Emergent Capital (EMGCQ) – Portfolio Run-off – 250%+ Upside

Current Price: $0.21

Target Price: $0.70

Upside: 250%+

Expiration Date: 2025

 

This is quite an unusual and fairly interesting idea that was published on VIC in August 2019. Please refer to it for more background on EMGC and life settlement insurance industry. The thesis remains largely the same, however, some important developments have happened over the last couple years. Worth noting that our knowledge of certain nuances in this situation is limited, including the life settlement business itself and various aspects of the trading shift to Vienna MTFs, where the company is due to relist shortly. Thus, any input from more knowledgeable SSI members would be very much appreciated.

A quick note on the industry – life settlement insurance business involves buying a portfolio of different policies and paying the premiums till the policies mature. i.e. till the insured individual dies. Such individuals are often very affluent and have entered very juicy insurance policies, therefore the average death benefit per policy is high – $4.7m in the case of EMGC portfolio. However, the average premiums are also substantial – $17k/month. The insured individuals might decide to sell their insurance policy to the likes of EMGC if they want to cash-out or are unable to continue paying premiums. Although it doesn’t sound very nice, in this business investors win if the insureds die sooner than it would take to turn the NPV of the policies negative.

Emergent Capital is a hold-co, which owns 27.5% in a run-off portfolio of life-settlements. The portfolio has 500 remaining policies with the remaining face value of maturities at $2.4bn and the average age of insureds at 85.9 years. EMGC stake in the portfolio has an actuarial fair value of $153m, which translates into a book value of $0.34/share. This fair value was assessed using a discounted cash flow model, which involved various actuarial estimates, the most important ones being life expectancy of the insureds and the appropriate discount rate (EMGC is using 14%). Thus, if these estimates are correct, you’re buying EMGC at a 39% discount to its intrinsic value. However, several aspects indicate that the actual value of EMGC stake could be significantly higher – one scenario outlined below shows a potential upside of 250%+. Margin of safety seems sufficient and the downside is protected due to the current hold-co structure.

The situation also accommodates an “unexpected surprise” factor, or an option style bet, where the number of maturities could randomly skyrocket during a particular period sending the share price upwards the way it has already happened during the COVID-19 outbreak when the stock went up from $0.20/share to $0.40/share in a short period of time. Such an event could provide considerable returns with a much shorter time frame.

Management owns 50% of the company and in recent years has done a great job saving and transforming a grossly mismanaged EMGC. Their stake and commitment here add confidence for positive outcome.

It is important to highlight that the company is in the process of restructuring. The current OTC listing will be canceled and the company will relist on Vienna MTF – multilateral trading facility managed by Vienna Stock Exchange. It is not yet clear how the shift will happen and how exactly smaller retail investors with no abilities to hold Vienna-listed MTFs will be treated. Shares have already dropped 30% upon this announcement, but there might be a further forced sell-off upon the actual relisting providing better opportunities to enter this trade.

In short, the whole EMGC investment case (in excess of the 39% discount to BV) rests on the insureds dying faster (at least in short term) than indicated by the actuarial life expectancy estimates baked in the valuations of the portfolio. It is best to look at EMGC as a very long-term option that might or might not pay-off, but if it does, the returns could be juicy.

 

Quick background

From its inception in 2011 till March 2017 EMGC was run, or it might be more correct to say, mismanaged by Antony Mitchell – CEO with a proven track record of value destruction. The management constructed an ill-balanced portfolio aiming to visually inflate the potential returns and went on promoting the stock while keeping high levels of SG&A. Eventually, the liquidity went dry and the company started issuing equity, expensive debt and even sold-off 45% of their future maturities to fund the ongoing operations. Then in 2017, the company announced a recapitalization transaction and Mitchell resigned several months after that. A bunch of investors together with the current CEO Patrick Curry injected capital and took a 70% stake in EMGC. Nonetheless, the portfolio’s insureds proved to be incredibly healthy and just continued on living. Due to lack of maturities, the company ran out of cash again, and in 2019 announced another reorganization with Jade Mountain Partners (JM) – 72.5% stake in White Eagle SPV (special purpose vehicle which held the portfolio of the insureds) was sold to Jade Mountain, with EMGC retaining 27.5%. JM also covered White Eagle’s debt, took over the management of the SPV, and agreed to finance all future policy payments. As a result of the restructuring (lowered SG&A and interest expenses) and increasing maturities, EMGC finally started delivering positive cashflows in Q2’19. Since then, the number of maturities continued to increase and were further escalated by the COVID-19 tailwinds.

 

Portfolio details

The whole life settlement insurance portfolio is held by the special purpose vehicle White Eagle. EMGC owns 27.5% of White Eagle, while the remaining 72.5% belongs to Jade Mountain.

Current portfolio overview:

The aggregate death benefit is $2.4bn. As of Q3, EMGC estimates fair value (NPV) of the total portfolio at $663m. Fair value of its 27.5% stake is estimated at $153m, including a certain amount of debt at 11% interest to be repaid to JM through waterfall distributions (more details below). Fair value is recalculated each quarter and since Q2’19 it has doubled from $77m to $153m in Q3’21.

Portfolio’s NPV is estimated using a DCF model. For the remaining life expectancy of the insureds, the company uses actuarial estimate tables from third-party companies. Portfolio split by remaining life expectancy is provided below:

For discount rate EMGC uses mid-teen rates with an average of 14.04%. As can be expected, even a small change in the discount rate would make a very significant effect on the EMGC’s portion of the portfolio NPV (e.g. 0.5% decrease in the discount rate, pushes up the fair value of EMGC’s stake by 2.6%) and even larger effect on EMGC book value due to high leverage at the hold-co level.

Overall, it seems fair to say that both life expectancy estimations and the discount rate could prove to be conservative. Most insureds are already very old, while the remaining 6.6 years of life in the actuarial tables seems to indicate that quite a lot of them will live up close to 100 years. The chances are, that on average they might pass away faster than that. There’s not much to say regarding the discount rate, only that 14.04% average seems like a stretch, and assuming a bit lower rate, the real fair value would end up materially higher.

 

Waterfall distribution structure

All proceeds from the maturity payments are collected by White Eagle and first of all, are used to cover all of the upcoming premium payments. The remaining amount is then set to be distributed among the SPV owners proportionally. Distributions are to made on the 5th day of each month.

Upcoming premium payments for the SPV are provided below (in thousands). 2020 refers to Q4’20:

If there are not enough maturities to cover the premiums, the deficit then has to be covered by JM and EMGC proportionally. However, during 2019 Jade Mountain has agreed to finance any future premium payments also on behalf of EMGC an interest rate of 11%. This structure protects EMGC from any direct exposure to premium payments, however, the amount including any accumulated interest that gets covered by JM on EMGC’s behalf then has to be repaid through the waterfall structure.

Distributions structure:

  • Insurance premiums are the highest priority. Collected maturities are first of all used to cover the upcoming premium payments and certain facility expenses (the required amount is transferred from the collections account to the premium/expense account).
  • The remaining amount from maturity payments is distributed proportionally between JM and EMGC.
  • Part of the agreement under the waterfall structure was that for the first three years EMGC will receive a guaranteed payment of $8m annually from the maturity proceeds and $4m/year in the next seven years. After the first three years (with $8m payments), further $4m payments will be prioritized to repay the outstanding $8m loan from JM (see the point below). These guaranteed payments ($8m first 3 years and $4m next 7 years) to EMGC will occur regardless of maturities, however, they are subordinate to the 11% JM interest payments.
  • Following the JM agreement to finance future premium payments, in August 2019, JM advanced $30.1m to the premium/expense reserve account ($21.8m on its own behalf and $8.3m for EMGC at an 11% annual rate). So far due to increased maturities, death benefits were enough to cover the premiums, and no further advances from Jade Mountain were required. The $8.3m is to be repaid through the waterfall distribution from amounts to be distributed to EMGC. So far, no payments with respect to this debt have been made and $1m unpaid interest has already accrued.
  • Additionally, in 2019 JM advanced EMGC $15.25m at an 11% annual rate. It seems that about $8m remains outstanding.

Overall, the current structure protects EMGC from covering the insurance premium deficit. After the JM loans ($8.3m and $8.0m plus interest) are repaid, EMGC will have direct exposure to 27.5% of further maturity proceeds, including the guaranteed $8m payment for one more year and $4m in the seven years thereafter.

 

Ongoing Restructuring

One of the major risks for EMGC was its $47m senior debt due in July’21. For that, the company has filed for a voluntary Chapter 11 in October’20 with a plan to reorganize. The docket and the restructuring plan can be found here and here. A short Q&A can found here.

Certain details of the proposed restructuring:

  • EMGC will continue its operations through its current Irish subsidiary Lamington, which owns 27.5% stake in White Eagle. All US operations will be wound up (including the OTC listing). EGMC common stock together with its new Series A and Series B notes and Trust Certificates (see below) will be listed on the Vienna MTF (multilateral trading facility).
  • Common stock of EMGC will get exchanged for new profit participating notes (“PPNs”) that will be equal in value to the common stock. EMGC will form a grantor trust and those PPNs will be exchanged into Trust Certificates, which will trade on Vienna MTF.
  • $47.6m senior debt (8.5% interest) will be exchanged for new Series A notes ($100 in value of senior notes for $104 Series A). Additionally, if the notes won’t be repaid by July’21, the interest rate will go up to 9.75%. The maturity date is fixed for 100 years.
  • $67m convertible debt will get exchanged for new Series B notes. Each $100 in value of the convertible debt will receive $100 of the new Series B notes plus 10 the new Trust Certificates. This will result in about 4% dilution to the current shareholders.
  • Current debtholders holding less than $125k of debt will get cashed out at par. Unfortunately, it seems that the debt is not traded.
  • New management structure will consist of the trustee plus 5 board members (vs current 8 board members plus chair/CEO). Together with the potentially cheaper listing, this should further reduce SG&A expenses.

The restructuring plan has already been approved by the court. The emergence was expected to take place by the end of 2020, however, it has not happened yet. The newest filing (Jan’21) indicates that preparations are still ongoing and the exact date has not been set yet.

 

Historical portfolio maturities

Unfortunately for EMGC, insureds in the portfolio proved to be incredibly healthy and despite high average age, the number of maturities over the years used to be just barely enough to cover the premium payments, which resulted in a significant cash burn after interest and SG&A payments.

The table below provides an overview of the White Eagle SPV maturity benefits/premium payment balance since 2017. Keep in mind that the actual liquidity situation was worse than might be expected from the data below as it usually takes time to collect the maturity payments and only a part of it is collected in the same period (other remain as receivables).

Note: apparently there were no maturities in Q4’19. The report also indicates that they did not pay any premiums in that quarter, which seems very unlikely. Possibly, there might have been some kind of mistake involved in Q4’19 reports.

Till Q2’19 EMGC’s total hold-co level expenses (mostly SG&A and interest) amounted to $12m/quarter and the company was burning material amounts of cash. Currently, at SPV level admin expenses have been reduced to c. $1.5m/quarter – i.e. JM’s management fee of 85 bps of White Eagle’s NAV.

At EMGC hold-co level, due to lowered SG&A and increased maturities for the first time in many years the company turned to profitability in Q2’19. Over the next several quarters, expenses varied around $4.5-$7m and were likely elevated due to various one-off reorganization costs. Overall, EMGC is currently operating at the brink of breakeven. Assuming the level of maturities remains stable, the ongoing restructuring should lower SG&A further and could finally bring the company to consistently above breakeven level. Any further increases in maturities would strongly catalyze this as well.

 

Valuation

Due to the lack of information and no visibility on individual policies (juts portfolio aggregates), the precise modeling of the portfolio is not possible. Instead, a simple thought process and some back-on-the-envelope calculations seem to indicate that it’s quite likely that the potential value of EMGC’s stake in the portfolio might be significantly higher than the actuarial fair value shown in financial statements. The calculations below were done using a similar approach to the one on the VIC write-up.

The essence is that given the COVID-19 tailwinds and upcoming SG&A cut EMGC should be able to reach consistent breakeven going forward if the amount of maturities remains stable. If that happens and the company manages to avoid any further cash-burn or debt increase, then it’s just a matter of time until a more material breakthrough in maturities is reached. After all, the average age of the insureds is 86 years and it’s only fair to assume that they should begin to pass away much faster going forward. So if EMGC manages to stay afloat for, let’s say, the next 4 years, the average age should get close to 90, and at that point, the whole thing should already be on a fast-track to cash conversion.

EMGC indirect and direct expenses:

  • Premiums – supposedly 27.5% of the total amount paid by SPV. However, premium payments are automatically covered by the maturities, so EMGC doesn’t have any direct expenses here. However, in case the maturity receipts fall short of the needed amount, EMGC’s part will be financed by Jade Mountain. This would make an impact on EMGC debt and interest payments, which will then have to be covered from the future maturities through the waterfall structure.
  • Current debt to JM – $9.3m (with already accrued interest) and $8m at 11% interest to be repaid through the waterfall structure. When calculating the face value of their 27.5% stake in the portfolio, EMGC takes into account this debt to JM – current face value is stated as $152.5m vs $182m which would be the actual 27.5% of $663m NAV. So for the sake of simplicity, let’s assume the total amount, including the future interest, to be paid here is $20m.
  • Interest payments on EMGC hold-co debt. The amount used to be around $10m-$11m/year, however, will probably increase slightly with the new restructuring and debt forbearance. Let’s assume $11.5m/year going forward.
  • SG&A. After portfolio management was taken over by JM, EMGC’s admin expenses stood around $3m/quarter with the lowest payment of $2m in Q2’20. Q4’20 and Q1’21 might be elevated again due to ongoing restructuring, however, going forward, expenses are likely to be lower after all of US admin functions are eliminated. Let’s assume the amount will be $6m/year.

In order to assess how many maturities are necessary for EMGC to breakeven over the next 4 years, we firstly look the number of maturities required to cover all the upcoming SPV premiums until the end of 2024:

Then we calculate what additional surplus of maturities would be needed for EMGC to breakeven (guaranteed payments minus the expenses). For the sake of simplicity, repayments of debt to JM are divided equally between the periods:

Finally, we add up the maturity numbers to see the total amount needed for this scenario to play out as expected:

Given the recent increase in deaths, 35-40 maturities per year seem quite possible going forward. In 9M of 2020 alone the amount of deaths reached 33, so just slightly short of the annual requirement for breakeven scenario.

Assuming maturities happened as outlined in this scenario, at the end of 2024, the portfolio would still have 338 policies left with a total death benefit at $$1.6bn. At that point, EMGC BV would be:

Note: Share count in the first column includes currently outstanding shares of 158m, new shares to be issued to Series B note holders upon restructuring agreement, as well 17m shares to be issued upon exercise of 17m warrants that are currently exercisable at $0.2/share. The share count in the second column additionally includes the conversion of $67m Series B notes at $0.5/share price as well as 25m shares to be issued upon exercise of 25m warrants that vest only upon the conversion of Series B notes.
Note 2: the remaining death benefit and remaining premiums in the table above would need to be discounted to arrive at fair NPV at the time, but as detailed data for that are not available, such simpler undiscounted calculation should at least directionally be correct.

In this scenario, EMGC BV at the end of 2024 would stand at $0.70/share offering 250% upside from the current prices. At the same time, there is a good chance that this scenario will prove to be conservative and a material increase in maturities would start sooner than in 2025. This would make a significant impact on the eventual upside due to faster debt repayment and reduced interest expenses. Also, all calculations above exclude the current White Eagle reserves of $31m ($8.5m would be attributable to EMGC) and EMGC cash of $12.7m (Dec’20).

The downside seems to be well protected as it’s quite unlikely that the number of maturities would decline substantially below current levels. Moreover, the premium financing agreement with JM adds further protection in case of any short-term fluctuations in the maturities. Overall, the estimated BV at the end of 2024 (plus the current reserves and cash) provides a sufficient margin of safety to tolerate any potential maturity fluctuations and some additional interest accrued for JM debt.

With all of that, keep in mind that the “unexpected surprise” factor is very much at play here and for example, if any given quarter/time period the number of maturities would skyrocket (for no reason), it would likely push the share price up considerably.

 

Uncertainties

  • Listing on Vienna MTF. This is a strange move seemingly aimed to reduce SG&A and provide some tax efficiency. Our knowledge here is limited. Vienna MTF is an unregulated facility mostly used by European firms to efficiently list their bonds. Existing EMGC shares would be exchanged into Trust Certificates, that are equal in value to the commons. Overall, this adds some uncertainty, especially towards the liquidity and future reporting/visibility into the performance of the company. EMGC liquidity is already quite limited, so a transfer to a European MTF is likely to make a further negative impact on the future trading volumes.
  • Also a big risk factors is a potential further sell-off before or after the company re-lists on the MTF as many investors might be unwilling or unable to hold European Trust Certificates in their portfolio. Some of them have apparently exited already – after the announcement on the 16th of October, EMGC price fell from $0.35/share to $0.25/share (current levels).
  • The number of maturities might turn out to be lower than expected going forward and might not be enough to cover premiums. This would burden the EMGC with additional debt from JM (as JM would cover any SPV’s cash deficit on behalf of EMGC) and this debt would continue to accumulate at a high 11% interest rate until repaid from future maturities in the waterfall structure. Such a scenario of low maturities in the upcoming few years would significantly reduce the upside. However, the margin of safety seems high enough to tolerate this risk, even if such a situation extends for several years.
  • SG&A expenses might turn out to be higher than expected. However, management has been cutting costs for a few years now and the new structure after the restructuring should result in material additional savings.
  • There is little information available on Jade Mountain (owner of 72.5% remaining portfolio). It’s not clear if JM will has sufficient resources to be able to cover a significant amount of premiums for a prolonged amount of time if maturities were to decline.

24 COMMENTS

  1. Intrader

    I would revise the target price to $0.85.

    Per the most recent 10-Q (Page 49), there are 42.5M shares of EMGCQ tied to warrants already in the money (not included in the 158M shares outstanding)

  2. Intrader

    Okay, some questions here as I believe the 158M shares outstanding is not the correct number – there is dilution from existing warrants and the restructuring plan not considered here:
    1. Add 42.5M shares tied to warrants already in the money (Per most recent 10-Q – Page 49)
    2. Add 6.8M shares tied to the convertible debt as stated above (Per restructuring plan – Page 57)
    3. Add 48M shares tied to the series A notes – apparently they are convertible to Trust Certificates on a 1:1 basis? (Per restructuring plan – Page 56)

    From this, I get to $0.67 / share, lower than the $1.08 estimate above

    4
    1. Intrader

      A follow up to my initial comment;
      1. Disregard #3 above – the convertibility of the Series A notes at $100 Principal for 100 PPN implies a $1 / Share Conversion price, which would not happen here.
      2. However, there is FURTHER dilution tied to the Series B notes! (Per restructuring plan – Page 58). They are convertible at a $100 Principal for 200 PPN basis, implying a $0.50 Conversion price.

      Removing Series A dilution and adding Series B dilution gets us $0.50 / Share. Now we have weird “BV depends on dilution, but dilution depends on potential BV”. We can infer that Series B holders will convert enough to make the BV equivalent to a $0.50 / Share equilibrium. At $0.49, they won’t convert. At $0.51, they will convert.

      Market price is now $0.27 / Share, so the implied IRR here may not be worth the juice, considering the extended timeline to realization, and crandyhill’s comment below, which can be summed up in two words – Adverse Selection.

      2
    2. dt

      Intrader, thanks for spotting this and correcting us – a large oversight on our side.

      We have updated the figures. Please refer to the last table in the write-up for the dilluted share counts. Keep in mind that 25m of the outstanding warrants vest only upon conversion of Series B, which will not kick in till $0.5/share (or a double from here).

      Whether IRR is sufficient or not is everyones personal preference. But keep in mind the optionality involved here – one a single year with high number of maturities (if that happens) might push up the share price even in the short term.

      Regarding adverse selection, as I responded to crandyhill below, that might have been the case when the insureds decided to sell these policies. However, that happened many years ago and I do think the effect of adverse selection should have worn off by now.

      For me much more worrying is the relisting to Vienna and what kind of effects it will have on short-term share price, which brokers will allow trading on it and how the move will affect liquidity.

      3
    3. dt

      Also keep in mind that in the last table showing the share count, calculation are based assuming cash exercise of warrants. However, it seems that 17m of warrants will get exercised upon restructuring on a cash-less basis. so dilution will be much smaller, or even zero if the stock price is equal to the exercise price.

      The Common Stock equivalents consist of warrants to purchase shares of Common Stock, some of which are vested (the “Vested Warrants”) and some of which are not yet vested (the “Unvested Warrants”), and stock appreciation rights (“SARs”) that may be settled upon exercise in shares of Common Stock. The Vested Warrants will be deemed to have been exercised immediately prior to the Restructuring on a cashless exercise basis and the resulting shares of Common Stock will be exchanged for Trust Certificates in the Restructuring. The Unvested Warrants will be replaced with new warrants to purchase Trust Certificates upon terms that are conformed to those of the Unvested Warrants to the extent possible (the “New Warrants”). The SARs will be replaced with new SARs that may be settled upon exercise in Trust Certificates upon terms that are conformed to those of the SARs to the extent possible (the “New SARs”). Upon the distribution of the Trust Certificates, the New Warrants and the New SARs, the Vested Warrants, the Unvested Warrants and the SARs will be deemed null and void and will no longer be considered outstanding.

      1
    4. Intrader

      I’m interpreting cash-less exercise as the 17.5M warrants getting exercised immediately to 17.5M EMGCQ shares. Those shares are then automatically converted to 17.5M Trust Certificates in the Restructuring.

      Am I reading this wrong? Not seeing the smaller impact on dilution.

    5. dt

      Cashless exercise usually means that the exercise costs (i.e. $0.2/warrant in this case) are covered by the value of shares received from the exercise – i.e. the amount of the new shares to be issued is reduced by the cost of the exercise itself.

      Whether the same applies here I am not 100% sure, but that is how I understand the sentence on cashless exercize in the comment above.

      2
    6. dt

      The obvious implication being, that if upon the emergence of restructuring EMGC trades at only $0.2/share, then there will be no dilution from the 17m warrants that will get automatically exercised at $0.2/share.

  3. crandyhill

    Thanks for the intriguing idea.

    My biggest question is whether using actuarial estimate tables is an accurate way to estimate the life span of this highly self-selected group. They sold for a reason, and it seems that a significant number of them may have had sales motivations that run run counter to ours. Just off the top of my head I see two main motivations

    1) They are broke, can’t afford the payments but had accrued a great deal of value in their eventual demise.
    2) They can afford the payments, but feel so healthy that they don’t want to pay them for decades more when they can cash out now.

    Actuarial tables are built upon the general population, and at these ages the rates of cancer and terminal illnesses are a substantial portion of the death rate. If you had a terminal illness, why would you sell your life insurance policy at any substantial discount? If I only had a year or two left I’d leverage up and borrow money to cover my policy and final YOLO activities so that my family could get as much as possible when I’m gone.

    But if I’m super healthy, active, and someone offered me a nice buyout price, I’d dump the policy to ensure I had enough money to live well on until I’m 100 years+.

    So I’m betting the reason the insured haven’t died as quickly as expected in the past is that these motivations caused a strong enough self selection of healthier people to significantly raise the expected death rates. If recent rates spiked, that could just be COVID related and could recede as quickly as it appeared over the next year (most of the insured should already be vaccinated). So pending deeper insight into their portfolio of policies I’m going to stay on the sidelines for now.

    3
    1. dt

      Fair points – that’s one of the risks of holding EMGC.

      But keep in mind that the current policy portfolio was acquired during 2010-2015. So for whatever reasons the insureds sold these policies, they did that at least 6-10 years ago and potentially even earlier (if EMGC acquired the policies not directly from the insureds, but from another life settlement portfolio manager). A lot can change to person’s health in such a long time, especially when the average age of the insureds in 2015 stood at 81 years.

      2
  4. Dan Silverstein

    A potential major flaw in this thesis is that the recent increase in maturities will continue in the future. When the CDC eventually publishes their official statistics I believe that they will show that there were many excess deaths related to Covid-19 in 2020. Covid mortality is related to advanced age and the health of the person. One could hypothesize that the excess mortality in 2020 will be followed by years of lower mortality. It’s possible that the oldest and sickest patients were at least partially responsible for the excess mortality in 2020. The remaining patients, therefore, are younger and or healthier. It’s not out of the question that 2022 and 2023 to be years with a dearth of mortality.

    2
  5. Dan Silverstein

    Another consideration here is the bet against Life insurance companies. I assume Life Insurance Companies are in the business to make money off their policies. They expect to take in more money in premiums than pay-out in policy benefits. They have major resources available to them to help make that decision. A back-of-the-envelope calculation of expected mortality may not have the accuracy of highly researched actuarial tables that have mountains of data upon which to base their estimates.

    1
  6. jwestern

    Interesting idea. Selling a lucrative life insurance policy to a public company sounds like putting a hit out on yourself.

    I agree with dt, the listing on an obscure exchange is my biggest gripe.

    3
  7. Intrader

    One more question:
    – I would imagine the premiums to increase over time. This would make the -$572M even larger than it is right now, further lowering the BV:

    Per previous 10-Qs and 10-Ks, average monthly premiums were as follows:
    2017 Q1 – $11.4
    2017 Q2 – $11.5
    2017 Q3 – $11.8
    2017 Q4 – $12.3
    2018 Q1 – $12.8
    2018 Q2 – $13.5
    2018 Q3 – $13.9
    2018 Q4 – $14.4
    2019 Q1 – $15.0
    2019 Q2 – $15.5
    2019 Q3 – $15.5
    2019 Q4 – No Data
    2020 Q1 – $16.2
    2020 Q2 – $16.9
    2020 Q3 – $17.4

    Per this trend, you can see how the reported $572K in premiums may be much higher once 2025 actually comes around

    1
    1. jwestern

      Just to be helpful: that trend is roughly linear, and is fit well by

      (time in years) * $1.78 + $11.2.

      Based on that extrapolation, in 2025 it’s at $26.25 or so.

      1
    2. Ilja

      The continuous increase in premiums is most likely related to at least some of their policies having premium step-ups at 90, 95, or 100 years. So as the average age is slowly getting close to 90, naturally, there is this tendency for premiums to increase gradually, especially with limited maturities so far. In any case, I would expect any contractual premium step-ups to be already baked into management’s future premium projections – in that sense if maturities evolve as suggested by actuarial tables, then $572m should be the correct figure to use. On the other hand, if during the next 4 years we have a lower number of maturities than currently projected, then obviously the remaining expected premiums number might end up higher.

      Historically, management’s future premium projections have been quite close to the actual reported figures:

      – 2015 estimate – $56.8m, actual – $64.9m.
      – 2016 estimate – $68.9m, actual – $71.7m.
      – 2017 estimate – $82.3m, actual – $84.7m.
      – 2018 estimate – $89.9m, actual – $78.7m.
      – 2019 estimate – $101.1m, actual – $68.9m (probably data for 9 months only, as annual figures have not reported correctly).

      Longer-term predictions were a bit more off, however, not materially so to have an impact on the investment thesis.

      Moreover, current life expectancy tables estimate about 123 insureds to pass away in the upcoming 4 years. That’s around 31 maturity per year, which is substantially below the scenario described in the write-up, so if EMGC manages to perform at breakeven in the upcoming years, it seems that the remaining premiums by the end of 2024 might actually be lower than the current forecast (thus higher upside).

      Again, it all depends on the actual maturities and various guesstimations around it. It is best to look at the situation as an option that will payout when maturities at least temporarily exceed the projections.

      2
  8. Intrader

    Something seems off here – did they have 35 Maturities in Q4 2019?

    -In the 2020 Q1 10-Q (Page 56), they state 524 policies on 2/29/20, with 9 matured over the period. So we can assume they had 533 policies at the end of 2019 Q4

    -In the 2020 Q3 10-Q (Page 59), they state 568 policies on 8/31/19. So we can assume they had 568 policies at the end of 2019 Q3.

    Difference is 35. Seems quite high for a quarter (and this is pre-COVID). Thoughts?

  9. Intrader

    What about the guaranteed return to Palomino? They owns the other 72.5% of the settlements. I don’t see it here.
    -Palomino gets an 11% guaranteed return on their net investment – this comes straight from the top, and is first priority in terms of payment. It is taken out even before the 72.5% / 27.5% split. See most recent 10-Q – “Class A Minimum Return Cumulative Amount” for details.

    $42.7M (11% of $388M = $366.2M purchase price + $21.8M reserve funding) of cash goes to Palomino straight from the top in year 1 (declines as the pool matures). This is ~9 maturities, which would bring the maturities needed in 2021 from 40 to about 49. Even the 2020 run rate of 44 (which may even be biased upwards due to COVID) would indicate a further shortfall.

    What happens then? Palomino covers the shortfall, that $388M grows even more. The 11% payment grows even further in 2022. I don’t see a way out of this.

    Second point is the maturities after 2024. You claim that if EMGC breaks even for the next 4 years, the whole thing should already be on a fast-track to cash conversion. I disagree. Looking at the weighted average remaining life expectancy (6.6 years), one can model out what the pool might look like:

    0-1 Years (Average 0.5) – 9 People (Given)
    1-2 Years (Average 1.5) – 30 People (Given)
    2-3 Years (Average 2.5) – 30 People (Given)
    3-4 Years (Average 3.5) – 54 People (Given)
    4-5 Years (Average 4.5) – 54 People (Given)
    5-6 Years (Average 5.5) – 47 People (Assumption)
    6-7 Years (Average 6.5) – 46 People (Assumption)
    7-8 Years (Average 7.5) – 46 People (Assumption)
    8-9 Years (Average 8.5) – 46 People (Assumption)
    9-10 Years (Average 9.5) – 46 People (Assumption)
    10-11 Years (Average 10.5) – 46 People (Assumption)
    11-12 Years (Average 11.5) – 46 People (Assumption)

    This gives us a weighted average of 6.6 years. Claiming that this would be on a fast-track to cash conversion after 2024 would load the pool at the 6-7 and 7-8 year tranches at the expense of the 8+ year tranches. That would lower the weighted average age to below 6.6 years, so that would not be true here.

    The 11% guaranteed return places very tough cash constraints in the early years, leading to a possible ‘debt spiral of death’. Due to the math in the 2nd part, I don’t see EMCGQ being saved post-2024. I don’t see how this works.

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    1. dt

      Thank you for insightful discussion, however, I think your concerns on 11% guaranteed return are misplaced. Let me know if you think the explanation below is incorrect.

      This is how I understand the waterfall structure works. The first priority is the premium/expense account, which covers the upcoming premium payments (see the waterfall steps below). 11% IRR requirement (class A minimum return) is the second priority, class B minimum return is third, while the fourth step is re-balancing and true up payments. True up payment is the difference between 72.5%/27.5% of class A/class B interest in the total distributions and the payments already made in the second and third step.

      Therefore, the $42.7m you are referring to is not a separate, first priority payment on top of the 72.5% distribution for JD, but is simply a minimum payment – “Class A Minimum Return Cumulative Amount”. In case there are enough maturities to cover further waterfall steps, class A parties receive true up payments so that their total distribution amount reaches 72.5%. Maturities assumed in the write-up’s breakeven scenario (about $81m) are more than enough to cover all of the waterfall steps and for EMGC to stay afloat.
      In other words 11% IRR for Palomino is already implied in the scenario described in the write-up.

      Regarding your second point, we’ve simply made the assumption that insureds would start passing away much faster, especially when the average age would get close to 90. This seems logical and should be directionally correct. Basing the argument on the estimated life expectancy is slightly flawed as people do not die only when their life expectancy reaches 0. Actually, the average remaining life expectancy of the insureds that passed away since 2017 was around 5 years, which following your logic would actually prove the “fast-track” assumption as in 2025, most of the remaining insureds in your model would be very likely to pass away in the following 1-2 years or sooner.

      On waterfall structure (the document blacked out confidential parts, but they are easily visible after selecting the text):

      https://www.sec.gov/Archives/edgar/data/1494448/000149444819000055/equityprojectrodeoformofco.htm

      On the Distribution Date, funds on deposit in the Collections Account shall be distributed (in each case, only to the extent sufficient funds are available) in the following order of priority:
      a) First, to the Premium/Expense reserve fund, to increase such reserve fund until the reserve equals the Manager’s 3-month budget for premiums and expenses,
      b) Second, to pay any amount necessary so that the Purchaser Support Parties shall have received the PSP Minimum Return Cumulative Amount (as defined below) as of the last day of the month immediately prior to such Distribution Date,
      c) Third, to the extent the Minimum Class B Interest Monthly Distribution is subordinated as contemplated by the proviso to the definition thereof during years 9 or 10, then to the Class B Interests the portion thereof not paid from the Premium/Expense reserve fund,
      d) Fourth, for the purpose of rebalancing the Total Return Distributions to 72.5% to the Purchaser Support Parties as holders of the Class A Interests and 27.5% to the holders of the Class B Interests, as applicable as of such Distribution Date, to either (x) the Purchaser Support Parties on account of any necessary PSP True Up Payment or (y) the holders of the Class B Interests on account of any necessary Class B True Up Payment,
      e) Fifth, 72.5% to the Purchaser Support Parties as holders of the Class A Interests and 27.5% to the holders of the Class B Interests.

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  10. dt

    EMGC was delisted from U.S. on the 8th of April and stock transfer to Vienna is currently in progress – Interactive Brokers placed the stock on ‘value exchange’ which is a placeholder for corporate actions in progress. IB support was not able to comment how long the transfer might take.

    On Vienna exchange the trading (not yet started) can be followed here:

    https://www.wienerborse.at/en/market-data/shares-others/quote-direct/?ISIN=KYG5365M1024&ID_NOTATION=329895587&cHash=662b08dfe73f23eaf7018a230bb46fc8

  11. dt

    We are removing EMGC from active ideas as the case is no longer actionable – there is no trading on Vienna exchange in Lamington Road shares (the new entity that holds assets previously owned by EMGC).

    As I noted in one of the comments above:

    “For me much more worrying is the relisting to Vienna and what kind of effects it will have on short-term share price, which brokers will allow trading on it and how the move will affect liquidity.”

    Apparently, the worst-case scenario happened and previous EMGC equity investors are stuck with non-tradeable ‘profit participating notes’. I am not even sure where can I track news/fillings (if any) for the new trust. Any advice here? Lamington Raod DAC (the entity that holds 27% share in the portfolio) is registered in Ireland and there are some fillings here https://core.cro.ie/e-commerce/company/574377. So I am hoping that at least the annual return form should be available there (though no idea how useful it will be).

    The likelihood of a positive outcome (i.e. eventual distributions materially exceeding the initial investment), in my opinion, is still high, but this will now take multiple years to work out.

    For tracking portfolio purposes we will keep this position marked at the last closing price – $0.21/share.

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    1. JM

      Where did you see that the shares are non-tradeable? The Wiener Börse page shows no activity for the certificates but it does look like it’s at least tradeable.

  12. dt

    Lamington Road launched a new website https://lamington.ie/
    So there is a chance some financial disclosures will get released here in the future. I have reached out to the provided IR contact and will relay any response I receive.

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