Description

The Upcoming IPO of Tiptree (TIPT) Subsidiary The Fortegra Group (TFG) Could Drive 50%+ Upside

Why Care Now?

Tiptree (TIPT) owns 73.1% of The Fortegra Group (“Fortegra”), and Fortegra has filed three recent public S1s (on November 8, 2023, December 19, 2023, and January 5, 2023) with a high-quality syndicate team led by Goldman Sachs, JPM, Jefferies, and Barclays. We are assuming that Fortegra will IPO in late January at 17.5x 2023 Adjusted Net Income (versus specialty insurers that trade at 19.4x EPS). We estimate that Tiptree’s ownership in Fortegra is worth approximately $31.87/share. We think TIPT, which does not have any research coverage, should benefit from discovery as investors contemplate investing in Fortegra.

Business Overview

Tiptree is a holding company that owns two businesses: The Fortegra Group (~90% of TIPT’s value) and Tiptree Capital (~10% of TIPT’s value).

The Fortegra Group

Fortegra is a specialty insurer that has grown premiums at a 25% CAGR since 2019 while maintaining consistent Combined Ratios in the low 90s percent and 30% returns on equity. Fortegra underwrites admitted and excess and surplus (E&S) lines. Fortegra also offers services, which includes warranty products and motor club programs; these are capital light, fee-based products that provide meaningful cash flows to grow the insurance business. Fortegra likely wrote around $2.7 billion in Gross Written Premium and Premium Equivalents (“GWPPE”) in 2023. GWPPE is the combination of insurance policies written or assumed and warranty service contracts issued. Insurance policies will comprise approximately 86% of GWPPE, and warranty service contracts represent approximately 14% of GWPPE.

What does Fortegra Write?

Fortegra focuses on small premium-per-risk insurance—underwriting that is (a) focused on smaller premiums and (b) geared towards more frequent but less catastrophic losses. Further, Fortegra focuses on niche risks in underserved markets. As we previously said, 86% of Fortegra’s book is either admitted or E&S insurance. 74% of Fortegra’s insurance GWP is comprised of less than $10 million programs, and 90% of Fortegra’s insurance GWP is comprised of less than $25 million programs. Therefore, approximately 78% of Fortegra’s GWPPE is made up of insurance programs less than $25 million. These “niche” and “underserved markets” are underserved principally because they are small and don’t move the needle for larger carriers. Effectively, Fortegra built the distribution network, technology, and process that allows Fortegra to excel in small programs. Fortegra utilizes technology to automate the underwriting/administrative processes, and employs a differentiated distribution network to overcome these challenges.

Fortegra also offers services (14% of GWPPE) which are principally warranty products and motor club programs. At the underwriting level, services are more profitable than the insurance business. Fortegra offers vehicle service contracts and guaranteed asset protection (GAP) for automobiles, and consumer goods warranties for “white box products” like phones, consumer electronics, appliances, etc. Fortegra also offers motor club programs. For those who don’t know, motor clubs are memberships that provide roadside assistance if a vehicle owner needs a tow, a tire change, or is locked out of the vehicle. Both products are capital light, fee-based products that provide meaningful cash flows that Fortegra uses to grow the insurance business.

CEO Rick Kahlbaugh does an excellent job of telling investors what risks Fortegra “will not” underwrite. Our opinion is that he wants to make sure that potential investors have a clear understanding of how Fortegra thinks about risk, and that starts with knowing what risks Fortegra will not take. At the highest level, Fortegra prefers frequency-exposed business and avoids severity-exposed business. Additionally, Fortegra prefers short-tail risks. Fortegra does not write workers comp or long-tail commercial auto because they are commoditized, longer-tail risks. Longer-tail policies are more exposed to compound mispricing. Fortegra will also not underwrite aviation or marine (to be clear Fortegra does underwrite inland marine). Fortegra has historically avoided catastrophic risks. So, what does Fortegra underwrite in its insurance business? Fortegra underwrites property and short tail risk (short-tail commercial auto physical damage, commercial property, homeowners), professional liability, contractual liability (i.e, contractual liability insurance policies), general liability, and personal lines (i.e., credit life insurance, admitted only).

The preceding several years have been marked by rapid growth in Fortegra’s E&S book. Fortegra entered the E&S market on October 1, 2020. Fortegra has quickly grown that book to approximately $900 million of GWPPE in a little over 3 years to capture just under 1% share of US E&S Direct Premium Written (“DPW”). Fortegra’s E&S growth has accounted for approximately 80% of commercial insurance growth over the last three years. Importantly, the commercial admitted (non-E&S business) has grown at approximately an 11% CAGR, so this business is still attractive, but the commercial admitted business’s growth has been dwarfed by E&S growth.

U.S. industry E&S DPW has increased from 13% of Commercial Lines DPW in 2012 to 22% in 2022. E&S DPW has grown at approximately twice the CAGR of the P&C industry over that time period. Why? Admitted coverage is regulated by states, and states regulate admitted coverage rate and form; admitted carriers are limited by the rates that they can charge. The tradeoff is that the admitted market is drastically larger than the E&S market. E&S focuses on harder-to-place risks that standard insurers cannot profitably underwrite. Insurers are facing increasingly complex risks, which are better served by E&S products. Conversely, COVID, supply chain disruptions, and inflation have driven some admitted carriers to vacate some admitted markets, which has opened opportunities for E&S lines to capture attractive business.

We think Fortegra is well positioned to continue to drive GWPPE growth in the mid-to-high teens. First, Fortegra’s E&S business continues to post exceptional growth. We believe Fortegra’s E&S business has written more premium (gross) in the first nine months of 2023 than it did in all of 2022. The E&S business is on pace to write gross premiums just shy of $900 million (run rate); that’s up from $640 million in the trailing twelve months ending Q1’23. Second, the insurance market continues to remain hard, which is supportive of incremental price increases. Third, Fortegra is continuing its expansion into Europe. Our understanding of the European market is that there is significant freedom in rate and form, so it behaves a lot like E&S market in the U.S. Lastly, Fortegra will be well capitalized with the proceeds from this IPO to accelerate its growth.

Distribution

Fortegra employs a highly efficient “one-to-many” approach. Fortegra uses Managing General Agents (“MGAs”), which allows Fortegra to leverage the expertise, personnel, and networks of MGAs. Fortegra gives its distribution partners “limited delegated underwriting authority,” which allows MGAs to underwrite business within parameters set by Fortegra. MGAs can “quote, bind, and issue policies” within those parameters, but MGAs do not control the pricing, terms, or reinsurance. Lastly, MGAs are generally not responsible for managing and processing claims. Importantly, Fortegra is significantly aligned with its distribution partners. Fortegra believes that the best way to instill underwriting discipline in an agency is through alignment of incentives. Fortegra deploys retrospective commission agreements that allow agencies to earn larger commissions for profitable underwriting and penalizes agencies for unprofitable underwriting. This is a key reason that Fortegra has consistent combined ratios; when losses increase, commissions decrease and vice versa. Lastly, Fortegra does not have significant distribution partner concentration. Fortegra’s largest distribution partners represented 6% of GWPPE for the nine months ended September 30, 2023. In summary, Fortegra relies on a “one-to-many” approach, using MGAs to leverage their expertise, personnel, and networks, and Fortegra incentivizes them to underwrite profitably.

MGAs are generally attracted to Fortegra for a combination of reasons. Fortegra is smaller and more entrepreneurial which allows for faster decision making. Fortegra has a good data and analytics platform that helps MGAs underwrite more profitably. The variable profit-sharing commission model allows talented MGAs to make more money partnering with Fortegra. And, Fortegra has a good reputation and platform. Fortegra does a great job retaining its best MGA distribution partners. Fortegra’s five-year annual average retention is greater than 95%, which indicates that MGAs are happy to continue working with Fortegra. Many MGAs may only start with one Fortegra specialty, but Fortegra will audit performance and identify potentially attractive new lines to grow with MGA partners over time. For example, Fortegra has evaluated over 250 potential new P&C programs in 2023 and has entered 13 new programs.

Technology

Fortegra’s technology infrastructure is purpose-built to handle a high volume of policies and claims to effectively service many small policyholders and contract holders. Fortegra’s administrative processes are highly automated which enables Fortegra to operate with a relatively low cost structure. Many insurers have built their business around large premium per risk products that have low frequency of claims but high severity. Consequently, larger insurers have IT systems designed to handle lower volume of large policies and cannot scale to cost effectively handle Fortegra’s volume of policies and claims. Fortegra built its business around credit insurance, which is a small premium per risk product with high frequency of losses but low severity. While we don’t have an updated estimate for this metric, we know that in 2020 Fortegra’s credit insurance claim adjudication team processed 6,100 claim adjudication transactions annually per employee. Assuming these employees didn’t work weekends, that’s 23.5 transactions per person per day. We would argue that many insurers’ internal technology systems aren’t designed to handle that workload.

Fortegra employs technology as a profitability and scalability tool, a performance tracker, and a persistency driver. Fortegra manages a lot of claims because Fortegra manages a lot of volume on small-premium-per-risk business with a high frequency of losses. Fortegra has deployed technology to expedite document processing and claims intake. Additionally, Fortegra uses data to monitor program performance. Armed with data, Fortegra can decide whether a program is performing in line with its expectations, and it can tweak the terms of the program to enhance the profitability of programs or cut a program if it is underperforming. Rick Kahlbaugh, Fortegra’s CEO, has frequently cited the case study mentioned on page 112 of Fortegra’s S-1 for how Fortegra has successfully used data to enhance the profitability of its underwriting. Essentially, conventional wisdom estimated that small law firms with 1-2 lawyers had less risk than a law firm with 3-10 lawyers. However, Fortegra’s data science team found that the opposite was true. Fortegra adjusted the program to increase premiums on law firms with less than 3 lawyers, and the actuarial team believes it will reduce the loss ratio by 6.5 points. Lastly, Fortegra’s implementation of technology drives agent retention or “persistency rate.” The case example above not only improves the profitability for Fortegra, but also the profitability for the agent. Moreover, Fortegra integrates its technology platform with the agent’s platform and provides the distribution partner with access to claims and performance dashboards. Fortegra improves its value proposition which buttresses agent retention by improving the profitability of the agent’s book and improving the agent’s process and experience.

Reinsurance

Insurers are liable as the direct insurer on all risks reinsured. Therefore, insurers that cede a material amount of their book are exposed to more counterparty risk than insurers that cede less. Fortegra cedes between 50% and 60% of what it writes. Approximately 50% of Fortegra’s reinsurance receivables and prepaid reinsurance premiums are related to contracts with third-party captives in which Fortegra holds collateral or letters of credit in excess of the reinsurance receivable. The other 50% of Fortegra’s reinsurance receivables and prepaid reinsurance premiums are held with high quality reinsurance partners, which substantially all have a rating of A or better by A.M. Best. Fortegra’s largest non-affiliated reinsurers are Allianz Global (A+ rated), Canada Life Assurance Company (A+ rated), and Canada Life International Reinsurance (A+ rated) and represent approximately 16% of reinsurance receivables.

Fortegra’s reinsurance partners are willing to take substantial volumes of paper from Fortegra because of Fortegra’s track record of consistent underwriting. Fortegra would likely keep more of its policies if it were better capitalized, and we expect Fortegra’s IPO to potentially be a catalyst that drives less reliance on reinsurance in the future.

Fortegra has two reinsurance treaties: a whole account quota share arrangement and excess loss reinsurance. Fortegra’s uses the whole account quota share arrangement for capital management purposes; Fortegra’s whole account quota share covers 40% of Fortegra’s commercial P&C insurance gross written premium. Fortegra underwrites very little catastrophic risk, and Fortegra has excess of loss reinsurance for the catastrophic risk it does take. Fortegra’s excess of loss reinsurance protects Fortegra in excess of a 1:200-year catastrophic event.

Key Ratios

We would like to quickly define a few terms for non-insurance investors. The Loss Ratio is claims and loss adjustment expenses divided by earned premiums and fees. Acquisition Ratio is commission expense divided by earned premiums and fees. Underwriting Ratio is the sum of the Loss Ratio and the Acquisition Ratio. Operating Expense Ratio is employee compensation and benefits divided by earned premiums and fees. Combined Ratio is Underwriting Ratio plus Operating Expense Ratio. Fortegra’s distribution model is essentially highly variable because its distribution isn’t owned, and Fortegra has a retrospective profit-sharing arrangement with MGAs. Fortegra’s Underwriting Ratio should be relatively consistent going forward. Therefore, Fortegra’s business model is really about getting more volume. This is a velocity model. Fortegra will drive some leverage in its Operating Expense Ratio with scale. We think there is potential for Fortegra’s Operating Expense Ratio to trend towards Kinsale’s Operating Expense Ratio in the high single-digits over time.

We don’t think investors should overly concern themselves with the shift in Loss Ratio and Acquisition Ratio. Investors should instead focus on Underwriting Ratio and Combined Ratio. We estimate that Fortegra has a material amount (up to 12% of GWPPE in the first nine months of 2023) of its book in credit insurance. Comparatively, we think credit insurance could have been as high as 35% of GWPPE in 2019. Credit insurance has meaningfully different Loss and Acquisition Ratios than the rest of Fortegra’s book. We think credit insurance is more like a 30% loss ratio product (better than Fortegra’s average loss ratio), but credit insurance can have up to a 60% acquisition ratio. Fortegra’s consolidated Loss Ratio increased, and its acquisition ratio decreased as credit insurance has declined as a percent of Fortegra’s total book.

Investment Portfolio

Fortegra’s investment portfolio is currently over $1.2B and yielding 3.2%. The portfolio is mostly comprised of “A” rated paper with an average duration of 2.4 years. As securities mature, Fortegra is reinvesting the portfolio into higher yielding securities. This continues to be a tailwind to adjusted net income.  

Fortegra Summary

In summary, Fortegra has strong growth and consistent combined ratios. Fortegra has carved out a niche for itself in small programs, focusing on lines that are underserved by larger insurers. Fortegra has built a scalable platform through its one-to-many distribution model and investments in technology. Fortegra is mindful of its risk selection and has meaningful continued growth ahead. Fortegra is Tiptree’s crown jewel, and we are excited that the IPO will highlight the quality of Fortegra’s business and the valuation disconnect of Tiptree’s stock.

Tiptree Capital

Tiptree Capital currently owns a Mortgage originator (Reliance), a profit share interest in a credit-focused asset manager (Corvid Peak), and a senior housing company (Invesque). Tiptree Capital previously owned maritime vessels before divesting all its ships (three dry bulk vessels and two product tankers) for a $34.8 million gain in 2022.

Reliance, a residential mortgage originator with 339 employees, is Tiptree Capital’s largest remaining investment. Reliance’s business has been impacted by the dramatic slowdown in originations due to the steep rise in interest rates over the past 24 months. Mortgage revenues and income before taxes in 2021 were $111 million and $28.4m, respectively. We estimate mortgage revenues and income before taxes in 2023 to be $50 million and $3.5 million, respectively, representing a greater than 50% decline in revenue. Importantly, this business could start to turn with the greater than 100 bp decline in the 30 year treasury over the last two months. We value this business at Tiptree’s stated book value of $54.1 million.

Tiptree Capital owns a 31.84% profit share interest in Corvid Peak. Corvid Peak manages materially all of Fortegra’s investment portfolio. Tiptree Capital is entitled to a 31.84% profit share from Corvid Peak in what essentially looks like a GP interest in Corvid Peak that increases by 10.2% per year through 2025. We view this asset as immaterial and ascribe no value to it.

Tiptree Capital’s business currently owns 14.1 million shares of Invesque (IVQ-TSE). Invesque is a CAD$17 million market cap company. Tiptree Capital’s ownership is currently worth approximately $4.5 million and is marked to market. We view this asset as immaterial and ascribe no value to it although it will provide a meaningful tax shelter if Tiptree sells any Fortegra stock in the future.

Tiptree capital’s cash and equity portfolio (minus the value of Invesque shares) is worth $120 million or $3.28/share. We add $54.1m for the value of the mortgage origination business to yield a $174.1m value, or $4.74/share, in Tiptree Capital.

Tiptree does incur recurring costs principally associated with employee compensation (27 employees), the costs of being public, and the cost of Tiptree’s leases. Corporate adjusted net income inclusive of stock-based compensation (i.e. not adding it back) is annualizing ~$27.6 million. At 10.0x, this detracts ~$7.51/share.

Prior IPO attempt

Fortegra attempted to go public in April 2021 in an IPO led by Bank of America, but the IPO ultimately failed. Fortegra’s April 2021 IPO filed with a $15-17 range with an expected pricing date of April 28, 2021 and an implied a $957m market cap. Fortegra would have gone public at 22.3x and 18.7x 2020 and expected 2021 EPS, respectively (versus specialty insurer comps trading at approximately 24x 2021 EPS estimates). Commentary on the IPO book was that it was oversubscribed on Friday April 23, 2021 with three days of marketing remaining the subsequent week. At one point on April 28, 2021 (the day of pricing), I talked with a co-manager on the offering who told me that the deal could come at $12 or lower, which was drastically different from the commentary that I was hearing from the lead manager. We later heard from the lead banker that there was a “good book” below the filing range, but Tiptree’s management thought that the updated deal price (materially below the filing range) was not an accurate reflection of Tiptree’s value and decided to walk away from the IPO. TIPT went from $14.90 on April 23, 2023 to as low as $8.04 on April 29, 2021 when the IPO was abandoned.

Fortegra still needed capital to continue to grow its business as fast as it wanted to grow. On October 12, 2021, Warburg Pincus invested $200m in Fortegra, which gave Fortegra sufficient capital to continue growing rapidly. At the time, Warburg’s valuation of Fortegra implied Tiptree’s ownership of Fortegra was worth $16.20. Warburg’s investment brought meaningful validation to Fortegra after the failed IPO, and TIPT traded 60% higher following the transaction. Warburg’s investment provided sufficient capital for Fortegra to grow until now.

Why was the IPO cold?

I think we need to put ourselves back in the mindset of April 2021. Money was free (the yield on the two-year treasury note was 0.14%), investors were chasing reflation stories coming out of COVID lock downs, and small caps were starting to drastically underperform large caps by April 2021.

We talked with several research analysts from banks on the IPO cover. We heard some notably awful opinions and some fair pushbacks including: “there isn’t a technology aspect like a Lemonade (LMND)”, “Fortegra doesn’t grow fast enough”, and “this shouldn’t have a dual class structure”. Well, LMND went from >$100/share to $17/share from April 2021 to December 2023. Fortegra’s growth meaningfully accelerated coming out of the failed IPO, and Fortegra has grown its GWPPE at a 25% CAGR since 2019. This IPO attempt removed the dual share class structure, which we applaud.

Once bitten, twice shy? Some investors will argue that Fortegra’s prior failed IPO makes them doubt this IPO attempt. We don’t recall a small cap IPO cover this strong that has failed. Further, Warburg’s name behind this IPO attempt will bring more credibility to the IPO and more attention from bankers that want to earn future Warburg IPOs. I think the prior process was very poorly run, and I’m excited to see a Goldman, JP Morgan, Jefferies, and Barclays lead-managed IPO. Importantly, Fortegra’s results have been absolutely stellar over the last 30 months since the failed IPO. Fortegra’s adjusted Net Income has increased from $43 million in 2020 to our estimate of $115 million in 2023. We see a path to Fortegra delivering $140-150 million in adjusted Net Income in 2024. Fortegra would be worth $39.95/share to TIPT proforma for a $300 million IPO if Fortegra earns a multiple (17.4x 2024 EPS) in-line with other specialty insurers. We see a path to Fortegra earning a multiple closer to KNSL and RLI over time, which currently trade for 27x 2023 EPS.

Valuation

We have bifurcated Fortegra’s comp group between standard carriers and specialty insurers. Fortegra’s business most closely aligns with other specialty insurers. Therefore, we’re focusing on comp analysis on other specialty insurers.

Few insurance underwriters grow premiums in the low double digits with consistent profitability as measured by the Combined Ratio with limited exposure to catastrophic risk. MKL, KNSL, RLI, SKWD are the closest specialty insurer comps based on operating metrics. Those four comps averaged 22.7% Gross Written Premium growth, an 87% Combined Ratio, and trade for an average of 22.4x 2023 EPS. We expect Fortegra’s to grow Gross Written Premium in the high teens percent while generating a 91% Combined Ratio. Fortegra’s book has been drastically more stable than those comps given Fortegra’s risk selection (less catastrophic risk) and retrospective commission agreements. Fortegra’s Combined Ratio had a 200bps range between 2019 and 2023. Compare that to a 500 to 900 bps range for MKL, KNSL, and RLI from the 2020 lows to today. Those models have more fixed operating leverage while Fortegra is a more variable model. We think there is a continent of investors that may prefer Fortegra’s combined ratio stability and assign a premium to Fortegra. We are modeling that Fortegra trades for a discount to these best-of-breed specialty insurers. We think 17.5x 2023 EPS is a reasonable IPO discount (5-turn discount), which would imply a $2 billion market cap. We are assuming that Fortegra raises $300 million in its upcoming IPO, which would reduce Tiptree’s ownership from 73.1% to 58.19%. Tiptree’s proforma ownership of Fortegra would be worth approximately $31.81/share.

We argue that TIPT could earn a 2024 EPS multiple in-line with the broader Specialty Insurer comp group (currently 17.4x 2024 EPS) over the course of 2024. Assuming our $300m IPO at 17.5x 2023 EPS is correct, then TIPT’s ownership in Fortegra could be worth approximately $40/share if TFG earns a peer group average multiple on 2024 EPS. This is a fairly reasonable upside case over the course of 2024, but our valuation is based on our more conservative base case.

We ascribe a 10x multiple to corporate costs when calculating TIPT’s price target. We add Tiptree’s proforma ownership of Fortegra with $4.74/share in book value from Tiptree Capital and subtract $7.51/share for our valuation of Tiptree’s corporate costs. We arrive at a $29.10 price target, which implies 57% upside from Tiptree’s closing price on January 5, 2023.

We believe that our 10x multiple on corporate costs is large, and we have seen other shareholders routinely use 5-8x on corporate costs. Our TIPT price target would increase by $1.50/share to $30.60 if we used 8x total corporate costs in our valuation.

Conclusion

Tiptree trades at less than 6x 2024 EPS, and Tiptree’s most material investment is being taken public by Goldman Sachs and JPM at probably no less than double TIPT’s current multiple. Fortegra should earn a high teens PE multiple over the next twelve months based on the most similar specialty insurers based on gross written premium growth and underwriting ratios. We believe Fortegra should also be able to cede materially less of its book after receiving proceeds from this IPO, and TIPT shareholders should benefit from Fortegra keeping more of its relatively stable and profitable book. TIPT, which has no research coverage, should undergo discovery after the Fortegra IPO launches, and we want to be invested ahead of that discovery.

Disclosure

Our firm currently holds a long position in this security which can currently be considered a long-term holding. Our research is completely independent and based on public information, our proprietary research, and our analysis of that information. While Author has tried to present facts it believes are accurate, Author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in TIPT or The Fortegra Group. Reader agrees to hold harmless and hereby waives any causes of action against author related to the note above. As with all investments, caveat emptor.

Catalyst

The Fortegra Group (TFG) IPO drives TIPT discovery