|Shares Out. (in M):||241||P/E||10.0x||7.0x|
|Market Cap (in $M):||450||P/FCF||10.0x||7.0x|
|Net Debt (in $M):||-83||EBIT||48||72|
The common stock of Omega Insurance Holdings, OIH on the London Stock Exchange (115p or US$1.90), presents investors with little downside risk and 30%+ upside return in four months owing to a readily identifiable catalyst.
Omega is a short tail insurance company trading at 90% of 2009e year end net tangible assets (tangible book value), and at 10x 2009e EPS and 8x EPS based on the trailing 4 year average ROE (2006 = 11%, 19%, 8%, 2009e 13%). The Market is valuing the stock near the bottom of its group of peers (0.9x to 1.4x book value) and near its 52-week low (115p current, 160p high, 110p low) because the lead underwriter departed on October 29 due to a difference of opinions with the CEO and the board. But the top shareholder has called a special general meeting of shareholders to replace the the CEO and the board, and to bring the lead underwriter back. The motion has support from over 50% of shareholders including: (1) Invesco (30%), (2) Artemis (10%), and the (4) lead underwriter John Robinson (7%).
Omega’s former chief underwriter, John Robinson, owns an outstanding track record of underwriting profitably in each year since 1980. Omega’s subsidiary is a Lloyd’s managing agent for Syndicate 958. Robinson, was a founding partner of Syndicate 958 in 1979, and has been an underwriter for the Syndicate for all of its 30 years of operation. Omega has delivered an underwriting profit in every single year, including two soft cycles amounting to nine years in which Lloyd’s was unprofitable (1989-92 and 1998-2001). These outstanding results are nicely presented in a chart in Omega's 2009 Interim Results Presentation. http://www.omegauw.com/investor/
Omega’s lead underwriter possesses an outstanding reputation among peers for underwriting ability. Outstanding underwriting track records are usually the result of a combination of skill and luck. Robinson’s 30 year’s of profitable underwriting must certainly benefit from some good fortune. But two top underwriters at Lloyd’s volunteered that Robinson was a terrific underwriter, and one of the best. He’s a maverick, one of them said, he made the company, and he is one of the few good underwriters around. Robinson is so disciplined, that when Omega embarked upon a growth program during a soft pricing environment earlier this year, he fought it, and ultimately resigned.
Omega’s top shareholders are unwilling to tolerate corporate malfeasance. Invesco, which owns 30% of Omega, has requested a special general meeting of shareholders to approve its resolution to replace the chairman and four other directors with nominees of its own. Invesco is operating with the support of Artemis, and apparently with the support of John Robinson and other shareholders. Because management followed a strategy of expansion, which included adding expenses and premium during a period of falling insurance rates, the chief underwriter John Robinson became increasingly dissatisfied.
As tension mounted, management called Artemis and claimed to have the support of Invesco for the growth strategy which it favored and Robinson opposed, and management asked Artemis for its support as well. Artemis consented. Then management called Invesco and advertised the support of Artemis for its growth strategy, and asked Invesco for its support too. Invesco consented. Feeling confident that they had the support of the top two shareholders, management was more determined in its stand off with Robinson, who resigned in frustration. But then Invesco and Artemis communicated, discovering that management had misled them both. So Invesco is seeking to replace management. Invesco, Artemis, and Robinson own 47.5% of shares outstanding. (This is not my principal source for details, but it is an easy and recent link to access = http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/insurance/6928276/Omega-Insurance-shareholders-back-boardroom-coup.html)
SIGNIFICANT DOWNSIDE FOR THE STOCK IS HARD TO IMAGINE
Significant downside for the stock is difficult to envision. If Robinson hasn’t returned by June of 2010, it is likely that one can sell the shares for no loss of principal.
The stock trades at less than 90% of net tangible assets. Financial investments account for 60% of assets. The investment portfolio is low risk and liquid because Omega is a short-tail carrier. So among a US$545m investment portfolio, 65% is government related, another 18% is deposits with credit institutions, and just 13% is corporate bonds. Cash accounts for 9% of assets. The lower-risk investment portfolio is evident in the company’s investment yield, which has averaged 1% lower than peers during the past several years.
Omega is not the sort of insurance business that is likely to experience reserve inadequacy. A common way to lose money investing in insurance companies is because reserves are inadequate. This risk is low for Omega for two reasons. Most important, the company writes short-tail property and not long-tail casualty lines of insurance. Second, the company and its chief underwriter have an outstanding track record and reputation. Of course, now that Robinson has resigned, Omega is operating without an experienced underwriter, so this is a risk to monitor. So far, there is nothing I have learned from industry sources which suggests Omega is underwriting without discipline. It is unlikely, furthermore, that Omega can lose more than 20% of its shareholders’ equity in one year.
PAY LITTLE FOR THE LIKELY OUTCOME THAT THE KEY UNDERWRITER RETURNS AND THE STOCK IS WORTH 130% OF BOOK
It seems we pay little for the option that within four months Robinson returns and the share price appreciates 30%+. The most likely outcome is that the board and senior management are replaced, and that John Robinson returns as chief underwriter in the first quarter of 2010. Robinson’s strong track record indicates that with him in control and operating Omega on a small scale (policy is a 70% dividend payout ratio), the business should return around 13% on shareholders’ equity. So the stock is worth around 130-140% of shareholders’ equity, or around a 10% earnings yield and 7% dividend yield.
The foundation for a valuation of 130% of tangible book value is the company's outstanding underwriting profitability, which drives expected returns on equity of 13%. The average underwriting profit since 1980 is 12% (min of 2% in 1989 and max of 45% in 1993). Given underwriting leverage of about 0.6x net premium earned to shareholders' equity, and a tax rate of 10%, the underwriting return on equity is 6-7%. Omega gets another 2% return on equity from fees associated with managing capital for the other investors in Syndicate 958. The investment return is below normal today, at around 1%, but I consider 3% more normal, and with investment leverage of about 1.75x investments to shareholders' equity, the investment return on equity is 5%. So the overall normal ROE is 13%, with contributions of 6% from underwriting, 5% from investments, and 2% from underwriting fee income.
Shareholders, led by Invesco (30%), vote to remove management and the board and to bring back the outstanding underwriter John Robinson. This should happen during January at a special general meeting of shareholders, that Invesco requested in December.