Financial markets are inefficient. To prove my point, take a look at Investors Title Company (Nasdaq: ITIC). Investors Title Company offers title insurance coverage to both owners and mortgagees of real estate. It also provides tax-deferred real property exchange services, investment management and trust services as well as management services to title insurance agencies. The company is currently trading at a 14% discount to its net cash and investments value and a 33% discount to its net tangible book value. If markets were truly efficient, Investors Title Company would be trading at a minimum of $49 per share but probably much closer to $76 per share (over a 100% premium). Why is the stock worth so much more? Let me explain.
As of September 30, 2011, the company had $126.2 million of total investments ($83.6 million of fixed income, $17.8 million of equities, $21.7 million of certificates of deposit, and $3.1 million of other investments) and $14.7 million of cash. Therefore, the company had total cash and investments of $140.9 million. Liabilities on Investor Title Company’s balance sheet totaled $51.6 million (accounts payable and accrued expenses of $13.1 million, $5.9 million of known title claims, and $31.7 million of accrued title claims by the company that have not been incurred by title insurance holders). The difference between $140.9 million and $51.6 million is $89.3 million. If you divide $89.3 million by the current number of shares outstanding (2.12 million), the value per share is over $42 (a 14% premium to the January 17th closing share price of $36.85). However, the company also has accounts receivable of $6.6 million, $7.6 million of tax assessed land and building value in Chapel Hill, North Carolina (right next to the University of North Carolina), and accrued interest and dividends of an additional $913k. If these assets are considered in the valuation, the Company’s shares should be trading above $49 per share (a 33% premium). Now, that’s a margin of safety that any investor should be excited about.
So far, however, this valuation has not taken into account the fact that Investors Title is a very profitable company. The business has and continues to be an excellent generator of free cash flow. This fiscal year (2011) the company is expected to earn $12 million of EBITDA with only $400k to $500k of capital expenditures. Conservatively, the business is probably worth 5-6x EBITDA or $60 million to $72 million. If the business is worth roughly $28 to $34 per share and the excess cash and investments are worth $42 per share, the stock should be trading between $70 and $76 (roughly 2x the current share price).
Since the company is grossly undervalued from a financial standpoint, is there something wrong with the business model? No, there isn’t. Title insurance has existed in the United States since the late 1800s and there remains a great need for the company’s services. Title insurance exists because of comparative deficiency in land records laws. It was created to protect the financial interests of an owner or lender against loss due to title defects. Therefore, as long as real estate transactions (i.e. sales or mortgage refinancing) take place in the United States, there will continue to be a great need for title insurance. While the volume growth of real estate transactions in the United States may be challenged for the foreseeable future, Investors Title Company continues to perform well in its major markets (i.e. North Carolina, South Carolina, Virginia, Michigan etc.) and is even experiencing top and bottom-line growth through its recent expansion into Texas.
Does management have a vested interest in the business? Investors Title Company has a very strong management team. The company was founded by J. Allen Fine, an accounting professor at the University of North Carolina (Chapel Hill), in the early 1970s. After significant research, he identified the growing need for title insurance and concluded that the volume of policies written in the United States would rise substantially as secondary markets for mortgage loans began to develop. He was right. J. Allen Fine is still the Chairman and CEO of the company today. According to Bloomberg and Capital IQ, he owns 9.3% of the company’s shares. Jim Fine, Allen’s oldest son, is the Chief Financial Officer of Investors Title. He is a chartered financial analyst and owns 8.5% of the company’s shares (according to Bloomberg and Capital IQ). Allen’s younger son, Morris, is the Chief Operational Officer. According to Bloomberg and Capital IQ, he owns 4% of the company’s shares. Collectively, they own roughly 22% of the company’s shares. Therefore, one could argue that management is definitely incentivized to maximize shareholder value. I believe the Fines are doing just that. Over the past decade, Investors Title has repurchased approximate 18% of its outstanding shares (net of options exercised). It has also grown tangible book value per share from approximately $17.59 to $48.95 (or a compound annual growth rate of 11% per year).
This performance has not gone unnoticed. Markel Corporation is the company’s largest shareholder at 10.8% according to Bloomberg and Capital IQ. If that’s not a vote of confidence, I don’t know what is. Markel is one of the best managed insurance companies and capital allocators of the last decade.
Disclosure: I personally own shares of ITIC. The accounts I manage also own shares of ITIC.