CRM Holdings (CRM) is a leading provider of a full range of products and services for workers’ compensation risk management. Said another way, CRM is a sleepy, boring and misunderstood insurance services, primary insurance and reinsurance Company that trades for 6.4x FY 2007e earnings and 5.7x my estimate of FY 2008 earnings. Despite a double digit return on average equity, the stock trades for 56% of its IPO price and at least 88% of its liquidation value. A combination of low market cap, a fairly concentrated shareholder base, "penalty box" status after coming public and over promising, and a lack of Investor/Public relations skills in properly explaining the story are the cause of its depressed valuation.
As of the time of this writing, the Company has a market value of $120m, long term debt of $44m and cash of $14.5m.
Throughout this write-up, I will pull various descriptions and information from the Company's 10-K, adding color or changing the format where I feel it appropriate to get the message across. Background:
Headquartered in Bermuda, CRM HOLDINGS, LTD. was spawned out of the insurance brokerage roots of its CEO, Daniel Hickey. It was founded in 1999 to service New York State self-insured groups (I explain what a self-insured group is below). In 2003 CRM expanded to California and created its Reinsurance arm, Twin Bridges. The Company IPO'd in late 2005 at $13.00 per share and bought Majestic, a primary insurer in November of 2006. CRM's three businesses are detailed below.
1. FEE BUSINESS - SELF INSURED GROUPS (SIGs)
First it is necessary to understand what a SIG is. The operating principles behind group self-insurance are relatively simple. Members contribute into a fund, which is conservatively invested and tracked by policy year. The SIG pays each policy year's expenses (administrative costs, claims, etc.) from collected funds and retains any surplus from contributions and investments for those members who contributed to the group that year. Self-insurance groups are created by employer members to prevent injuries and to help pay for their workers' compensation benefits in a timely, efficient, and cost-effective manner. Employers insured through SIGs contribute to a fund that remains within the group’s control. Any money not spent to cover claims or operating costs is retained by the group and could potentially be refunded to the members.
CRM provides self-insured groups (SIGs) with a comprehensive range of services, including assistance in the formation of self-insured groups, underwriting, risk assessment, safety and loss control services, medical bill review and case management, general management and recordkeeping, regulatory compliance and, in New York, claims management services. CRM also acts as a broker by placing excess coverage insurance and any required surety bonds for the groups. CRM’s reinsurance subsidiary, Twin Bridges (which I will describe in a minute), insures a portion of this excess coverage. Revenues in this segment consist purely of fees paid to CRM for the services I have listed above. Industries represented by these groups include: Healthcare, Contractors, Transportation, Wholesale/Retail, Auto Dealers, Banks & Wineries.
At the end of 2006, CRM managed 2,482 group members (mainly in NY and CA), up from 359 group members at the end of the year 2000. Retention rates have been in excess of 95% in NY State (where the majority of the groups reside) and 97% in California. WHAT DETERMINES THE FEES THAT CRM RECEIVES?
Fees in NY (w the exception of one group) are based on a percentage of the workers' compensation rates set by the NY Workers' Compensation Board that are attributable to the members of the groups that CRM manages. With respect to groups in CA and in TX (and that one group in NY), CRM's fees are based on a percentage of the premiums paid by group members. CRM also receives fees for medical bill review and case management services in addition to commission income from U.S. insurers for placing the excess coverage that the groups are required by law to obtain.DISTRIBUTION
All of the business in this segment is generated by general agents and brokers. Given Hickey's history in the brokerage business, it comes as no surprise that CRM has relationships with several hundred general agents in NY and CA.REVENUE AND EBIT FROM THE FEE BUSINESS SEGMENT DETERMINE ITS VALUE
Fee Revenue has grown from $20.8m in 2003 to $40.0m in 2006. On this revenue base, CRM earns anywhere from $4.5 - $5.5m in EBIT before central corporate overhead costs. Using the midpoint of this number, or $5m, and taxing it at 40%, I estimate that this business in the hands of an insurance brokerage or other financial services-type business is worth $30m, or 10x after tax recurring earnings of $3m. This equates to $1.85 per CRM share.GROWTH
CRM is growing its fee business by creating SIGs for additional industries such as hospitals and manufacturers. As the business is extremely scalable, each new group under management adds significant operating leverage to the business.
2. PRIMARY INSURANCE BUSINESS - MAJESTIC
Through its subsidiary Majestic Insurance (“Majestic”), acquired for book value in November 2006, CRM is also a direct writer of workers’ compensation provides workers’ compensation insurance through independent insurance brokers and agents primarily to medium and large size businesses located in California. Majestic is also licensed as an insurance company in 15 other states, including New York, with active operations in Alaska, Arizona, Nevada, Oregon and Washington. In addition, Majestic has also historically provided workers’ compensation insurance under the U.S. Longshore and Harbor Workers’ Compensation Act, or the “USL&H Act.” Majestic’s experience in underwriting complex risks allows it to target potential accounts with attractive premiums relative to exposure, good employee relations and effective risk management policies. Majestic is rated A- by A.M. Best. BACKGROUND: THE MAJESTIC ACQUISITION
CRM acquired all of the outstanding shares of Majestic's holding company for a total purchase price of $48.2 million. CRM USA Holdings, issued $36.1 million in junior subordinated debentures to a newly formed Delaware statutory trust subsidiary in connection with the issuance of $35 million of trust preferred securities used to partially finance the acquisition of Majestic. The balance of the purchase price for Majestic was financed through the sale of investments and the use of cash balances on hand of approximately $17 million.
Majestic's record prior to its purchase looks like this:
2006: Revenue of $72.5m, $6.7m in net income
2005: Revenue of $77.0m, $5.2m in net income
2004: Revenue of $75.8m, $4.4m in net incomeWHAT MAJESTIC MEANS FOR CRM
The benefits of Majestic are significant for CRM as the hundreds of agents that CRM touches can now offer a first dollar, standard worker's comp product to its customers. MAJESTIC - VALUATION
Majestic currently underwrites to just under a 100pct combined ratio, but should improve as it scales its premiums across a fixed expense base. Even though premiums in CA have been in decline for the last 3 - 4 years, claims experience has decreased at an even greater pace. Majestic reported $141m in reserves and $157.5m of invested assets at the end of December 2006. 93% of assets are fixed-income securities with 80% of these securities rated AA or better. Majestic should write ~$65m in premium this year and $80+m in premium next year. Publicly traded SEAB and ZNT, both workers comp players w significant CA exposure, trade at 1.4x and 1.8x book value, respectively. Let's give Majestic a discount for size and scale for the time being. If we take Majestic's $45m of book and put a 1.2x multiple on it, we get $54m, or $3.32 per CRMH share.
3. REINSURANCE BUSINESS - TWIN BRIDGES
Twin Bridges is a Bermuda exempted class 3 insurance company, incorporated in 2003. It reinsures a portion of the excess coverage provided to a significant majority of the groups that CRM manages. Since Twin Bridges began writing this excess coverage in December 2003, only eight claims have been reported and there have been no paid losses. It is in my opinion, the most misunderstood and most exciting element of an investment in CRMH.
The groups CRMH manages purchase excess workers’ compensation coverage from U.S. admitted insurers to cover claims that exceed a minimum level established by state law or regulation or by administrative determination.
Typically, managed groups purchase excess coverage for losses and loss adjustment expenses in excess of $500,000 per occurrence. This “excess coverage”’ purchased by the groups provides them with coverage for losses in excess of the $500,000 per occurrence liability typically retained by the groups up to a per occurrence limit. In addition, all of CRM's groups also purchase coverage to insure against the risk that a large number of claims will occur and result in losses that are each less than $500,000 and that the aggregate result of such losses could exhaust their resources. This “frequency coverage”’ is triggered in the event that the aggregate amount of losses and loss adjustment expenses during the coverage period exceeds a range from 90% to approximately 160% of the premiums paid to the groups by their members. If the frequency coverage is triggered, the reinsurer pays the next $2,000,000 of losses and related loss adjustment expenses of the group during the coverage period.
NOW PAY CAREFUL ATTENTION TO THIS: Since, the excess coverage must be provided by a U.S. admitted insurance company, which Twin Bridges is not, CRM typically would underwrite the coverage through a reinsurance contract with a “fronting” company. The “fronting” company underwrites the entire excess and frequency coverage to our groups and then cedes a portion, or layer, of the coverage to Twin Bridges under a reinsurance contract.
Until CRM's acquisition of Majestic in November 2006, Twin Bridges had been solely engaged in reinsurance contracts with NY Marine & General (ticker: NYM, 14x P/E, 1.4x P/B) as the “fronting” company. Following the acquisition of Majestic, Twin Bridges has entered into a reinsurance contract with Majestic. THIS IS WHERE THE TRUE VALUE OF MAJESTIC / TWIN BRIDGES RESIDES.
Twin Bridges reinsures 90% of the coverage which Majestic provides to the groups net of liability ceded to unaffiliated reinsurers (such as Hanover Re) and receives 90% of the premiums paid to Majestic by the groups net of premiums paid to unaffiliated reinsurers. ESSENTIALLY, CRM not only saves the egregious fees charged by former "fronting" Company NY Marine & General they are able to shift most of their insurance business' income into the tax free Bermuda domiciled company.
RISK MANAGEMENT AT TWIN BRIDGES
Twin Bridges’ liabilities under the quota share reinsurance agreement with Majestic, are capped at specific levels. First, for the excess coverage, Twin Bridges reinsures 90% of the losses and loss adjustment expenses in excess of the group’s retention (currently set at $500,000) up to a per occurrence limit of $2,000,000. For the frequency coverage, Twin Bridges reinsures 90% of Majestic’s policy coverage to the group up to $2,000,000. Twin Bridges allows Majestic a ceding commission of 15% on all ceded premiums to cover Majestic’s costs associated with the policies.
REVIEW OF THE REINSURANCE STRUCTURE
The easiest way to think about the way CRM is set up is as follows:
Old model (2003 - 2005):
first $500,000 of claims: responsibility of SIGs
$500,000 to $1,000,000: 50% Twin Bridges / 50% NY Marine
$1,000,000 to the Statutory Limit: Other Reinsurers
2006 Model (Twin Bridges had more capital to take on more risk)
first $500,000 of claims: responsibility of SIGs
$500,000 to $5,000,000: 70% Twin Bridges / 30% NY Marine
$5,000,000 $50,000,000: Other Reinsurers
$50,000,000 to the Statutory Limit: 70% Twin Bridges / 30% NY Marine
2007 and GOING FORWARD (most favorable)
first $500,000 of claims: responsibility of SIGs
$500,000 to $2,000,000: 90% Twin Bridges / 10% Majestic
$2,000,000 $50,000,000: Other Reinsurers
$50,000,000 to the Statutory Limit: MajesticSO WHAT IS THE REINSURANCE SEGMENT WORTH?
Twin Bridges will write something in the $30m range in premium this year and sport a combined ratio in the 60% or better range. This $12m in profit before taxes is only taxed at 10% because of its Bermuda status. Net income should fall in between $10m - $11m. At a 10x multiple, this is worth $105m or $6.46 per CRMH share.ADDING UP THE PARTS
Fee Business: $1.85
Primary Insurer: $3.32
Twin Bridges: $6.46
*** TOTAL VALUE: $11.63 per share (58% upside) ***
Mgmt Guidance for 2007 earnings (re-confirmed on 5/2/07): $1.10 - $1.20
As a P/E of my sum of the parts: 9.7x - 10.5xhaircut my sum of the parts by 15% and there is still a lot of upside in the stock. MARGIN OF SAFETY: ANOTHER WAY TO LOOK AT THE BUSINESS
Assume for a moment that Majestic and Twin Bridges never wrote another policy and that the fee business was sold to a financial or insurance brokerage buyer. We already know that the fee business is worth $1.85 per CRMH share. How do we pull apart the balance sheet to see what the insurance entities are worth? I try and accomplish this task here by taking total assets and liabilities subtracting the elements related to the fee business. It is not difficult as the assets related to the fee business are mainly people.
Data as of Dec 31, 2006
Total Assets: $306.1m
Long Term Debt ($44.11m)
Net Assets before Insurance Segments: $255m
Primary Insurance Claims: (Reserves of $142 x by 95% combined ratio - tgt over time) = ($135m)
Reinsurance Claims: (Reserves of $12m x by 60% combined ratio) = ($7m)
Accrued Expenses: ($14.7)
Reinsurance Payable: ($1.53m)
Unearned Premium (becomes an asset) $8.0m
Unearned Mgmt Fees (becomes an asset) $0.613
Total Value of non-fee businesses of CRM: $105.4m
Shares Outstanding: 16.247
Value per share: $6.49
To recap: Fee business of $1.85 + insurance business of $6.49 = $8.34 per share, or 13.4% above current levels. This means that the market is basically saying that CRM is worth more dead than alive. I disagree.RISKS / FACTORS CONTRIBUTING TO THE DEPRESSED VALUATION
I see the risks to an investment in CRM and the factors that have depressed its valuation to date as being very similar. I will attempt to list them in least-most risky / chronological order.
- In CRM's first earnings even as a Public Company, they disappointed investors by guiding below consensus. As a newly public company, they have yet to set investor expectations properly and meet those expectations.
- California Worker's Comp. As touched on earlier, rates in California have been on the decline, yet it is at a point now where things should be stabilizing. If the Company can produce decent fee income and insurance returns during a depressed rate environment, they should be able to do a lot better as the market hardens. Again, even though rates have gone down, claims have gone down as well.
- Dan Hickey share sales (source of recent weakness in the shares). In an unfortunate case of BAD PUBLIC RELATIONS, on May 21st, (and revealed in an 8-K) Dan Hickey entered into a pre-arranged stock trading plan under Rule 10b5-1 for the "purposes of financial planning and asset diversification". Hickey, who currently holds 1,539,691 shares or approximately 9.7% of the Company’s total outstanding common shares, may sell up to 195,000 shares from May 22, 2007 through December 31, 2007, with no more than 65,000 shares sold in any one quarter, except for certain carry-forwards if shares are not sold in prior quarters. If the full amount of shares is sold pursuant to the plan and no transactions take place outside the plan, Hickey will remain the beneficial owner of over 8.5% of the Company’s common shares based on the number of Company common shares currently outstanding. In addition, two members of the Company’s Board of Directors, Daniel G. Hickey, Sr. and David M. Birsner, and the Company’s General Counsel and Secretary, Louis J. Viglotti, also entered into separate 10b5-1 trading plans on May 21, 2007. Under the plans, Mr. Hickey, Sr., Mr. Birsner and Mr. Viglotti will sell up to 99,000, 100,000, and 195,369 shares, respectively, of the Company’s common shares and were entered into for the purposes estate and financial planning and asset diversification.
When asked about the sales, the word from the Company was that Viglotti is undergoing a personal issue and that Hickey needs to be below 10% or he risks being subject to taxation under the “controlled foreign corporation” rules. If you read the 10-K there is some merit to this. Through incentive stock, Hickey would go over 10% so it makes sense for him to sell down. If would have been nice if CRM did a press release reiterating Hickey's commitment and belief in the business as opposed to the 8-K we got which detailed the share sales. All I can say on that note is welcome to small-cap land. But wait...
SHARE SALE PLAN TERMINATED AFTER INVESTORS COMPLAIN
** Jim Scardino, the CFO, made a special trip to NY following the investor backlash from this 8-K to comfort investors that nothing has changed in the business whatsoever. After hearing investors' concerns, Hickey filed an 8-K ending the share sale plan.** This was an important sign in my opinion that management is willing to communicate with shareholders and listen to their concerns.
- The last risk I will mention is liquidity. Only 54,000 shares a day trade on average.FINAL NOTE ON THE OPPORTUNITY
CRM is now positioned to offer excess AND primary coverage. They will leverage the extensive brokerage network they developed over years of managing SIGs. Majestic’s reach will expand to places like NY and NJ while Twin Bridges will be able to retain excess premium and earn its returns virtually tax free.
<<1>> A few quarters of actually hitting (and / or) exceeding investor expectations. Management is learning how to manage the Street. <<2>> Investor realization that the Company is worth more alive than dead (as my liquidation analysis shows). <<3>> Shareholder Activism. A few shareholders I have spoken to have expressed an interest in taking a more active approach with the Company if the market continues to discount the value of CRMH shares. There is a lot of "noise" that can be made, from requesting CRM to buy back stock, to de-staggering the Board, cutting high Board fees (for a Company of this size) and instituting a dividend. The Bermuda entity is overcapitalized and could repatriate capital, however that capital probably has the highest return in Bermuda as it's used to grow the book of business. Either way, it will draw attention to CRM's depressed valuation. <<4>> General growth and synergies between the fee / primary and reinsurance business which will take effect in the second half of 2007, the first year in which all three pieces are working in tandem.
|Entry||07/18/2007 09:42 PM|
wonder if you could talk about valuations a bit.
1. Price to book is around 1.37 which seems fairly priced for a work comp insurer. How high do you think it can go?
2. Market cap to premium is a tad high. Do you think they can grow the business? Otherwise, it looks like they are overcapitalized. Thoughts?
3. Debt to equity is 0.50, which high for insurance. How is their debt structured?
|Subject||reply to miser 861|
|Entry||07/19/2007 11:11 AM|
|Thank you for the thoughtful comments. I would agree that rates do have more room to drop in California. Keep in mind though that this is a State that before 2003, had eight consecutive years of combined ratios in excess of 100 percent. Coming off of that, rates were artificially high and have been working to strike a balance between affordability and fair risk pricing. Two things are also important to note. 1. headlines concerning premium reduction in California (or any state for that matter) are not always the reality. While the insurance commission may say rates must be lowered, the carriers layer in enough fees, commissions and special charges to offset some of this. (It's like your $49.99 Verizon plan which really costs you $61.09 a month). 2. California's historical pure loss ratio has fallen at a greater pace and has achieved a lower absolute level than the rest of the U.S. in every accident year since 1999 (w the exception of 2004-2005, where it still had an absolute level that was lower, but the U.S. loss ratio fell at a greater pace). |
Despite an environment where rates are lower, the self insurance model has always been, and will continue to be, an important part of the New York and California marketplace. When members enroll in these groups, it is because they see the benefit of avoiding volatile swings in standard insurance prices, which are certain to fluctuate wildly over time. CRM's retention rates demonstrate how enrollment is a long term commitment, i.e. the benefit that customers gain by self insuring is the enhanced safety in the workplace (due to the 'ownership aspect' of self insurance) which at the end of the day results in less downtime and absence. A small businessperson who is educated properly on the merits of the product will see how downtime and worker absence have a much greater effect on the bottom line than saving a few bucks one year or another on hustling to find the cheapest policy. Members take an active ownership interest in the SIG and it is well documented how claims results and Group profitability beat the industry averages over time. In essence, participation in a SIG is not akin to bargaining down a supplier to get a better rate on paper supplies or coffee filters.
I am comfortable that the premium that Twin Bridges receives is a function of the statutory need for this product plus what the market will bare. This segment can expand its offering as Majestic writes new business over a greatly expanded broker network. As far as premium being negotiated between related parties, CRM's clients would have visibility into this. If they thought something was unfair, they could choose another carrier.
|Subject||reply to david 101|
|Entry||07/19/2007 12:24 PM|
|Thank you David for your thoughtful questions. |
1. Price to book is a little misleading here. Since the fee based business uses very little capital, it’s important to strip that out of both the book and the market cap to get a more reasonable ratio. In my analysis, I demonstrated why I thought the fee based business was worth $1.85 per share. Subtracting that from the current share price of $7.35, you get $5.50 per share as your price for the insurance business. Going back to the 'Margin of Safety' section of my analysis, we had $6.49 per share as the liquidation value of the insurance business. We would need to subtract the unearned premium and unearned management fees from this first. This equates to $0.53 per share, taking us down to $5.96. Next we would have to add back the values I initially subtracted when I assumed my combined ratios. This equates to $12m or $0.74 per share, taking book down to $5.22 per share. $5.50 ex fee business divided by $5.22 produces a more accurate price to book ratio of 1.05x, which is not expensive given their double digit ROE's.
2. Similar to the comments in #1, lets take the fee based business off of the market cap to get down to $5.50 per share. Premiums at $100m would be $6.15 per share.
3. I go over CRM's debt in the write-up. Again, strip out the embedded value in the fee business when looking at the overall level of leverage.
|Subject||response to dkepesh935|
|Entry||07/20/2007 12:56 PM|
Thank you for your questions.
1. I have spoken to a couple of risk managers in CRM's self-insured groups. They defend the value proposition in a few ways. For one, even though rates are lower now, historically speaking there have been large swings. Members take comfort in not having to time the market in this fashion and understand that as a group, they will get the benefit of an increased attention to safety between group members whether it be in the form of a dividend when statutorily possible, or a reduction in premium. In short, they view the group as a unique, long term commitment that mitigates rate risk and employee absence over time. SIG members own an 'embedded call option' on rates skyrocketing as soon as one carrier goes under, with the additional kicker of getting some capital back.
2. CRM did do a secondary offering to take Martin Rakoff out of his shares. Rakoff was co-CEO of the Company along with Hickey, a concept that I have yet to see work anywhere. I am told that Rakoff was going through his 3rd or fourth divorce and was becoming less and less involved with the Company. As a shareholder, I think I would be happy to see him go. His sale made it possible for better shareholders to become involved, notably Anton Schutz, Millenium Capital, and interestingly, Marketus Associates. Marketus is run by Edmund Hajim, the former Chairman and CEO of Furman Selz. Hajim sold Furman Selz to ING for $600m in 1997, at a monster multiple of book value.
I try not to read too much into secondary offerings, especially in less liquid names. For example, Seabright (ticker: SEAB) did a secondary in Jan 2006 to take private equity firm Summit Partners out of $47.25m worth of stock at $15.75 per share. The stock subsequently rose 21% to $19.00 (full disclosure: I have owned SEAB since 2005, my cost is in the 12's). The point here (not super original) is that different investors have capital and liquidity needs that can't always be accommodated in the open market and/or at the prices they think are fair when the securities are less liquid. Both Summit and SEAB management agreed on the great opportunities ahead for the firm, but Summit must manage its capital according to fund life and vintage, and it was time to scale back.
|Entry||08/09/2007 03:28 PM|
|Any updated thoughts on recent earnings or on the continued decline? thanks,|
|Subject||response to: update|
|Entry||08/13/2007 10:46 PM|
|I was pleased in general with earnings, especially given the though market conditions which will not last forever. The management fee business, while not profitable when fully loaded w corporate overhead, is clearly explained to investors on the call. In better markets, this is a significant contributor to eps. Management will be in New York City and in Boston next week. From what I hear, they will be meeting with various existing shareholders (including myself and another large holder whose principal is well regarded in the financial services space) in addition to looking for some new groups to tell the story to. I encourage you to call Cochran (http://www.ccwco.com/index.php) if you want to schedule a meeting. As far as the pullback, I have been adding shares. Competitor SEAB reported great results and Greenlight holding EIG will report on the 15th. CRMH is a gift at these prices.|
|Subject||CRMH - No exposure to subprime|
|Entry||08/27/2007 01:01 PM|
|it's good to see management address this - hopefully they can continue to communicate better with investors.|
CRM Holdings, Ltd. (Nasdaq: CRMH), a leading provider of a full range of products and services for the workers' compensation insurance industry, today confirmed it does not have any material exposure to the U.S. residential mortgage market in its investment portfolios. At June 30, 2007, the majority of its investment portfolio at its reinsurance subsidiary, Twin Bridges, was comprised of short-term U.S. government and agency securities, and cash and money market equivalents. The majority of its investment portfolio at its primary insurance subsidiary, Majestic Insurance Company, was composed of debt obligations of states and political subdivisions, corporate bonds, debt of U.S. government and agencies and equity securities. "We have conducted a careful analysis of our investment portfolios, and we
are very comfortable with our minimal exposure to the sub-prime mortgage market," commented Dan Hickey, Jr., CRM's CEO. "Going forward, we will continue to monitor our portfolios to maximize value, and remain focused on
creating long-term opportunities to grow at attractive rates of return and, ultimately, driving shareholder value."
(full disclosure: we have been adding)
|Entry||08/27/2007 02:01 PM|
|A couple more questions:|
1) What are your thoughts on CRM in relation to comps? From what i could tell, many others in the same space are trading at comparable P/Es.
2) What makes CRM a better bet than others at a similar valuation?
|Entry||08/27/2007 04:53 PM|
|Thank you for your question.|
1. CRM trades for 5.4x this year's expected earnings
Here are some other comps:
2. Remember again, that the comps are pure play insurance companies. If you back out the value of CRM's fee-based business, the p/e for the insuance entity is even lower.
|Entry||03/05/2008 11:42 AM|
|Any thoughts on recent earnings or outlook? Especially regarding the self-insured groups and any thoughts on a catalyst. Are you still involved here?|