2023-11-20 05:07:40 ET
Summary
- Global Indemnity is a small cap insurer offering specialty property and casualty insurance.
- The company has hired an investment banker to explore potential deals, indicating a possible sale in the future. However, be mindful that the company has controlling shareholder.
- While Q3 results were not stellar, book value continued to grow, and the shares currently trade around a 25% discount to book value.
Global Indemnity ( GBLI ) is a specialty property and casualty insurer, offering coverage through its Penn America Group, as well as underwriting lines ranging from special events to vacant buildings to the cannabis industry.
I last covered Global Indemnity in July , with a bullish thesis. The investment case was built on the acknowledgment that there had been interest expressed by possible buyers for some or all of the business the prior month. The shares had already rallied on the news of course, but I believed there was still upside potential as I considered the company to still be undervalued. In the intervening months, shares have appreciated modestly, and outperformed the broad S&P index fund ( SPY ) nicely, as well as the Fidelity Select Insurance Portfolio ( FSPCX ).
While no sale has been announced, the company has hired an investment banker with Insurance Advisory Partners to assist in the process. The acquisition possibility still drives the thesis here, but with updated results from the last couple of quarters, it is a good time to drill in a little more on the sort of valuation shareholders might want to get.
Third Quarter Review
Given restructuring in the business that started in 2022, direct comparisons of financial results to the prior year are uneven and not necessarily meaningful. Total revenue in the quarter was $126.1 million, primarily derived from net earned premiums of $111.7 million, and nicely supplemented with $14.2 million of investment income. After expenses and reserves, net income attributable to common shareholders was $7.6 million for the period, or $0.55 per diluted share.
On a cash flow basis, through 9 months of 2023, cash from operations is down modestly from last year, to $36.8 million from $41.7 million, but nothing terribly concerning in my view. Cash was allocated to investing activity, as would be expected, with about $274 million in maturities and proceeds from sales, and $283 million in purchases through three quarters, as their portfolio of bonds or other fixed maturity securities has continued to shorten in duration while also benefiting from rising yields. The book yield on their invested cash reported by management as of September 30 was 4%, with an average maturity of 1.2 years, both solid improvements, with the income from investments more than doubling over the prior year as they reap one of the benefits of the current macro environment. Total cash and equivalents at the quarter end stood at $46.5 million.
CEO Jay Brown has articulated a clear set of operating goals for the commercial specialty business, specifically an expense ratio target of 36% within the next two years, a loss ratio in the mid 50% range (naturally, with a combined ratio therefore near 90%). For the nine-month period just ended, those objectives look relatively ambitious, as Global Indemnity hit an expense ratio of 37.4%, a loss ratio of 60.2% (for a combined ratio of 97.6%). In other words, the earned premium is not providing much margin relative to the losses incurred and the expenses. Mr. Brown made the following point during the earnings call concerning the loss ratio thus far in 2023:
In terms of loss . . . the 60.2% ratio is falling short of our long-term target due to a combination of high catastrophe losses, about two points higher than expected year-to-date, and continued loss emergence for terminated casualty business in Package Specialty and Targeted Specialty class specific, causing another couple of points below target. . . .I will share the observation that the same terminated business that has hurt our 2023 accident year results, was the source of reserve strengthening that we have experienced this year in Commercial Specialty. The net effect on calendar year loss ratio was $12 million in the third quarter and $19 million through nine months.
The combined ratio should hopefully move back toward the stated targets as the impact of higher overall risk pricing roll through, assuming it can keep ahead of any growth in losses, and other expenses can be kept in balance.
Valuation
In spite of not being as close to the goals as they would like to be, the quarter did continue to move the book value per share modestly higher from $46.03 at mid-year, to $46.27 at the end of Q3. As one of the key metrics in the industry by which valuation is measured and deals evaluated, a rising book value is an important part of the thesis. At book value of $46.27, the current price to book discount is roughly around 25%.
Pure comparisons from public markets are difficult: there are plenty of relatively comparable general insurers of similar market cap, but few that focus on specialty lines and reinsurance. For example, Donegal Group ( DGICA ) underwrites personal, commercial, farm and title insurance, Heritage Insurance Holdings ( HRTG ) focuses on homeowners and residential property managers. James River Group Holdings Ltd. ( JRVR ) is perhaps the best direct comparison from the standpoint of being a similar market cap and its areas of underwriting focus. However, they just reported Q3 results as well, which included an announcement to sell their casualty reinsurance business and disclosed a material weakness in internal controls pertaining to financial reporting. The shares have recently dropped by ~30% as a result, making current comparisons based on market price multiples less meaningful as the market digests what needs to be done. I've included Ambac Financial Group ( AMBC ) for good measure, although it has business beyond the borders of the United States.
I believe the best direct comparison is with James River Group, prior to their Q3 disclosure that had them valued at 0.90x book value and higher. I am intrigued to learn more about Ambac, but that will require a separate exploration, as I am not deeply familiar with their business.
If an acquisition is a serious possibility for Global Indemnity, the deal landscape for the past few years has trended down from a high of over 1.50x book value in 2019 down to the 1.00x range last year, according to this Deloitte report. For easy math, that would suggest an acceptable range starting at the low end of ~$42 per share at 0.90x, up to ~$51 at 1.10x. If an offer is forthcoming, I would anticipate an opening bid somewhere quite close to book value. Of course, getting that combined ratio moving closer to a sustainable 90% would make a more attractive set of assets to a buyer, so there is some work to be done to make operating and underwriting improvements. Regardless of a buyout, however, those improvements should ultimately benefit the cash flows and by extension, the shareholders.
Saul Fox's Role
Global Indemnity has a controlling shareholder, Saul Fox, whose role with the company goes back to 2003 when his private equity firm Fox Paine & Company bought what is now Global Indemnity. He has been the chairman for twenty years now, and two of his entities own all of the class B common shares (which each have 10 votes instead of 1 vote for each class A common), and all of the preferred shares in the company. All told, the Fox Paine entities held nearly 84% of the voting rights as of September 30th (per Note 11, "Related Party Transactions" of the 9/30/2023 10-Q , page 28). The investment thesis is clearly premised on a sale of the company at a premium to its current market value, but the decision to accept any specific offer ultimately rests with Mr. Fox, and that does not necessarily work in the favor of all shareholders. However, prospective or recent investors may be able to benefit assuming the market adjusts if or when a specific offer is disclosed, and not need an offer to be accepted in order to come out ahead.
Conclusion
The primary risk to the thesis is that no offer is made within the sort of time-frame expected, and the shares would potentially drift down if that were to become evident. Assuming a serious offer is entertained in the next 6 months or so, which certainly appears to be the hope of Mr. Fox, then there is a strong likelihood that the shares will move up further towards book value and stay there as the offer is evaluated. If he is looking for a buyer at unrealistically high valuations without much willingness to compromise around the book value, then buyer interest could dissipate, or he could choose to sell parts of the business without selling it all together.
In the meantime, shareholders can pick up a reasonable yield, nearly 3% on annual basis. Within the capital allocation framework, there is no debt on the balance sheet. No debt, combined with growing income from its investments and efforts at improving operating metrics relative to the most recent quarter, there is real potential for a special distribution, or an eventual raise to the distribution in the event that business just continues as normal, assuming the operating metrics move in the desired direction. But even without those improvements, CFO Tom McGeehan pointed on the call that:
We have $800 million of cash flow coming off between now and the end of next year. That is being invested at close to -- literally, you can get yields very -- treasury close to 5.5% today. So it's -- we have full expectations that the bulk yield of our portfolio will continue to increase. And if rates stay at the levels they are today, I mean yields in that range will eventually be realized.
The basic return on $800 million at 5.5% is $44 million, and in comparison, over the course of a full year, the common and preferred shares combined payouts would come to approximately $10 million. Year to date, $12 million has been put into share repurchases (although there is no current buyback program underway), but the point is that the return on investment alone should be able to more than cover that sort of scale of returns to shareholders. I should note that Global Indemnity is structured as a partnership for tax purposes, and investors should expect to receive a K-1.
Although shares have already rallied strongly on the news of possible interest in a sale, there continues to be room for further appreciation, and I believe the downside risk to be limited. I still consider it a buy at current levels.
For further details see:
Global Indemnity: One Step At A Time