Quick Pitch: James River Group (JRVR)

Strategic review – 35%+ Upside

 

James River Group has just completed the sale of its troubled casualty reinsurance business and is now running a strategic review (essentially a sale process) for the two remaining segments: Excess and Surplus (E&S) and Specialty Admitted Insurance. E&S, representing 85% of JRVR’s net written premiums, is the core business. It offers specialized coverage for unique/high-risk scenarios, outside the scope of standardized Property & Casualty insurance. Therefore, if the underwriting is good (which is the case for James River Group), E&S can be a much more profitable business than standard P&C insurance. The other segment, Specialty Admitted, is mostly a fronting business, where policies are issued on behalf of other companies (reinsurers), with JRVR retaining minimal risk exposure, but earning a fee income instead. It’s a stable and capital light business that can perform well even in soft markets.

The strategic review for JRVR’s remaining businesses is ongoing amidst a booming E&S market, which is even labeled as “the golden age of E&S”. The bidding process has reportedly narrowed down to 3 potential suitors. Two of them are insurance giants Everest Group ($19bn market cap) and Arch Capital Group ($34bn market cap). The third one, Global Indemnity Group (GBLI) is more of an oddball – a lower-quality, similar sized peer that reportedly offered an all-stock merger of equals for $15/share (vs $9.2/share JRVR’s current price). GBLI is a public partnership controlled by PE firm Fox Paine (43.3% stake). Fox Paine and other major holders have long been trapped in GBLI’s orphaned and relatively illiquid stock. The merger with JRVR would allow GBLI to convert into a C-corp and also scale-up materially in anticipation of an eventual market cycle turn.

Pro-forma for the recent divestment, JRVR now trades at 1x tangible common equity. GBLI’s rumored $15/share offer implies 1.7x TCBV and 60%+ upside from the current prices.

I think the market underestimates the likelihood of JRVR’s strategic review ending up at a premium to today’s prices. James River is a micro-cap insurer with a muddy track record and limited coverage among retail investors. Over the last few years, the company/management has disappointed investors many times, which resulted in the stock price tumbling 75% since 2020. However, I think most of the issues are already in the rear view mirror, and market’s skepticism towards the company or the ongoing strategic review might be unwarranted:

  • Historically, the company has underperformed due to constant adverse developments in its reserves. However, the losses were pretty much confined to only two areas: the commercial auto line (which JRVR exited at the end of 2021) and the Casualty Reinsurance segment that has just been sold. In contrast, over the years the remaining E&S and Specialty Admitted segments have demonstrated solid underwriting performance with stable combined ratios in the low-mid 90s and minimal adverse developments of reserves. I guess you could even argue that following several turbulent quarters JRVR has finally completed a game-changing divestiture, completely transforming the story around the business. There’s a strong chance that the market hasn’t fully digested this yet.
  • The sale of the reinsurance segment wasn’t very smooth. Announced in November’23, the deal nearly fell through in March when the buyer decided to abort the transaction. After JRVR went to court, the buyer then asked to alter the economic terms of the deal. The court, however, ruled that the transaction should be completed under the originally agreed terms, and thus, the divestment was finalized earlier this week. The buyer said it will appeal. Although I’m not a legal expert, it has been evident from multiple instances over the past few years that walking away from a deal is extremely difficult. In JRVR’s situation, where the transaction has already closed, the prospect of a successful appeal is basically non-existent.
  • The company encountered issues with its internal controls last year, necessitating a restatement of its Q2’23 results. It discovered errors in how reinsurance premiums were recorded in the E&S segment, which led to overstated net income. The whole story led to a downgrade in JRVR’s financial rating. However, the issue has been quickly remedied with new internal controls in place and minimal adjustments to the previously reported financials. The auditor also approved the new internal controls.

Valuing James River Group is rather tricky as not only the insurance business, in general, is a black box, but the multiples of E&S peers and similar transactions are all over the place. The higher end of the spectrum is held by vastly superior peers and industry titans such as KNSL, RLI, WRB, MKL, all of which are way larger and have a track record of faster growth, better underwriting, and higher profitability (20-25% ROTE versus 7-15% for JRVR). These peers trade at 3x-4x TBV with KNSL, as the industry’s frontrunner, standing in its own league at 10x TBV.

Meanwhile, the lower end of the E&S valuation spectrum is demonstrated by the most recent transactions involving inferior peers. These includes takeovers of Argo Group at 1.16x TBV last year, ProSight Global at 0.96x TBV in 2021 and Aspen Insurance Holdings at 1.12x TBV in 2018. However, all of these companies exhibited worse underwriting performance (indicated by higher combined ratios) and slightly lower profitability/growth compared to JRVR’s remaining businesses.

I suppose 1.4x-1.7x TCBV, or $12-$15/share, could be a reasonable expectation for JRVR and would result in 35%-60% upside from current levels. GBLI’s rumored offer ($15/share, 1.7x TBV) would likely indicate the upper limit here. GBLI is a controlled partnership, which trades much lower liquidity than James River, so persuading JRVR’s shareholders to agree to an all-stock merger would naturally take a relatively higher premium. However, reaching closer to 2x TCBV zone would probably be a stretch.

 

Some other things

  • Potential downside is difficult to pinpoint as there’s no available pre-announcement price reference given everything that’s been going on with JRVR lately. However, the troubled Casualty Reinsurance segment was sold at 0.75x TBV. I suppose the much higher quality RemainCo should trade above this level even in a no-deal scenario. Thus, If I had to point a finger to a potential downside range, my guess would be around 10-20%.
  • The rumors of merger of equals between JRVR and GBLI sparked quite a substantial pushback from one of GBLI shareholders, Cove Street Capital (0.7% stake). However, this pushback occurred before the issues related to Casualty Reinsurance segment divestment got resolved. Many of the concerns raised by Cove Street – like the ongoing legal dispute and potential issues with JRVR’s reserves – have likely been mitigated following the recent completion of the sale.
  • JRVR’s management owns just around 2% of shares. However, the sole holder of JRVR’s convertible preferred shares, Gallatin Capital, also has one representative on the board. The pref. shares were issued in early 2022 for a substantial $150m. Conversion price is $26.6/share, almost 3x above current levels. The interest rate stands at just 7% and will increase to 5-year treasury rate plus 5.2% only in 2027. I think Gallatin Capital could also be incentivized to push for the full company sale.

10 Comments

10 thoughts on “Quick Pitch: James River Group (JRVR)”

  1. Nice idea DT, are the prefs tradeable, GPC is the sole owner I guess?
    On February 24, 2022, we entered into an Investment Agreement with GPC Partners Investments (Thames) LP (“GPC Partners”), an affiliate of Gallatin Point Capital LLC, relating to the issuance and sale of 150,000 7% Series A Perpetual Cumulative Convertible Preferred Shares, par value $0.00125 per share (the “Series A Preferred Shares”), for an aggregate purchase price of $150.0 million, or $1,000 per share, in a private placement. The transaction closed on March 1, 2022 (the “Series A Closing Date”).

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    • No, preferreds are not publicly traded. And yes, they are fully owned by GPC.

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  2. James River Favorable (Adverse) Reserve Development excluding Rasier

    Total ($M)
    Calendar Year (excl. Rasier)
    2023 $(31.6)
    2022 $4.4
    2021 $11.9
    2020 $37.0
    2019 $11.5
    2018 $11.2
    2017 $21.4
    2016 $27.9
    2015 $29.0
    2014 $33.1
    Cumulative Development $187.3

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  3. During the earnings call, GBLI management confirmed that they had indeed engaged in buyout discussions with JRVR. So the previous rumors were true. However, these discussions were paused (not clear why) and may be re-examined in the future if both parties are still interested. It’s not great, but I don’t think it breaks the thesis just yet. Yesterday, JRVR reported pretty good Q1 earnings results and confirmed that the strategic review is still ongoing. It suggests there might be other parties interested in the company. JRVR remains cheap and I’m inclined to wait for the conclusion of the strategic review.

    Underwriting performance for the E&S business was remained solid in Q1. The combined ratio was at 87%. Gross and net written premiums tumbled (7% and 20% YoY respectively) due to exiting of certain lower quality/less profitable large accounts.

    EPS, adjusted for the discontinued operations of the already sold Reinsurance business, was at $0.39/share. Tangible common equity per share stood at $9.03/share. Annualized return on tangible common equity was 17.4%.

    The company is currently valued at 5.5x PE on Q1 run-rate numbers and less than 0.94x TCBV.

    JRVR will hold a conf. call later today.

    https://www.bamsec.com/filing/162045924000086?cik=1620459

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  4. I think a “pause” can be a normal part of the negotiations. Possibly James River are trying / want to get more than $15 a share and now they are in the “negotiations dance”. However, if James River absolutely wants more than $15, I hope they are correct about their intrinsic value estimate.

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  5. With the Fleming deal officially closed, it is possible James River will be able to resume talks with Global Indemnity Group now that the uncertainty is behind them. Any thoughts?

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    • No thoughts but I did think it was interesting that they added a new board member in the middle of the strategic review. She’s the past chair of Willis Towers Watson. Not sure what it means but seems significant. And she was added to the comp committee.

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  6. JRVR continues to clean the house and has recently reinsured/de-risked its legacy E&S casualty portfolio (accident years 2010-2023). Potentially this was done in preparation of the company sale. The strategic review is ongoing. Management commented:

    “We are pleased to have successfully completed a significant legacy reinsurance transaction with a highly rated carrier that is consistent with the Company’s track record of de-risking the organization while bolstering the balance sheet and providing improved certainty to our stakeholders.”

    The stock went up by 15% following the news.

    The company will record $52m loss on the excess consideration paid over reserves ceded. This should reduce the tangible common equity (TCBV) to $7.65/share. JRVR currently trades just slightly above tangible book value. Company’s sale at 1.4x TBCV would result in 34%+ upside.

    https://www.bamsec.com/filing/162045924000095/3?cik=1620459

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