2023-07-19 00:16:32 ET
Summary
- Global Indemnity Group has revealed that there is active interest from multiple parties in acquiring some or all of its business, causing a sharp rise in share price.
- The complexity of underwriting and pricing risks in the insurance sector is increasing, making consolidation a sensible move for many companies.
- Despite a 20% increase in share price following the announcement, GBLI's price/book value remains the lowest among its peers, suggesting potential for further valuation.
Global Indemnity Group, LLC ( GBLI ) is a fairly traditional commercial property and casualty insurer and has been pretty conservatively managed over the years, although tossed about somewhat by recent initiatives that did not pan out as hoped. As a result, shareholder returns have been disappointing over the last five years, relative to both a broad portfolio of insurance company shares as well as the S&P 500 index.
However, in early June management announced that there was active interest from multiple parties in acquiring some or all of the business, and as a result, the market reacted by boosting the share price very quickly, from $27.50 to between $33 and $34, where it has remained since the announcement.
A Few Words on the Sector
In certain ways, consolidation in these insurance sectors makes some sense, as the complexity of underwriting and pricing the risks is increasing. The Wall Street Journal reported in a July article that the combination of inflation and severe weather incidents are impacting commercial insurance in much the same way that homeowners' insurance is being impacted. Businesses are having a more difficult time in finding coverage at all in some places, and when they do, the premiums are significantly higher than in the past. For the insurers underwriting the risk, having greater scale and diversity could help with concentration risk, so acquiring Global Indemnity could be playing right into that.
According to a Deloitte report (available to download at the link), merger activity in the P&C insurance sector has been running at a generally elevated level since 2015 relative to the 4 years prior, although very unevenly. After a period trending over 1.0x price/book value, the valuations involved on average have drifted down towards that 1.0x level for 2022.
Property&Casualty Insurance M&A activity, 2011-2022 (DeLoitte Development LLC, report "2023 insurance M&A outlook | Balancing uncertainty with optimism")
In the Deloitte report, they find that there is clear opportunity in the P&C space for smaller businesses, stating that "as a $150 billion market in which 60% to 65% is held by carriers with less than 1% market share, small P&C remains ripe for consolidation." Global Indemnity falls into this category - the company's own website states plainly that it is "focused on small to middle-markets."
Recent Results and Developments
The first recent development worth pointing out is that the board appointed Joseph ("Jay") Brown as CEO effective from October 2022, although he has been a director there since 2015. He comes to the CEO role with extensive industry experience already, including CEO stints with MBIA Inc. ( MBI ) and Fireman's Fund Insurance Company.
Besides the change in day to day senior management, there has been a process of making substantial strategic and operating changes to its business over the last couple of years, exiting some businesses altogether, slowing in another, and pursuing growth in what remains. This makes consistent year over year comparisons a little dicier, but also revealing how the strategies are working. Since 2021, Global Indemnity has exited manufactured home, agribusiness (under the American Reliable name), and wholesale brokerage business lines. Furthermore, the company decided to de-emphasize reinsurance, and instead focus on a core commercial specialty line. Some of these were attempts to acquire growth a few years ago that simply did not work out as hoped - for example, Global Indemnity acquired the American Reliable agribusiness insurance in 2015 and by 2022 had already decided to sell it off.
So with that said, here is a summary of the most recently available quarterly results (Q1 of 2023), and how those compare in certain respects to previous periods. For the period ended 3/31/2023, total revenues came in at $150.9 million, compared to $130.5 million in 2022, but this requires a little unpacking. Net written premiums were considerably lower in 2023 over 2022, $115 million versus $159 million, but with the benefit of much lower realized investment losses and higher realized gains on investments, the total revenue picture managed to come out ahead. Operating expenses were generally flat year over year ($148.6 million last year, compared to $147.8 million in Q1 2023), which netted an income of $2.4 million for the quarter, as opposed to a net loss of ($14.9 million) in 2022.
So there is clear evidence that from the drop in net written premiums that the changes in operations and strategy are already kicking in, and for now the difference is being made up by its management of its investment portfolio. CFO Tom McGeehan shared some details of the investment portfolio during the earnings call , stating:
The increase in investment income is due to higher book yields. Book yield on the portfolio increased from 2.3% at March 31, 2022 to 3.6% at March 31, 2023. At March 31, 2023, the duration of the fixed income portfolio was 1.5 years. Now in comparison of the March numbers to December 31, 2022, at December 31, 2022, book yield was 3.5% and duration was 1.7 years. Between March 31, 2023, and December 31, 2024, we expect our investment portfolio will generate approximately $900 million of cash flow as bonds mature and investment income is realized. Realized losses in the first quarter were $1.5 million. Approximately 2/3 of this realized loss is due to Silicon Valley Bank. During the first quarter of 2023, the fixed income portfolio appreciated in value by $10 million.
This was a well-managed transition during a major shift in interest rates, and has helped stabilize overall results.
The Valuation Gap
If the signs are generally pointing towards the likelihood of a deal coming together, the question becomes whether or not there is room for the valuation to go much higher from here, or alternatively if the market is over-valuing the chances based on the available information.
Compared a group of approximate peers in terms of market cap size, it stands out clearly that Global Indemnity sits at the lowest price/book value of the lot at 0.73x, well under 1.00x and well under the next lowest peer, even after the June announcement pushed shares up just over 20%. I do realize these are imperfect comparisons due to variations in the lines of business, but nevertheless serves as launching point for exploring the potential for greater valuation still should an offer come through. Alternatively, it is equally important to consider whether or not there is a likelihood for shares to revert to a much lower valuation again if no offer comes, or a deal cannot be reached.
Given that the Deloitte report found an average M&A transaction in this space to be done at about a 1.00x P/B, it would seem likely that there is additional upside, even after the gains from last month on hopes for a deal, though no specific offer has been revealed. An offer for the company that was in line with book value would be $45.68 per share as of March 31, or a solid 35% premium to the shares' recent trading range. Between the interest being reported now and the long-term trends towards consolidation in the industry, I believe an eventual deal is more likely than not, and well north of $40 per share.
However, if a deal does not come together by the end of the year, I still anticipate that it would be a short-term set back only. An investor would still be left with a well-managed insurer picked-up at a relative discount and the upside still in place, either from working out a deal to sell the company further down the line, or from management putting the pieces together to create shareholder value. The dividend yield for waiting is not high at ~3%, but is something to keep in mind. Just as important, there is additional shareholder return with a fairly aggressive share buyback in place, a $60 million authorization that had an additional $26 million available as of early May.
The $34 million that has been used (including purchases after the close of the 1st quarter) already took out 1,357,000 shares for an average price paid of $25.05. The remaining $26 million could conceivably take out an additional 680,000 shares assuming an average price around $38 per share. If the total comes to ~2 million shares repurchased in total, that would reduce the share count by approximately 13.5%. The net result is increasing the book value, although at a slower pace for the rest of the way.
Final Thoughts
There are definite risks here, beyond those inherent from investing in the business of covering risk. Underwriting has some bit of luck involved, for either good or ill, but that comes with the territory here. The additional risk I am thinking of is primarily how interest rates continue to play out and what may mean for the value of Global Indemnity's investment portfolio. Having navigated the recent environment quite well, they are sitting on a pile of relatively short-term dated bonds, which is working in their favor for the moment. As rates presumably peak in the next 6 months, keeping pace with the right decisions in managing the investment portfolio will continue to be critical, especially as the company settles into being a smaller, more focused business.
That being said, the I think the downside risk seems to be relatively muted, and I think the risk/reward balance is tilted in favor of reward. The shareholder returns already in place, especially the buybacks, are increasing the book value (and hopefully the market value), while slimming down the overall operations seems strategically planned to make Global Indemnity a more attractive candidate for an acquisition. The combined impact of these moves could result in the potential for an even higher offer in a buyout, or a valuation multiple that catches up to its market peers.
For further details see:
Global Indemnity Group: Upside Still Available, Potential Candidate For Acquisition Or Merger