Street Capitalist: Event Driven Value Investments

Over the last few weeks, I have spent a lot of time trying to find certain industries that appear undervalued. One area is insurance, where many insurers with good combined ratios and past performance are trading below book. I was happy to see Wilbur Ross agree in this Q&A with Fortune:

Where do you think the biggest opportunities are now?

There are deep value opportunities in insurance stocks, which were beaten down because of their exposure to the subprime crisis, annuities, and commercial real estate. I won’t name names, but some well-managed life insurance and fire and casualty companies will come through this stronger. They used to trade at one or two times book value but now trade at three-quarters book…

Mr. Distress is ready to buy (Fortune)

A quick look at Google shows us how the sector is looking for reinsurance players:

Most appear pretty cheap on the basis of book value. For the moment, it seems as if these companies are trading at discounts mainly due to market conditions. Most insurance companies are reporting that they are still in a soft market. I know that the folks at W.R. Berkley are expecting that things will start to turn. One indicator of that, to me, seems to be with the uptick in M&A activity. We saw Fairfax Financial acquire Zenith, and recently Perry Capital urged Endurance Services to find a merger partner:

PEMBROKE, Bermuda—One of the largest shareholders of Endurance Specialty Holdings Ltd. has urged the Pembroke, Bermuda-based insurer to find a merger partner.

New York-based hedge fund manager Perry Corp.—which owns 12.6% of Endurance and whose president, Richard C. Perry, is a member of its board of directors—said in a regulatory filing Monday that it expects consolidation in the Bermuda reinsurance market to accelerate in the near term.

Endurance “should undertake an evaluation of its strategic alternatives and pursue a possible merger or other strategic transaction in order to create a stronger company with a defined growth strategy,” Perry, which does business as Perry Capital L.L.C., wrote in the filing with the Securities and Exchange Commission.

In addition, Perry said recent executive appointments at Endurance will “not position the insurer to capitalize on consolidation opportunities.”

Endurance Shareholder Urges Merger (Business Insurance)

Richard Perry might also see the reinsurance sector as undervalued, which is why he thinks opportunities are ripe for Endurance Services. If that is not enough, we also saw Warren Buffett purchase stakes in Munich Re and Swiss Re. Smart, value savvy investors appear to be really interested in these companies and I think they are worth a look.

To me, the key will be to find insurance companies that are trading at low multiples with the capacity to increase policy volumes as the market improves.

(Click for full size)

I still like Fairfax given its book value growth, great management team, and current price. However, I see plenty of other opportunities worth analyzing, especially with P&C insurers. I plan on posting some work that I have been doing on insurance companies sometime this week, so be sure to look for that.

When I saw the 13F for Fairfax Financial Holdings (TSE:FFH) come out, one of the things I wondered was when Prem Watsa would do another acquisition. With Fairfax’s success over the last few years and good financial shape, I thought the company would be poised for an acquisition. Watsa has publicly said that they are not interested in straying too far out of the insurance business when it comes to acquisitions. They don’t want to build another Berkshire Hathaway.

So, I’m pretty happy to see this acquisition of Zenith National Insurance (NYSE:ZNT). Zenith is in the workers’ compensation insurance business, which means that policies are generally long tail, meaning that payouts happen over longer periods of time. To contrast, short-tail insurance usually has payouts over shorter periods of time and more frequently. This is typical when you look at the likelihood that a person will get into an accident in their car versus an injury at the workplace.

So why is acquiring long-tail insurance operations so beneficial to a company like Fairfax? For one, Zenith is well operated. Moreover, the long-tail policies enable Fairfax to increase the size of its float — which is the amount of Zenith receives in premiums that it does not have to be paid out immediately or held in reserves. That capital is often invested in securities, in Zenith’s case mostly bonds, which could potentially be redeployed into more attractive securities by smart capital allocators like the people at Fairfax. Fairfax is not the only smart investor to have acquired workers’ compensation insurance companies, Warren Buffett’s Berkshire Hathaway owns National Indemnity which has workers’ compensation operations in California.

The one stickler for the Zenith deal is the fact that Fairfax will have to issue a little equity to complete the deal but will still have about $1 billion in cash on hand after the acquisition.

Via Bloomberg:

Fairfax Financial Holdings Ltd., the Canadian insurer run by Prem Watsa, agreed to buy Zenith National Insurance Corp. for about $1.3 billion in cash, adding sales in California.

Fairfax will pay $38 a share, the Toronto-based company said today in a statement. That’s 31 percent more than Woodland Hills, California-based Zenith’s $28.91 closing price on the New York Stock Exchange yesterday. The deal is expected to be completed in the second quarter.

Watsa, 59, is betting on a rebound in a workers’ compensation market pressured by rising medical costs and falling payrolls. Like Warren Buffett at Berkshire Hathaway Inc. and Loews Corp.’s Tisch family, Watsa built his company by investing the assets of insurance operations, often in out-of- favor securities.

“Workers’ compensation is probably the softest of all lines right now,” Bob Hartwig, president of the Insurance Information Institute, said at a conference in November, using industry parlance for a market where rates are falling. “Rate accounts for the vast majority of premium reduction we have seen in workers’ compensation.”

…Zenith, run by Chairman and Chief Executive Officer Stanley Zax since 1978, said in its 2009 annual report that it has “a long-term record of outperforming the industry.” Zenith’s workers’ compensation loss ratio, a measure of how much of each dollar of premium is paid in claims, was lower than the industry average every year from 2002 to 2008, according to Zenith’s annual report.

“There will be no changes in Zenith’s strategic or operating philosophy,” Watsa said in the statement.

Watsa’s Fairfax Agrees to Buy Insurer Zenith for $1.3 Billion

Warren Buffett is pretty active with foreign insurance companies these days. Not to long ago, Berkshire Hathaway (NYSE:BRK-A) did a deal to take on some of Swiss Re’s life insurance portfolio. Now, Munich Re is reporting that he owns 3% of the company:

Release of an announcement according to Section 21 WpHG [German Securities Trading Act]
WKN 843002
ISIN DE0008430026

Warren E. Buffett, USA, informed us in accordance with Section 21, para. 1 of the German Securities Trading Act (WpHG) that his share of the voting rights in our company had exceeded the threshold of 3% on 18 January 2010 and amounted to 3.045% (6,011,029 voting rights) as per this date. Thereof 2.994% (5,911,029 voting rights) are attributable to him in accordance with Section 22, para. 1 sentence 1 item 1 of the WpHG.

Munich, 26 January 2010

The Board of Management

Notifications relating to holding of voting rights 2010 (Munich Re)

I don’t know too much about Munich Re, but for any global value guys, it is probably worth taking a look at.

Lloyd’s of London is fascinating for anyone with an interest in catastrophe risk insurance. Something most shareholders of Berkshire Hathaway are probably well acquainted with. Their syndicate writes policies on everything from terrorist attacks to Ugly Betty’s smile!

Click Here for the Interview transcript. The video appears to be down temporarily.

I liked the following quote, related to AIG on the benefits of being boring:

CHARLIE ROSE: OK, but then how do we have two different opinions? What made you sure it was not right and they thought it was right?

PETER LEVENE: Well, I cannot get inside what their thinking was. But I can tell you what our thinking has been. Our thinking has been that years gone by, Lloyds got itself into serious trouble.

CHARLIE ROSE: Right, exactly.

PETER LEVENE: Fortunately we got out of that mess and we are in a very strong position. And we said, we’re not getting into that position again. Therefore, any risky proposals that come along, no, thank you very much. For the last three or four years, we have had various finance houses come along and saying, you’re sitting on a lot of cash, we have got some great ideas for you as to how to use that cash, and they would be quite complex. And we would look at them and say, that’s very kind of you, but no, thank you very much. And they would say you know what, you are really boring. And I have to say.

CHARLIE ROSE: And you are missing your chance to make a lot of money.

PETER LEVENE: Yes. Well, I have to say today, being a little bit self-satisfied about it, we can say boring is beautiful.

Also, Here’s a great introduction to Lloyd’s, via Warren Buffett:

Our tale begins around 1688, when Edward Lloyd opened a small coffee house in London. Though no Starbucks, his shop was destined to achieve worldwide fame because of the commercialactivities of its clientele – shipowners, merchants and venturesome British capitalists. As these parties sipped Edward’s brew, they began to write contracts transferring the risk of a disaster at sea from theowners of ships and their cargo to the capitalists, who wagered that a given voyage would be completed without incident. These capitalists eventually became known as “underwriters at Lloyd’s.”

Though many people believe Lloyd’s to be an insurance company, that is not the case. It is instead a place where many member-insurers transact business, just as they did centuries ago. Over time, the underwriters solicited passive investors to join in syndicates. Additionally, the business broadened beyond marine risks into every imaginable form of insurance, including exoticcoverages that spread the fame of Lloyd’s far and wide. The underwriters left the coffee house, found grander quarters and formalized some rules of association. And those persons who passively backed the underwriters became known as “names”.

Eventually, the names came to include many thousands of people from around the world, who joined expecting to pick up some extra change without effort or serious risk. True, prospective names were always solemnly told that they would have unlimited and everlasting liability for the consequences of their syndicate’s underwriting – “down to the last cufflink,” as the quaint description went. But that warning came to be viewed as perfunctory. Three hundred years of retained cufflinks acted as a powerful sedative to the names poised to sign up.

Berkshire Hathaway – Chairman’s Letter (2006)