Global compensation (NYSE:GLOBAL) is a specialty property and casualty insurer, offering coverage through its Penn America Group, as well as lines of insurance 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 is built on ACKNOWLEDGMENT that there has been interest expressed by potential buyers in some or all of the business in the past month. The stock 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, the stock has 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 committed an investment banker with Insurance Advisory Partners to help in the process. Buyability still drives the thesis here, but with updated results from the last two quarters, it’s a good time to delve a little more into the kind of valuation shareholders might want to get.
Third quarter review
Given the restructuring in the business that began in 2022, direct comparisons of financial results with the previous year are uneven and not necessarily meaningful. Total income in the quarter was $126.1 million, primarily derived from net earned premiums of $111.7 million and well complemented by $14.2 million in investment income. After expenses and reserves, net income attributable to common stockholders was $7.6 million for the period, or $0.55 per diluted share.
On a cash flow basis, through the 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 distributed to investing activity, as expected, with about $274 million in maturities and proceeds from sales, and $283 million in purchases over the three quarters, as their portfolio of bonds or other fixed-maturity securities continued to shrink in duration. , while also benefiting from increased 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 investment income more than doubling over the past year, while reaping a from the benefits of the current macro environment. Total cash and equivalents at the end of the quarter stood at $46.5 million.
CEO Jay Brown has articulated a clear set of operating goals for the specialty commercial business, one in particular expense ratio target of 36% within the next two years, a loss ratio in the mid-range of 50% (of course, with a combined ratio so close to 90%). For the nine months just ended, these targets seem relatively ambitious, as Global Indemnity achieved an expense ratio of 37.4%, a loss ratio of 60.2% (for a combined ratio of 97.6%). In other words, the premium earned does not provide much difference in relation to the incurred losses and expenses. Mr. Brown made the following point at length call earnings regarding the loss ratio so far in 2023:
As for the 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 the continued showing of losses for the casualty business completed in the category specific to the targeted Packages and Specialties. , causing a few more points below the target. . . .I will share the observation that the same business disruption that hurt our 2023 crash year results was the source of the reserve strengthening we experienced this year in the Commercial Specialty. The net effect on the calendar year loss ratio was $12 million in the third quarter and $19 million through the nine months.
The combined ratio should hopefully return to stated targets as the impact of higher overall risk pricing continues, assuming it can contain any increase in losses and other costs can be kept in balance.
Despite not being as close to targets as they would like to be, the quarter continued to move book value per share modestly higher from $46.03 mid-year to $46.27 at the end of the third quarter . As one of the key metrics in the industry by which valuation is measured and deals evaluated, a growing book value is an important part of the thesis. With a book value of $46.27, the current price to book discount is roughly around 25%.
Simple comparisons from the public markets are difficult: there are many relatively comparable general insurers with similar market capitalizations, but few that focus on specialty lines and reinsurance. For example, the Donegal Group (DGICA) provides personal, commercial, farm and title insurance, Holdings Heritage Insurance (HRTG) focuses on homeowners and residential property managers. James River Group Holdings Ltd.JRVR) is probably the best direct comparison in terms of being a similar market cap and its areas of underwriting focus. However, they just reported Q3 results also, which included an announcement to sell their casualty reinsurance business and disclosed a material weakness in internal controls over financial reporting. Shares have recently fallen ~30% as a result, making current comparisons based on market price multiples less meaningful as the market digests what needs to be done. I have included Ambac Financial Group (AMBC) for good measure, though it has business beyond the borders of the United States.
I believe the best direct comparison is to James River Group, prior to their Q3 disclosure that had them valued at 0.90x book value and higher. I’m intrigued to learn more about Ambac, but that will require some special exploration, as I’m not deeply familiar with their business.
If a buyout is a serious possibility for Global Indemnity, the deal landscape for the past few years has fallen from a high of over 1.50x in 2019 to the 1.00x range last year, according to this. Deloitte report. For some easy math, this would suggest an acceptable range starting from the low end of ~$42 per share at 0.90x, up to ~$51 at 1.10x. If an offer comes in, I would anticipate an opening bid somewhere very close to book value. Of course, getting this combined ratio closer to a sustainable 90% would make for a more attractive set of assets for a buyer, so there is some work to be done to make operational and underwriting improvements. Regardless of an acquisition, however, these improvements should ultimately benefit cash flows and, by extension, shareholders.
The role of Saul Fox
Global Indemnity has a controlling shareholder, Saul Fox, whose role with the company dates back to 2003 when his private equity firm Fox Paine & Company bought what is now Global Indemnity. He was head of twenty years, and two of its units own all of the Class B common stock (each of which has 10 votes instead of 1 vote for each Class A common stock) and all of the preferred stock in the company. However, the Fox Paine entities held nearly 84% of the voting rights as of September 30 (per Note 11, “Related Party Transactions” as of 9/30/2023 10-P, 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 this does not necessarily work in favor of all shareholders. However, prospective or recent investors may be able to profit by assuming that the market adjusts if or when a specific offer is disclosed and do not need the acceptance of an offer to come forward.
The main risk to the thesis is that no bids are made within the kind of timeframe expected, and the stock would potentially fall lower if this were to become apparent. Assuming a serious bid materializes in the next 6 months or so, which certainly seems to be Mr. Fox’s hope, then there’s a good chance the stock will rise further toward book value and stay there while the bid is appreciated. . If he seeks a buyer at unrealistically high valuations without much willingness to compromise on book value, then the buyer’s interest may be dissolved, or he may choose to sell parts of the business without selling all together.
Meanwhile, shareholders can get a reasonable yield of nearly 3% on an 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 to improve operating metrics compared to the most recent quarter, has no real potential for a special distribution, or an eventual distribution increase should the business it simply continues as normal, assuming the operating metrics move in the desired direction. But even without these improvements, CFO Tom McGeehan emphasized on the call that:
We have $800 million in cash flow coming in between now and the end of next year. That’s being invested in the vicinity of — literally, you can get very — Treasury yields near 5.5% today. That’s right — we have full expectations that the yield on most of our portfolio will continue to rise. And if rates stay where they are today, I mean yields in that range will eventually materialize.
The underlying return on $800 million at 5.5% is $44 million, and by comparison, over a full year, the combined common and preferred stock payouts would total roughly $10 million. Year to date, $12 million has been put into share buybacks (although there is no current buyback program), but the point is that the return on investment alone should be able to more than cover that kind of rate of return. for 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 news of potential interest in a sale, there remains room for further appreciation and I believe the downside risk will be limited. I still consider it a buy at current levels.