Hilltop Holdings: Holding on to a Hill of Cash

| About: Hilltop Holdings (HTH)

Gerald Ford was 38th president, but the Gerald Ford who interests me is the Gerald Ford who made a bundle in buying up busted banks. He has been profitably investing in banks for over 30 years and has become a billionaire as a result. He has several vehicles through which he has been investing in financial companies in the aftermath of the credit bubble. Hilltop Holdings (NYSE:HTH) is one of them. While blindly following the money is not the most prudent investment strategy, the price of Hilltop appears to offer some room for error and recent events might give some confidence that the company is profitably executing its strategy. The company trades at 82% of book value, which is quite a discount for a $468m net cash position, a $50m loan with warrants, and a profitable insurance business compared to a $536m market cap.

Hilltop Holdings has two buckets, the first is comprised of an insurance company that sells fire and homeowners insurance on manufactured/low value homes predominantly in Texas and a small amount around in other southern states. The insurance division was acquired in 2007. The second is a pile of cash. The pile of cash was also acquired in 2007 in exchange for all the assets of the trailer parks they owned and managed (the company refers to them as manufactured home communities, but I think this means trailer parks). Gerald Ford became involved in 2005 and affected this change in 2007 when he became Chairman. The stated plan for the pile of cash is to make opportunistic acquisitions, ostensibly in the insurance and banking sector based on Ford's expertise.

I'm not knowledgeable about insurance, but from the look of it the business, called NLASCO, has been underwriting profitably with the exception of 2008 in recent years. As a property and casualty insurer though, the business is lumpy. It was acquired for $122m in 2007. The filings break out the operations of the insurance company as the income statement includes the additional expenses of personnel and consulting for finding uses for the company's cash. I don't have any strong opinions about this business. Hilltop bought the company in 2007 and has been conservative in accounting for losses judged by retroactive adjustments (minimal) to claims and keeping its combined ratio under 100 in most years. So far, the return on the investment hasn't been impressive. Net Income was $6.6m and $7.1m in 2009 and 2010. Subtracting the net cash position from the market cap, the market seems to be valuing this business in the $18m range or 2-3x earnings. There isn't much upside from this though because it is quite small relative to the overall market cap. A repricing to 8x earnings would only mean the stock price increases 5%. So while you are getting a good deal, the upside is minimal.

The second bucket is the cash/investments portfolio. The company is loaning $50m to SWS, a full service brokerage and bank in Texas, at 8% for 5 years in exchange for warrants to purchase 8,695,652 shares at $5.75 each. This was in response to a buyout offer the bank received for $6.25/share from Sterne Agee. While I don't know if it applies to this specific deal, these types of deals are usually done because management doesn't want to lose their jobs, so they throw shareholders under the bus. Hilltop is on the beneficial side because it is getting a great deal (warrants are already in the money) and getting a seat on the board, so that SWS can't do to them what it is potentially doing to its current shareholders. They stand to make some money on this and it is nice to see the cash being spent on promising deals like this.

Gerald Ford owns/controls 26.6% of Hilltop through Diamond Financial, a partnership that Ford is the sole general partner. Diamond Financial has a consulting agreement with Hilltop where in exchange for $104,000 a month, DF provides financial and acquisition evaluation. Gerald Ford has also installed his son, Jeremy Ford, as CEO. Jeremy's experience was at his father's various investment vehicles and some investment banking. Jeremy Ford's brother-in-law is the General Counsel of Hilltop. Hank Greenberg used to say "All I want in life is an unfair advantage." Nepotism is one of them.

One of the more recent public investments of the Ford clan is First Acceptance Corporation (NYSE:FAC), a direct competitor of Affirmative insurance, which I've written about previously. First Acceptance has been a real dud. It was a cash pile for several years before it acquired FAC and has lost 80% of its value since then. While Ford is a billionaire, that doesn't make him a legend worth investing with. I don't doubt that Ford, the elder, with his large stake is looking over his son's shoulder, but the mixed investment record doesn't make me want to follow the Fords into Hilltop. Ford the elder has been making some interesting private investments in distressed financial companies, so it's difficult to know where his priorities are when it comes to directing opportunities to his various entities. If that is the case, Ford the junior is the one with more authority to invest Hilltop's cash. He doesn't have the same record as his dad, nor the same ownership stake (unless he is invested through the same vehicle of which Ford the elder is the general partner).

While the downside is pretty limited at this price, I don't see tremendous upside. Gerald Ford is well positioned to make money buying up distressed banks. He has already made some moves, but not to the benefit of Hilltop shareholders. The SWS loan is a step in the right direction, but represents only 10% of the company's cash prior to the investment. Patience and discipline are admirable, but the unexciting NLASCO acquisition, the failure of the FAC acquisition at a prior cash pile company (Liberté Investors, now FAC) and the uncertainty as to Gerald Ford's priorities means that the patience and discipline might not pay off. One can find plenty of interesting bank stocks to invest in on their own. There are plenty of opportunities to invest alongside investors with better track records who have strong balance sheets to take make opportunistic investments à la Berkshire, Leucadia, Brookfield Asset Management, Loews, etc. Although the discount to book is interesting, one must also recognize a poor comparative track record and uncertain alignment of interests compared to other publicly traded investor bandwagons on to which you can jump.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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