Tag Archives: tangible book value

Hot Take-outs

In many episodes of fervent investment activity within a particular hot spot, like the current insurance M&A party, there is a point where you think “really?”. The deal by Mitsui Sumitomo to take over Amlin at 2.4 times tangible book is one such moment. A takeover of Amlin was predicted by analysts, as per this post, so that’s no surprise but the price is.

With the usual caveat on the need to be careful when comparing multiples for US, Bermuda, London and European insurers given the different accounting standards, the graph below from a December post, shows the historical tangible book value levels and the improving multiples being applied by the market to London firms such as Amlin.

click to enlargeHistorical Tangible Book Multiples for Reinsurers & Specialty Insurers

Comparable multiples from recent deals, as per the graph below, show the high multiple of the Mitsui/Amlin deal. Amlin has a 10 year average ROE around 20% but a more realistic measure is the recent 5 year average of 11%. In today’s market, the short to medium term ROE expectation is likely to be in the high single digits. Even at 10%, the 2.4 multiple looks aggressive.

click to enlargeM&A Tangible Book Multiples September 2015

There is little doubt that the insurance M&A party will continue and that the multiples may be racy. In the London market, the remaining independent players are getting valued as such, as per the graph below tracking valuations at points in time.

click to enlargeLondon Specialty Insurers Tangible Book Values

When the hangover comes, a 2.4 multiple will look even sillier than its does now at this point in the pricing cycle. In the meantime, its party like 1999 time!

Reinsurer & Bank TBV Multiples

Given the increase in the tangible book values (TBV) of reinsurers over the past few quarters, I wanted to quickly update the graphic shown in previous posts (like this one) to see how the share price changes (generally flat over 2014 since the run-ups in 2013) over that time have impacted multiples. The graphic below is based upon a limited pool of pure reinsurers only which doesn’t include the specialty insurers (who on the LSE generally have higher multiples than their European and Bermudian brothers, as a previous post shows). As it turns out, the mounting pricing pressures in reinsurance have impacted current market values and based on Q1 TBV the multiples are therefore relatively stable since the end of 2013.

I wanted to compare the change in TBV multiples for reinsurers against those for banks, particularly for the global banks, but have not been able to get the clean data on the banking sector. The red line below is based upon data on all publically traded banks up until 2010 with adjustments made on the data from 2011 to 2014. With both sets of data, it’s difficult to include a consistent set of firms given the structural shifts and business changes in both sectors. The current diversion in trends between US & European banks is a case in point. So a health warning applies on the data.

click to enlargeReinsurers & Banks NTA Multiples June 2014

Updated TBV multiples of specialty insurers & reinsurers

As it has been almost 6 months until my last post on the tangible book value multiples for selected reinsurers and specialty insurers I thought it was an opportune time to post an update, as per graph the below.

click to enlarge

TBV Multiples Specialty Insurers & Reinsurers September 2013I tend to focus on tangible book value as I believe it is the most appropriate metric for equity investors. Many insurers have sub-debt or hybrid instruments that is treated as equity for solvency purposes. Although these additional buffers are a comfort to regulators, they do little for equity investors in distress.

In general, I discount intangible items as I believe they are the first thing that gets written off when a business gets into trouble. The only intangible item that I included in the calculations above is the present value of future profits (PVFP) for acquired life blocks of business. Although this item is highly interest rate sensitive and may be subject to write downs if the underlying life business deteriorates, I think they do have some value. Whether its 100% of the item is something to consider. Under Solvency II, PVFP will be treated as capital (although the tiering of the item has been the subject of debate). Some firms, particularly the European composite reinsurers, have a material amount (e.g. for Swiss Re PVFP makes up 12% of shareholders equity).

Lancashire’s recent lackluster share performance

Lancashire (LRE.L) is a London quoted specialty insurer that writes short tail (mainly insurance) business in aviation, marine, energy, property catastrophe and terrorism classes. Set up after Hurricane Katrina, the company operates a high risk high reward business model, tightly focussed by the experienced hand of CEO Richard Brindle, with an emphasis on disciplined underwriting, tight capital management and generous shareholder returns. Shareholder’s equity is managed within a range between $1 billion and $1.5 billion with numerous shareholder friendly actions such as special dividends resulting in a cumulative shareholder return of 177% since the company’s inception over 7 years ago.

I am a fan of the company and own some shares, although not as many as in the past. I like their straight forward approach and their difference in a sector full of firms that seem to read from each other’s scripts (increasingly peppered with the latest risk management speak). That said, it does have a higher risk profile than many of its peers, as a previous post on PMLs illustrated. That profile allows it to achieve such superior shareholder returns. The market has rewarded Lancashire with a premium valuation based upon the high returns achieved over its short history as a March post on valuations showed.

However, over the past 6 months, Lancashire’s share price has underperformed against its peers, initially due to concerns over property catastrophe pricing pressures and more recently it’s announcement of the purchase of Lloyds of London based Cathedral Capital.

click to enlargeLondon Market Specialty Insurers Share Price 2012 to August 2013

Cathedral’s results over the past 5 years have been good, if not in the same league as Lancashire’s, and the price paid by Lancashire at 160% of net tangible assets is not cheap. Given the financing needs of the acquisition, the lack of room for any of Lancashire’s usual special dividend treats in the near term has been a contributing factor to the recent share price declines in my opinion.

Based upon the proforma net tangible assets of Lancashire at end Q2 as per the Cathedral presentation and the circular for the share offering, the graph below shows the net tangible valuation multiples of a number of the London market insurers using net tangible asset values as at end Q2 with market values based upon todays’ closing prices.

click to enlargeLondon Market Specialty Insurers Net Tangible Book Multiples August 2013

The multiples show that the market is now valuing Lancashire’s business at a level more akin to its peers rather than the premium valuation it previously enjoyed. Clearly, the acquisition of Cathedral raises questions over whether Lancashire will maintain its uniqueness in the future. That is certainly a concern. Also, integrating the firms and their cultures is an execution risk and heading into the peak of the US wind session could prove to be unwise timing.

Notwithstanding these issues, Brindle is an experienced operator and I would suspect that he is taking full advantage of the current arbitrage opportunities (as outlined in another post). It may take a quarter or two to fully understand the impact of the Cathedral acquisition on Lancashire’s risk/reward profile. I, for one, look forward to stalking the company to find an attractive entry point for increasing my position in anticipation of the return of Lancashire’s premium multiple.

Historical Price to Tangible Book Value for Reinsurers and Wholesale Insurers

Following on from the previous post, the graph below shows the historical P/TBV ratios for selected reinsurers and wholesale insurers with a portfolio including material books of reinsurance (company names as per previous post). The trend shows the recent uptick in valuations highlighted in the previous post. The graph is also consistent with the Guy Carpenter price to book value graph widely used in industry presentations.

Historical P to TBV Reinsurers & Wholesale Insurers 2001 to 2013Over the past 12 months the sector has broken out of the downward trend across the financial services sector following the financial crisis, most notably in the banking sector as the graph below from TT International illustrates.

TT International Bank Price to Book Ratio

Tangible book value growth across the wholesale insurance sector was approximately 10% from YE2011 to YE2012 and the weighted average operating ROE of 11% in 2012 has been rewarded with higher multiples.

The sector faces a number of significant issues and a return to valuations prior to the financial crisis remains unrealistic. An increase in capacity from non-traditional sources and the increased loss costs from catastrophes are cited in industry outlooks as headwinds although I tend to agree with EIOPA’s recently published risk dashboard in highlighting the impact of macro-economic risks on insurer’s balance sheets as the major headwind.

One issue that deserves further attention in this regard is the impact low interest rates have had on boasting unrealised gains and the resulting impact on the growth in book values. Swiss Re is one of the few companies to explicitly highlight the role of unrealised gains in its annual report, making up approximately 13% of its equity. In a presentation in September 2012, the company had an interesting slide on the impact of unrealised gains on the sector’s capital levels, reproduced below.

Reinsurer Capital & Unrealised Gains

P/TBV is one of my favoured metrics for looking at insurance valuations. But no one metric should be looked at in isolation. The impact of any sudden unwinding of unrealised gains if the macro environment turns nasty is just one of the issues facing the sector which deserves a deeper analysis.