ProCentury Corp PROS
December 31, 2004 - 12:26pm EST by
met99
2004 2005
Price: 12.33 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 162 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Through a somewhat convoluted IPO, and internal capital restructuring accomplished this past spring, PROS has emerged as a well capitalized specialty surplus and excess lines P&C insurer, exploiting a variety of niches in the industry. How about pet-sitting insurance?

PROS is small, not making it to the top 50 in the AM Best list in its category on a size basis, but garnering an excellent A- rating. They believe they can compete on niche business and service.

$55MM of the capital raised in the IPO went to the insurance subsidiary, and as a result more business can be generated. Top line growth is 38% in Q3 '04 vs. Q3 '03 due to more premiums, and greater investment income on more invested assets. For the quarter, income for continuing operations is 3.712MM (.28/share) vs. year ago 3.069MM, an increase of 21%. (Per share comparisons, are meaningless given the huge swings in share count.) For the 9 months, income from continuing ops is 9.585MM vs. a loss of 3.952MM.

I have a TTM adjusted earnings estimate (pro forma in effect) of $1.20/share on the present share base. As with most insurers, the cash flow numbers are quite attractive as premiums come in and move to the ‘float’. Since there are no line items for either depreciation or cap ex, earnings translate to FCF. Thus PE and FCF multiple are 10.25x on today's price of $12.33/share.

Balance sheet valuation is more readily compared. Book is $8.38/share for a P/B of 1.47x. As a comp, PNG (a similarly sized E&S lines insurer) has agreed to a buyout by UNGL on the basis of $13.875 worth in UNGL shares + $1.50 or $15.38 in value. In mid-October when this was announced this represented a PB multiple for PNG of 1.62x on PNG’s Q3 book value . At the time, UNGL was trading at $14.84. Now it is at $18.44. The market certainly appreciates that capped price for PNG.

PROS operates in the surplus and excess lines segment of the P&C insurance industry. This allows better control over the terms and specific coverages they write. PROS conducts detailed underwriting review of every policy it issues. It intends to make its profits in underwriting, as it maintains a very conservative investment profile on its investments. Income from investments is to a degree ‘gravy’. PROS understands it can’t fully control losses, or premium pricing, but it exerts full control over its own expenses aggressively. Management has stated it will not chase business if a competitor wishes to undersell. The management is conservative, and since taking over 4 years ago has done an excellent job of improving the company’s business to the extent the IPO could be successfully executed last spring. Now with additional capital available, they expect to more fully exploit the niches they have identified. The one drag has been longer tail legacy policies in construction. Management has progressively bumped up reserves, particularly in the last two years. Reserves were increased by 49.1MM from '01 through '03.

PROS expects to grow its business through next year based on the ability to write more premium given the capital infusion. Earnings in the most recent quarter were $.28. If this is merely annualized, book value will grow to $9.78 by year end ‘05. With a 1.5 PB multiple, the stock price could readily move to $14.67. With likely additional growth, this would move even higher.

Growth expectations are based on increased premium and in part on less pressure to reserve for losses going forward. PROS has been moving away from long tail business, and as this declines, and the emphasis on newer premiums written on shorter tail niches PROS has more recently exploited increases, the need for recent conservative reserving declines. Top line growth cited above YOY gives some confidence growth is distinctly possible. The recent expense ratio is 30.1%, and the loss ratio is 62.0%, for a combined ratio of 92.1%

PROS has had a significant move on its stock price in the last month. I regret I didn’t get this idea processed before that, but given the parallel movement in the UNGL price, PROS remains at least proportionately less expensive. At the bare minimum, this conservatively run operation, with significant book value increases ahead deserves addition to a watch list.

Catalyst

1) Significant increase in book value driving share price increase.
2) Disciplined growth in premiums and earnings utilizing recent IPO capital.
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