Fairfax Financial Works Up a $1.4 Billion Deal for Zenith National
The insurance business is fairly cyclical, and the downward trend has been exaggerated in the past two years, especially in hard-hit places like California. So for Fairfax, this could ultimately be a lucrative play.
A Look at Zenith
Founded nearly 40 years ago, Zenith is now a top player in workers compensation insurance that is required by state statute. While the company operates in 45 states, roughly 80% of its revenues come from California and Florida.
Despite the recession, Zenith has been able to push forward. In its latest quarterly report, the company posted net income of $10.8 million, or $0.29 per share. For the full-year, net income was $34.4 million, or $0.91 per share. It helps that the company has a strong risk-management approach and a good customer base, with 29,600 policyholders. Zenith has also restructured its operations, with layoffs that trimmed away 13% of its workforce.
But the rising unemployment rate and health costs have resulted in lower gross premiums and put pressure on growth (last year, policies in-force fell by 14%). In other words, Zenith will need the U.S. economy to make a comeback before it can rebound.
Timing is Everything
Fairfax CEO Prem Watsa has proven to be a savvy deal-maker. The company's founder, he built it up in a similar fashion to the way Warren Buffett grew Berkshire Hathaway (BRK.A) and the Tisch family built Loews (L): by making insightful investments with the assets from its insurance business, often betting on dark-horse securities. In fact, Watsa's nickname is the "Canadian Warren Buffett."
One of his recent moves nicely illustrates that: The company made more than $2 billion on credit default swaps, which surged in value because of the global financial meltdown. Fairfax also saw a variety of its equity investments generate substantial returns.
With its CDS windfall, Fairfax has gone shopping: It recently made a $1 billion deal for the 27% of Odyssey Re Holdings it did not already own. And even after the purchase of Zenith, Fairfax will still have $1 billion in extra capital, enough to make some other deals that will take advantage of the current low valuations and the anticipated growth phase of the insurance cycle.