companies. The two companies continue to operate separately under a single listed entity.

Their 48.8% stake would be worth around USD139m.

In May 2019, Fairchem's board of directors approved a draft plan to reorganize Fairchem into two listed entities. As part of the reorganization, the existing oleochemicals and neutraceuticals businesses will spin out into a newly formed wholly-owned subsidiary Fairchem Organics Limited, which was incorporated on March 27, 2019 in anticipation of the Fairchem reorganization. Privi will be amalgamated with the remaining Fairchem business and subsequently be renamed Privi Speciality Chemicals Limited.

The reorganization is anticipated to be completed in the third quarter of 2020 and shares of Fairchem Organics listed in the fourth quarter of 2020.

In two moves, FI had managed to sell their private entity Privi to Fairchem and then a subsequent reorganisation to spin off Privi. These moves help to crystallise a market value in the previously unlisted entity Privi.

Demerger:

A common theme on the Indian stock exchange is the number of demerger that happens. It is similar to FI investment, IIFL Holdings demerger exercise through the years.

On October 20, 2017, IIFL spun off, and separately listed on the Indian stock exchanges, 5paisa, a company it had incubated to take advantage of business opportunities in digital trading and distribution services.

In 2017, IIFL announced its intention to divide their three business groups into three separate companies (Finance, Wealth and Securities), with each to be listed on the Indian stock exchanges.

  • 5paisa (26.6%) - USD 32m

5paisa is one of India’s fastest growing technology-led financial services companies. It offers an array of financial products and services through a digital platform and mobile application. Its services are targeted at retail investors and high-volume traders who actively invest and trade in securities markets and seek DIY (do-it-yourself) services at a low cost.

  • IIFL Finance (26.5%) - USD 111m

IIFL Finance is a non-deposit taking, is the 22nd largest Non Banking Financial Company (NBFC) in India. IIFL FIN is moving forward aggressively to consolidate its position as one of the major NBFCs in India. It added 504 new branches in 2019, taking its total to over 2,350 branches, with over 18,000 employees and 3 million customers.

  • IIFL Wealth (13.9%) - USD 160m

IIFL Wealth is the number one wealth manager in India for UHNIs with consolidated total assets under management (AUM) of $25.1 billion, 29 offices in India and abroad, 900 plus employees and 64 teams consisting of 288 relationship managers serving over 5,600 families.

  • IIFL Securities (26.5%) - USD 42m

IIFL Securities is one of the major capital market players in Indian financial services. It offers advisory and broking services (both retail and institutional), financial products distribution, institutional research and investment banking services. It operates in over 2,500 locations across India, comprised of a wide branch and sub-broker network providing unparalleled research coverage on over 200 companies. 

Valuation:

Taking all these investments together,

  • BIAL (49.0%) - USD 464m

  • CSB (49.7%) - USD 262m

  • Fairchem (48.8%) - USD 139m

  • 5paisa (26.6%) - USD 32m

  • IIFL Finance (26.5%) - USD 111m

  • IIFL Wealth (13.9%) - USD 160m

  • IIFL Securities (26.5%) - USD 42m

The fair value of Fairfax will be at USD 1,210m.

At the same time, you get private investment in

  • India Housing Fund

  • Sanmar Chemical

  • Saurashtra Freight Private Limited

  • Seven Islands Shipping Limited

  • National Collateral Management Services Limited

  • National Stock Exchange of India (NSE)

If you do not recognise any of the companies above, you can do more research or just ignore, for these companies are your margin of safety and diversification from the Indian financial and aviation sector.

At current price, FI is a long term hold for us.


Average Purchase Price: USD 7.47

Current Price: USD 7.64 @ 17th Sep 2020

Holding Period: Till teleporting becomes reality and planes are no longer needed

Catalyst: Recognition that Covid is not hurting India growth or Fairfax India ability to structure deals