SiriusPoint (SSPCF) – CVR Trade – 11% Upside

Current Price: $12.38 ($5.25 SSPCF + $7.13 for partial SPNT)

Offer Price: $13.73

Upside: 11%

Expiration Date: February 26th, 2023

 

SSPCF is the ticker for SiriusPoint’s contingent value rights (CVRs), which were issued in conjunction with the merger between Third Point Reinsurance (TPRE) and Sirius International Insurance Group. The CVR agreement entails that 2 years after the merger closes (26th of Feb’23), each CVR will receive cash payout that equals $13.73 less 0.743 SPNT shares. The CVRs started trading on the 16th of June and currently are priced at $5.25/share. Meanwhile, SPNT stands at $9.59/share. Setting up the trade as long 0.743 SPNT + long 1 CVR at current prices gets you two things:

  • A payment of $13.73/share in 1.5 years vs $12.38/share cash outflow today, i.e. 11% upside.
  • A built-in SPNT call option with $18.5 exercise price.

In effect, you are getting a free out-of-the-money call option + an unsecured bond with maturity in 1.5 years at 10% below par. For comparison, SPNT senior unsecured bonds expiring in Nov’26 (i.e. 5.5 years out) are currently priced at 3.5% YTM, its series B pref shares trade 7% yield, and one-year treasuries are yielding close to zero. I do not believe there are any fundamental reasons for such price disconnect and the situation likely exists mainly due to low liquidity and obscurity of CVR.

The only risk (and let me know if I am wrong here) is that SPNT won’t be able to cover the CVR cash portion at the maturity date. However, the chance of this happening is close to zero. At current prices, the total CVR payment would amount to just $31m (4.7m CVRs were issued), which is a pretty negligible sum for a $1.6bn market cap company. Even if the stock price somehow drops to $6/share (COVID low), the CVR payment would still be only $43m. Overall, one needs to assume a pretty extreme bad case scenario in order for SPNT not to be able to pull enough cash for CVR payment in Q1’23.

Aside from this risk, there are two tiny nuances here. According to the CVR agreement: (1) the CVRs will be forfeited if SPNT 14-day VWAP goes above $18.50/share; (2) the company can redeem CVRs prior to the maturity date at the present value of $13.73/share discounted at 2.75% annual rate from the maturity date to the last 14 day period from the redemption notice. The first nuance is not really an issue, as the intrinsic value of CVR would be zero in that case anyways, while the second one (redemption) is quite unlikely in the short term. Premature redemption at current prices or any price, in general, would signal that the management doesn’t believe in further appreciation of the stock in the short term, which is simply the opposite of what they are communicating and are trying to achieve (close the 37% price gap to BV). In any case, 11% margin of safety is more than enough to offset the discount rate of the early redemption.

For the OTM option part of the equation, it is difficult to say whether going beyond $18.50/share is likely before Feb’23. The company currently trades at 0.63x BV vs 1xBV+ peer valuations. The reinsurance industry is recovering with more rational pricing across the board. If SPNT’s operational transformation proves to be successful, there is a non-zero chance that the stock could reach $18.50/share over the next 1.5 years. A number of other aspects, including actions of the largest SPNT shareholder (owns 41%) also point out this conclusion. The rest of the write-up will most focus on this optionality part.

More details and background on the merger leading to the issuance of CVRs can be found on the previous SSI write-up and the discussion section.

 

SiriusPoint background and ongoing transformation

The company was founded by Daniel Loeb in 2011 and went public in 2013 with an IPO price of $12.50/share. TPRE acquired SG on the 26th of February’21 and changed the name to SiriusPoint. Over the years, TPRE tried to combine safer, low volatility underwriting and focus on higher investment returns driven by Third Point hedge fund, which managed a major part of their investment portfolio. However, this strategy did not work out that well – although the investment returns were superior, the return volatility was quite high, and the underwriting part of the business was on average carried out at a loss. Naturally, the company was written off by the traditional insurance/reinsurance investors who left it trading at a significant discount to BV. Since 2019 the company started a transformation with the goal of focusing on more profitable reinsurance lines, entered property catastrophe business (most profitable yet volatile segment in the industry) and in 2020/2021 merged with SG. The merger was aimed to speed up the transformation, increase scale, diversify the portfolio and stabilize the investment portfolio returns. The company has also changed some of its executives with the new chair/CEO and CFO coming from AIG and introduced new business segmentation:

  • A&H (accident and health) – Global A&H reinsurance underwriting business;
  • Specialty – specialty reinsurance product offerings, which includes Marine & Energy, Credit, Casualty and Other Specialty;
  • Property – property catastrophe reinsurance, property risk and pro rata reinsurance;
  • Runoff & Other – retroactive reinsurance contracts consisting of loss portfolio transfers, adverse development covers and other forms of reserve reinsurance providing indemnification of loss and loss adjustment expense reserves with respect to past loss events.

Management of the merged SPNT has already started rebalancing the portfolio by reducing unprofitable business and catastrophe volatility. The company now intends to focus on growing non-cat business lines, primarily accident & health and specialty segments due to their superior risk/return profiles. From the investment portfolio side, one of the goals of this merger was to reduce the market overhang of TPRE being viewed as a captive vehicle for Third Point hedge fund. Under the new investment management strategy, the company has outsourced its fixed income & collateral investments to third-party asset managers (75% of the portfolio), while leaving the alternative (risk assets) to Third Point (25% of portfolio). SPNT believes this will allow them to reduce portfolio returns and still generate superior ROE vs peers. Management is now working towards closing the discount to BV (SPNT trades at 0.63x) and generating stable double-digit ROE (Q1 call):

At a closing price on Friday of $10.67 per share, SiriusPoint is trading at a meaningful discount to book value, which we expect will close over time as we produce consistent underwriting profits and less volatile overall returns. Third, generating returns on equity in excess of our cost of capital. As underwriting results improve, sustainable higher ROEs will follow.

Below you can see the backdated historical pro-forma view on the combined company (SPNT provides the info here) as well as the recent Q1’21 results. Q1 performance was very positive so far, although it doesn’t reflect any merger related synergies/benefits yet.

Note 1: SPNT doesn’t provide separate details on the Runoff & Other segment.

Note 2: Q1’21 BV drop is attributed due to an increased share count post-merger.

Major shareholders:

  • Dan Loeb – 9.4%;
  • CM Bermuda – 41%;
  • Vanguard – 5%;
  • Management – 4%.

 

A few notes on the potential optionality

It is not the goal of this write-up to convince you that SPNT will surely reach $18.50/share before the CVRs maturity date as the company is still in the process of transformation and 1.5 year timeline is long enough for the “unexpected” events to take place.

The reinsurance industry itself is swiftly recovering post-COVID and so far it seems like the reinsurance rates are hiking up, meaning more profitable underwriting. In May’s Q1’21 call, SPNT also commented on the improving industry conditions:

Overall, we are seeing market conditions stabilize around the world driven by underwriting discipline and positive rate improvement.

SPNT currently trades at 0.63x fully-diluted BV ($15.04/share) vs peers valuation of above 1x BV. Notably, the peer comparison in the table below might be skewed due to the size and a bit different business mix, however, given SPNT investment return/underwriting profile, the current discount size seems completely unwarranted.

Note: pre-merger SG used to trade at 0.93x-0.53xBV (COVID low) and TPRE at 0.74x-0.52xBV (COVID low).

The industry multiples haven’t reached the 2019 pre-COVID levels yet. However, if the pricing in the reinsurance industry continues to recover and SPNTs transformation proves to be successful with the continued growth in book and re-rating closer to peer P/BV valuation levels, $18.50/share price seems potentially reachable by the end of 2022.

A couple of historical charts from the AON’s January’21 reinsurance market industry outlook:

 

CM Bermuda choice of the merger consideration

At the time of the merger with TRPE, the largest SPNT shareholder CM Bermuda agreed to merger consideration which is superior to cash option off only if SPNT shares trade up to $13.5/shares and a further portion is paid out only if the stock reaches $20 price. CM Bermuda owns 41% of SPNT and used to own 96% of SG before the merger with TPRE. At the time of the merger, minority shareholders had 3 choices of consideration:

  • $9.50 in cash;
  • 0.743 of TPRE (currently SPNT) + two-year contingent value right (CVR), which guarantees that on the second year anniversary of the closing date, shareholders will have received a total sum of equity and cash of $13.73/share;
  • A mixed consideration of 1) $0.905/share in cash + 2) 0.521 of TPRE common shares + 3) 0.111 of class A TPRE preferred share + 4) 0.19 5-year warrant issued by TPRE with a strike price of $11/share  5) $0.905/share paid in stock if in one year after the effective date SPNT share price trades above $20/share for 30 consecutive days.

CM Bermuda agreed to the third option, while almost all minority shareholders chose the second. Even SG’s management chose the 2nd option.

Class A pref stock constituted c. 15% of the total merger consideration at the time of signing the transaction. However, due to agreement on covid loss adjustments, this portion of consideration became worthless at current SPNT share price levels. Warrants and upside rights are also effectively worthless at the current price levels. Current total value of the 3rd option combined is not only about50% below than the 2nd option, but is also below the SG price at the merger announcement ($7/share in Aug’20, still impacted by COVID). Overall, CM Bermuda is set to realize material upside from the 3rd option only if SPNT share price increases significantly.

With all of this, keep in mind that CM Bermuda is a subsidiary of China Minsheng Investment Group (CMIG) – the largest PE firm in China. It definitely is not “dumb money” and, clearly, the fact that they’ve agreed to the third option indicates that they believe in a very material short/mid term SPNT stock appreciation from the current levels.

A few more details on the preferred stock. A total of 11.72m of preferred shares was issued with the merger and CM Bermuda owns 99.9%. The final value of preferreds will be calculated upon the third anniversary of the closing date (Feb’24) and depends on the COVID-19 losses of TPRE in excess of $51m and SG COVID-19 losses in excess of $150m. If at the calculation date, SG losses will be higher than TPRE, then a number of class A pref stock will be forfeited equal to that difference capped at maximum $100m. If TPRE COVID losses are higher than SG’s, then a number of new series A pref shares will be issued. After that, all class A pref shares will be exchanged into common shares on 1 for 1 basis.

So far SG losses are much higher and the difference to TPRE is above the $100m cap. March’21 presentation:

10 COMMENTS

  1. Writser

    I don’t think the call option is really a call option, because SG can (and probably will) redeem the CVR’s as soon as they are worth zero.

    Also, as far as I calculate the implied discount rate for the stock + CVR package is currently about 4.3% (stock at 9.83, cvr @ 5.5). Not particularly exciting as far as I am concerned for a security that’s basically at the bottom of the food chain. At the time of the write-up the numbers were slightly better but still not that great, imho.

    Actually I’ve been surprised how well the CVR’s are trading. I was hoping for some interesting price action, I wouldn’t mind picking up a few CVR’s + shares at a ~10%+ implied return, i.e. below $4.50 with the current share price or something like that. At current prices – meh ..

    1
    1. dt

      It does not matter if CVRs are redeemed or not, as they will be valued at zero with SPNT above $18.5 – the option part of the trade comes from buying 0.743 shares of SPNT for every CVR. Just plot the payout of the combo at various SPNT prices and it is clearly equivalent to the bond + OTM call.

      At yesterday’s closing prices this an investment with 11% spread. What is the risk of holding the combo aside from the opportunity costs? How is that not better investment than any very high-yield corporate bonds?

      Using the numbers you indicated (stock at 9.83, cvr @ 5.5) I arrive at 7% remaining upside – still very good in the current zero interest rate environment.

      And I do not see why should it matter that the security is at the bottom of the food chain – do not see this trading at a larger than 10% spread.

      4
      1. hta

        Once the CVR is redeemed all you are left with is a long position in SPNT, which of course can go up or down. There is no more option. If you sell the SPNT at that point then you will have realized your maximum profit sooner- obviously a good thing. Otherwise you are just long SPNT from that point forward. In short, Writser is right about the call option.

        1
      2. dt

        ok, agreed – now I see what you are saying.

        The option will still be there at least for the 14 day period when the underlying price reaches $18.5 – as 14 day weighted average price needs to be above this level for the CVRs to be forfeited. Not much and way out of the money now, but one does not pay anything for it either.

        2
      3. Writser

        Yeah, I meant what hta said. Sure, you have a few days of option value when SPNT trades above $18.50 but then they redeem the CVR and your downside is not protected anymore. So there is perhaps a tiny bit of theoretical option upside, but I think that has basically zero value in practical terms.

        And yes, using my numbers there is ~7% upside, but the duration of the trade is ~1.6 year, so that is ~4.4% annualized. And the unsecured debt is trading at ~4% / 3.8% if I am not mistaken. Hard to get excited about either – you are not exactly buying Microsoft or Berkshire bonds.

        To be fair, I was probably too negative – if you spike some CVR’s at $5 you strike a relatively good deal with, approximately, a 6% – 7% IRR. And there’s also the chance that the CVR gets redeemed quicker, making your IRR even better. But my point, which I articulated badly, is that if you buy unsecured debt that yields 6.5% whereas you think it should yield 4%, you are basically a credit analyst. And that’s not really a game I am interested in. Is the CVR + share package a better deal than the unsecured debt? Sure! But in a vacuum, do I like to own 6.5% yielding unsecured debt in a random company? Meh, probably not, unless you can convince me that the company is rock solid.

        But that is probably partially my personal preference, others could find it interesting.

      4. snowball

        I think there is very good chance that we can see much wider spreads at some point during the next 1.5 years.

        By the design of this CVR, the spread on this trade can be very volatile. In a market-wide or SNPT-specific turmoil where SNPT price spikes down, it’s very likely that the relatively illiquid SSPCF will experience a fire sale, exactly when its intrinsic value should increase, thus widening the spread.

        Even taking into account the fact that credit risk may also increase, and justify some of the spread widening, I think such turmoil will very likely throw out attractive opportunities.

        I am wondering whether there is anyway for us algo-laymen to place a GTC conditional order in IB , hitting the asks automatically when “ask (SPPCF) + ask (SPNT) <12 " (spread of ~15%) for example?

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      5. Writser

        Yeah, you can do that. However, in illiquid securities like SSPCF it is not _that_ profitable, because 95% of the time the opportunity is to try to buy on the bid.

  2. dt

    The spread on SiriusPoint CVR relative to the expected payout of $13.73 (in Feb 2023) has narrowed down to 3.5%. Given the small upside and extended timeline we do not think it is worth holding onto the position any longer. We are closing this idea with 6.5% gain in 5 months – a sizeable gain for a bond-type risk.

    2

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