White Mountains Insurance (WTM) – Valuation Gap – 30% Upside

Current Price: $1080

Target Price: $1400

Upside: 30%

Expiration date: H1 2021

Q3 press release

This idea was shared by Tadas.

 

White Mountains Insurance is an underfollowed insurance investment holding company with a fantastic track record, a history of large buybacks, and an interesting but opaque set-up currently.

The thesis here is quite simple – Q4 results of WTM (to be released tomorrow or Monday next week) will reveal a substantial increase in BV/adj.BV due to the recent IPO of MediaAlpha (MAX) IPO in October. I am expecting this to act as a catalyst for WTM share price appreciation as the company has always traded around its book value and currently shares stand at 0.8xBV.

MediaAlpha is WTM’s major holding (12% of BV as of Q3, and 29% currently), which IPO’ed at $19/share and currently is trading at $58/share. The most recent WTM Q3 results showed adj. BV of $1100/share. However, taking into account the share price appreciation of MAX, the BV should now stand around $1400/share. Each $1 change in MAX share price results in around $6.6/share change in WTM BV (Q3 release):

Subsequent to the MediaAlpha IPO, each $1.00 per share increase or decrease in the stock price of MediaAlpha will result in an approximate $7 per share increase or decrease in White Mountains’s book value per share and adjusted book value per share.

Currently WTM trades at 0.8x adj. BV, which is well below its historical valuations:

Moreover, the company has a great track record of creating value, compounding its BV, consistently producing solid ROE (around 10%), and a history of large share buybacks. WTM has repurchased nearly half of its outstanding shares since 2016 (see the section below).

Together with the whole insurance industry, the company was impacted by COVID-19, which resulted in the share price fall during the first 3 quarters of 2020. However, WTM segments performed quite solidly with profitability remaining stable/growing and with limited/no effect on the BV. Upon successful IPO listing of MAX both – the share and the BV – started increasing, however, the gap between the two never closed. I would expect the company to get back to its previous valuation levels (1xBV) eventually and Q4 result announcement with a clearly indicated new BV might act as a catalyst for that.

There might also be more catalysts down the line to close the valuation gap.

It is likely WMT is willing to divest MediaAlpha fully, but the process could be delayed (IPO lock-up expires in April 2021). WTM sold down part of its stake (3m shares) in MediaAlpha IPO and back in 2019 sold a significant stake to Private Equity firm Insignia Capital. These actions suggest that WTM is more interested in selling MediaAlpha than keeping it. With MAX stake making up 30% of WMT book value any further sales would give plenty of dry powder for buybacks if the valuation spread persists.

 

White Mountains

WTM is a former insurance holding company founded by John J. Byrne. Currently, the insurance operations are a relatively small part of the whole with other insurance-related services making up the rest:

  • HG Gobal/BAM – Financial guarantor, insuring public purpose municipal bonds. The structure here is interesting – BAM is a mutual company owned by municipality policyholders and HG RE provides first-loss reinsurance to BAM. The best peer company to compare BAM with is Assured Guaranty Ltd. (AGO) however BAM’s insured portfolio consists only of essential public purpose U.S. municipal bonds, and it has no exposure to mortgage and asset-backed securities, derivatives, non-U.S. structured or sovereign credits or territorial credits.
  • NSM – full-service specialty MGU and program administrator in US and UK. The company places insurance in niche sectors such as specialty transportation, social services, and real estate. On behalf of its insurance carrier partners, NSM manages all aspects of the placement process, including product development, marketing, underwriting, policy issuance, and claims. NSM earns commissions based on the volume and profitability of the insurance that it places. NSM does not take insurance risks. The segment generated 48m of EBITDA in 2019 and 43,9m of EBITDA in 9m of 2020.
  • Kudu – provides capital solutions and advisory services to asset management and wealth management firms. The best public peer to compare it to would probably be Affiliated Managers Group, Inc. (AMG). Kudu invests in asset management companies and typically provides liquidity for MBO or growth in a form of fixed income instruments. At the end of 2019, the average cash yield to Kudu at inception for the $266 million of deployed capital was 10.6%.
  • MediaAlpha – insurance customer acquisition marketplace. MediaAlpha’s media buying platform (“MediaAlpha for Advertisers”) enables advertisers to create and automate data-driven bidding strategies designed to improve the efficiency and enhance the overall performance of their marketing campaigns. WTM owns 20.5m of MAX shares (32% stake).
  • Other operations – various other investment management, asset management subsidiaries and strategic investments (stocks, bonds, etc.).

The balance sheet looks like this:

Note – fair value of MAX stake was valued at $475m in Q3.

So far WTM has been very successful with its consistent book value compounding strategy (similar to Berkshire, which by the way used to be WTM major shareholder till 2008) – over the last 20 years BV of the company has been growing by around 9% (management letter):

Aside from the successful listing of MAX, one other big recent WTM win was the sale of OneBeacon in 2017. With the help from Warren Buffet, WTM acquired a struggling insurer OneBeacon in 2001 at below BV and then quickly transformed the company. In a few years the combined ratio went from 1.21 to below 1.00 (was 0.97 in 2016). Over 16 years WTM managed to significantly increase OneBeacon’s book value and in 2017 sold the company at 1.7x BV, generating 2.5x return on investment and 14% IRR.

WTM management has achieved this successful track record while retaining a very conservative and disciplined investment approach. For the last several years the company has been keeping a significant portion of equity capital undeployed and carried out large amounts of buybacks (at around BV).

Recently the company acquired Ark Insurance Holdings (an online system for insurer’ products comparison), so Q3 earnings release stated that the capital is now fully deployed. Thus any further buybacks will likely need to wait for MAX ownership selldown.

 

16 COMMENTS

  1. R

    Thanks for the interesting idea. The upcoming earnings report and valuation would be based on the year end $39.07 MAX closing price right? So we may see this BV adjustment spread across Q4 and Q1 if MAX remains at current levels in March? Am I thinking about this correctly?

    1. dt

      In q3 earnings release management clearly articulated not only the quarter-end BV but also the BV using MAX price at the time of release. So might be similar this quarter.

  2. Writser

    The main question I would have is: why would this not be priced in already? The company literally explains how to calculate adjusted book value in their latest earnings PR. I don’t expect that the share price goes up by 20% as they explain the exact same thing in a press release a few months later. It’s not like this is an illiquid microcap in Kazakhstan.

    This is perhaps an interesting idea by itself. A decent company with history of buying back shares, trading below historical valuation. Probably a decent investment. It’s just that I am not particularly impressed by the catalyst. Then again, I guess it could happen, what do I know.

  3. John Park

    WTM reported their Q3 on 11/6/20. On that date, MAX traded at $46. Today, MAX is $53.50, or $7.50 higher. If each $1 changes WTM BV by $6.60, that would be a $49.50/shr increase in BV, or a 4.6% of the stock price. This is certainly not bad, but would really be that much of a positive surprise to the market, all things held equal?

  4. Dan T

    White Mountains Insurance Group (WTM) posted Q4 earnings Friday of $157.70 per share, up from $19.12 per share a year ago.

    Total revenue was $520.8 million, up from $175.3 million a year earlier. The adjusted book value was $1,263.64 per share, up from $1,018.41 per share a year ago.

  5. Terence

    Q4 earnings out: as Writser predicted, no effect on stock price. But hopefully fundamentals/other catalysts will work later, per write-up and Writser. Thanks for the idea.

  6. Zulu Investor

    Hi – my question is, have the market value of public investments always been recorded as part of a holding company’s book value? Or were they always recorded at cost? I’m not an accounting expert so I am confused on this part.

    I might also be conflating this with the new accounting rules that were passed a few years ago that allowed companies to record unrealized gains/ losses as part of net income for a company which would increase or decrease the book value accordingly as retained earnings. Can’t someone say that if MAX plummets, then the valuation gap for WTM could easily be eliminated or narrow significantly?

    I understand that the valuation has always traded at 1x BV historically but I also think the rules might have changed in a way that makes book value not so relevant a measure anymore.

  7. fishwithwings

    Looks like WTM is offering 3,122,460 shares in a secondary offering, doubling the shares outstanding.

    Any update on the thesis?

    1. dt

      Not sure what you mean by ‘doubling the shares outstanding’.

      WTM is one of the selling shareholders in MAX secondary offering. The full sale of WTM’s MediaAlpha stake was part of the initial thesis:

      “It is likely WMT is willing to divest MediaAlpha fully, but the process could be delayed (IPO lock-up expires in April 2021). <...> With MAX stake making up 30% of WMT book value any further sales would give plenty of dry powder for buybacks if the valuation spread persists.”

      MAX is selling up to 7m shares (including 3.1m by WTM). WTM stake in MAX will get reduced from around 32% to 29%.

      At current price levels of MediaAlpha, WTM book value should be around $1350/share, meaning it still trades somewhere around 0.87xBV, which is well below historical norms. Importantly, this stake sale kind of confirms the assumption that that WTM will convert MAX holdings into cash at the earliest convenience. IPO lock-up expires in April’21 and the chances are that we might see some further divestment transactions in the near-term. This should help close the discount completely.

      https://www.sec.gov/Archives/edgar/data/1818383/000119312521082765/d149704ds1.htm

      1
  8. rc99ar

    I interpreted it as 3M of their Max shares they are dumping. It is driving down the price of Max as 7M shares total are coming on the market. The thesis is playing out correctly but I exited the trade for now, may come back in depending where Max price shakes out. (Maybe I’m the fish?.. 🙂 Shorting out the 29% BV portion of Max looks brilliant today, would have looked quite foolish a few days ago.

  9. Terence

    MAX: sale of 7m shares crushed its price by 31% from 65 to 45! MAX total outstanding shares is 64m per write-up above (34m per yahoo finance).

  10. dt

    The spread between WTM share price and it’s NAV has been virtually eliminated and currently stands at only 4% vs 30% at the time of the write-up. The spread has narrowed due to a combination of the increase in WTM price (+11%) as well as the decline in MAX share price (-28%), which in turn has lowered the adjusted book value.

    We are closing this idea with unhedged WTM position having delivered 11% return in 4 months.

    Hedge position returned far higher +20% profit (using 1:6 hedge ratio) as the share price of MediaAlpha (MAX) declined by 28% during the same period.

    3
    1. jwestern

      Interesting that with such a large share price, an odd lot is still defined as < 100 shares. Most shares tendered I imagine would be odd lots.

      3

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