WESTAIM CORP WEDXF
February 24, 2019 - 2:52pm EST by
Poms
2019 2020
Price: 1.97 EPS 0.9 0
Shares Out. (in M): 143 P/E 16.4 0
Market Cap (in $M): 281 P/FCF na 0
Net Debt (in $M): 39 EBIT 0 0
TEV ($): 328 TEV/EBIT na 0

Sign up for free guest access to view investment idea with a 45 days delay.

  • Discount to NAV
  • Sum Of The Parts (SOTP)
 

Description

Overview
Westaim (TSXV:WED) is an investment company traded on the Toronto exchange with a focus on financials. The company has gone full cycle on one investment, Jevco, which more than doubled in TEV from its acquisition in Mar-10 for $261.4M and sale for $530.0M in Sep-12, after which management returned the vast majority of the proceeds to its shareholders. Today, Westaim owns effective control positions in two companies: HIIG, a specialty insurer, and Arena Group, a fundamental credit investment manager. One note: share quotations are for the American Depository Receipts (WEDXF) and all financial figures are in USD, as the subsidiary operations are materially all in the United States.

The thesis on Westaim is a story as old as time for value investors: an undervalued sum-of-the parts. This is a well-run holding company with aligned management that trades at a discount to a book value. Book value, in turn, understates the economic value of each of its two subsidiaries.

At the highest level, the thesis is:

  • Market Cap: $281 million; $1.97 / share
  • Book Value: $338 million; $2.36 / share (0.83x price-to-book value)
  • Economic Value: $470 million; $3.28 / share (0.60x price-to-economic value)
  • Probabilistically, economic values are more likely skewed to the upside vs. the downside when compared to a base case shown above
  • High quality management team aligned with shareholders (own 9.7% of common shares)
  • Any further value-creating acquisitions are purely to the upside

The risks are relatively straightforward for these types of businesses:

  • HIIG: quality of underwriting, integration level of acquisitions, and profit sustainability of specialty lines
  • Arena: ability to scale the asset base at good fee rates and, relatedly, go-forward investment performance
  • One circumstantial negative compliance mark in the background of each portfolio CEO

The above bridge from market value to economic value is shown in more detail below, after which is a brief summary of the understated value of HIIG and Arena. A history of the Company and a more comprehensive explanation of each subsidiary follows.

 

HIIG is carried on Westaim’s books at 1.1x book value; both trading comps and recent precedent transaction comps would indicate a more appropriate value at ~1.6x. Westaim management received numerous inbounds for HIIG and announced a strategic review in Q2-18, which has not resulted in a sale, at least to-date. While a transaction not clearing is rightfully cause for some trepidation, this author speculates that management is unwilling to part with a good operation that has both organic and acquisition runway unless they can fetch an outsized exit price. Westaim has continued to build value at HIIG since announcing the strategic review, completing two acquisitions in the timeframe.

The Arena Group is a series of entities that combine to create a fundamentally-driven credit investment manager generating equity-like mid-teens returns with a CEO boasting a track record of doing so. There are three groups of Arena entities: Investors, Origination, and Finance. Origination and Finance are held at 1.0x book value and I have no good reasons to dispute those marks.

 

Arena Investors, however, is carried on the books at -$8.2M of book value. This negative value deeply understates the inherent economic and option value in the business, to say the least, but is a function of start-up costs when building an asset management platform (hiring and building infrastructure ahead of fee income). Westaim’s share of Arena Investors’ EBITDA should be ~$5M on a run-rate basis, but that could quickly break to the upside given the returns, pace of inflows, and senior team’s track record. A 10x multiple would make this a $50M business, which still leaves upside equity potential if the platform continues to scale or even begins to approach the $5B at the top-end of the agreed-to structure between Westaim and Arena management.

 

As spike945 noted in a great September 2017 write-up, management is composed of seasoned investors with skin in the game (~10% of CSO) and is therefore shareholder-friendly and focused on long-term value creation, not reporting.


History
First, the history of Westaim’s one realized acquisition with current management is well displayed by the company’s own case study on its first acquisition, Jevco. This slide is instructive and a link follows for the full presentation for those so inclined.


https://westaim.com/wp-content/uploads/2014/04/Jevco-Case-Study.pdf


Onto its current iteration; Westaim owns significant stakes in two subsidiary companies and it seems as though they’re running the same type of playbook.



Houston International Insurance Group (HIIG)

HIIG is a multi-line specialty insurer built through acquisitions and owned 44% (on a look-through basis) by Westaim, along with partners Everest RE and Catlin Group, who joined via a private placement. The company writes five lines of business across the following divisions:

 

  1. Accident & Health: Medical Stop Loss to Self-Funded Health Plans through Brokers & TPAs
  2. Construction: General & Excess Liability, Commercial Auto & Physical, Property & Inland Marine, and Workers Comp
  3. Energy: General & Excess Liability, Commercial Auto & Physical, Property & Inland Marine, and Workers Comp to Offshore, Onshore, O&G, Mining
  4. Specialty: General & Excess Liability, Commercial Auto & Physical, Property & Inland Marine, and Workers Comp to Hospitality, Pest Control, Monoline Workers Comp and other niche areas
  5. Professional: Insurance Agents Errors & Omissions, Title Agents Errors & Omissions, Miscellaneous Errors & Omissions, Mortgage Protection Insurance, Community Banks, and Allied Health

 

HIIG is carried on Westaim’s books at a conservative 1.1x adjusted book value, which marks HIIG in the bottom quartile of the valuation range on both book and earnings multiples (implied).