White Mountains Insurance: Creating Attractive Long Term Returns

Jul.29.10 | About: White Mountains (WTM)

White Mountains Insurance (NYSE:WTM): Current Price $326; Price Target $450-550

Brief thesis: This is one of the best managed P&C insurance companies that has relied on rational underwriting and deal making to create very attractive long term returns. Now trading at less than 75% of book value, having been punished for sticking to a large buy back in 2008, WTM has already started rebuilding capital at a swift pace ($20.35/share in 2Q) and will once again get a premium to book. Though there is no better catalyst than simply growing book value, a plan announced of rolling up a piece of their reinsurance business (2Q), releasing $400mm and deploying this should serve as another catalyst.

Company description: WTM is a property and casualty insurance company founded by Jack Byrne, a man dubbed “The Babe Ruth of Insurance” by Warren Buffett who ran Geico for him for several years. The business has effectively been run by Ray Barrette since 2000, who was his protégé and cut from the same cloth. The Company has three operating subsidiaries 1.) White Mountains Re, a multi-peril, Bermuda based, global reinsurer (51% of book value), 2.) OneBeacon (NYSE:OB), a publicly listed but approximately 75% owned U.S. based personal and commercial lines insurer (30% of book value), and 3.) Esurance, an online personal auto insurer (15% of book value). WTM also owns their own investment management company which manages the float. White Mountains has four simple operating principals (you may have heard these before):

1. Underwriting comes first

2. Maintain a disciplined balance sheet

3. Invest for total return

4. Think like owners

Management’s goal is to compound book value over the long term at 15-20%. They do this not only through sticking to their simple rules above but exploiting opportunities to act as merchant bankers buying blocks of business from competitors who operate by a different set of rules. A good example would be the purchase (or reinsurance) of a closed block of runoff business at a deep discount to book value structured to pay book value if the business performs the seller then reports to shareholders that they have sold a bad book of business for “book value, including an earnout” and WTM ends up paying a fraction in cash and makes large returns.

As a result of achieving superior results the stock has consistently traded at a premium to book value. Even after losing 21% of their book value in 2008 the Company still has managed a 10 year compound of 12%.

What went wrong with their long term strategy in 2008?

It’s actually not what you think.

· The fixed income portfolio avoided blow ups: WTM has always relied on underwriting results and their own insurance merchant banking to generate excess returns and not their investment portfolio. As a result, their fixed income portfolio was virtually free from troubled asset classes.

· The underwriting businesses performed above expectations. White Mountain management decided that the best way to deploy their significant excess capital was through a large share buy back when “By mid-January 2008, our stock traded below $500, a price that your board considered attractive for a significant share buyback.”

· Management approached Buffett, who owned approximately 16% of the shares and cut a cash rich deal (Buffett would take a run off business and $708mm in cash) at $485/shr or what the CEO called a “a significant discount to intrinsic business value.”

· The deal needed a private letter from the IRS to become official and this would take 6-9 months. Ray Barrette explained later, “Both sides understood the risks of the delay and a deal is a deal.”

· By 10/31/08, when the deal had been approved and was to be consummated, it was no longer MBS securities alone that insurance companies needed to fear and the stock had dropped from $485 to $325.

· The 50% premium stock repurchase in the throes of a crisis was exacerbated by bad losses in what the Company believed to be “safe” equity investments and seems to have been a bridge too far even for Buffett fans.

· At the end of 3Q’08 BVPS sat at $405 and started to decline due to equity and convertible investments but the Buffett purchase alone caused $22 of BVPS destruction and at YE’08 it had fallen to $353.

What’s different now about the business and its prospects?

Basically nothing.

· The Company does say that they have “derisked the investment portfolio which will take away some of the upside” but as stated before, this never really drove the upside.

· The Company just released an additional $400mm of capital in the second quarter through a roll up of their Bermuda reinsurance business (essentially a merger of Sirius Re back into its parent White Mountains Re).

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WHITE MOUNTAINS INSURANCE

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Disclosure: Long WTM