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White Mountains Insurance: A Compounder With The Philosophy Of Berkshire

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About: White Mountains Insurance Group, Ltd. (WTM)
by: Oddmund Grotte
Summary

Long-time outperformer of the market.

Has not managed to reinvest capital from sales of assets, but buybacks have reduced outstanding shares from 9 to 3 million over the last decade.

Traditional insurance liabilities are replaced by more commission-based insurance, thus limiting potential liabilities.

Owner-oriented management, a long-term mindset.

The lack of a strategic plan makes the management free to contemplate available opportunities any given time which best serve the interests of the owners.

Introduction and summary

Everyone wants to find the next Berkshire Hathaway (BRK.A, BRK.B), at least a smaller version that has the possibility of returning above market returns.

White Mountains Insurance (NYSE:WTM) is by many regarded as a "Mini-Berkshire", but is still rarely covered on Seeking Alpha. The stock is above 1,000 USD, few shares are traded, and the dividend is insignificant. Because of this, we can label the stock as "boring" (in a good sense).

The resemblance with Berkshire is in insurance and the management's opportunistic investments, long-term mindset, careful capital allocations, and the nurture of long-term shareholders.

The company has a 35-year track record and a quite impressive one. It started as a spin-off from American Express in 1985 and was led by the industry legend Jack Byrne. Berkshire Hathaway was a shareholder for many years, until March 2008, but sold all shares after Byrne retired.

Management is owner-oriented and thinks like owners. It seems like the undeployed capital has dragged down performance lately, but management has bought back lots of shares around book value, thus reducing outstanding shares from 9 to 3 million over the last decade.

I will be a buyer if the stock drops below book value.

Historical performance

Let's first look at the performance of both the stock and book values:

The performance has been pretty good since it was listed in 1995 (I only have quotes back to 1997). The graph below shows its relative performance compared to both Berkshire and S&P 500 (SPY).

White Mountain vs. Berkshire and S&P 500Blue line shows 10,000 invested in White Mountains, red line is Berkshire Hathaway, and pink line is S&P 500. Source: Yahoo Finance and my own calculations.

A $10,000 investment is now worth $122,000, while "only" $91,000 for Berkshire and $58,000 for S&P 500. But the ride was quite rough during the GFC in 2008/09, which coincided with Berkshire selling its stake in March 2008 and White Mountain subsequently buying back shares.

White Mountains measures its performance in growth in book value. Since 2001, it has risen about 8.75% annually:

White Mountain growth in book valueLeft x-axis is book value (blue line) and right axis is 5-year rolling CAGR. Source: Annual reports and my own calculations.

The business

The journey of White Mountains originates back to 1985 when the Fireman's Fund, a subsidiary of American Express (NYSE:AXP), was in trouble. Jack Byrne was headhunted to reorganize and improve the company, which he did successfully, and its IPO in 1985 was the largest in history, before being acquired by Allianz (OTCPK:ALIZF) in 1991. The holding company was retained by Byrne, and this subsequently became White Mountains and listed in 1995.

White Mountains is one of those few companies that publish a pretty useful and interesting annual management letter. These are often crucial in order to understand the business and the DNA of the management culture, especially if you are focused on the management (as every investor should be?). Their four priorities are good underwriting/operational performance, maintain a disciplined and conservative balance sheet (because they are owner-operated), invest for total return (not interest and dividends), and finally, base all decisions as business owners. They don't care about growing revenue or market shares, only growing the book value/intrinsic value. As a matter of fact, this is what the management writes in their annul letters:

We have never made a strategic purchase… Maybe we will someday. We often sell to strategic buyers. Our problem is we really don't have much of a strategy other than to increase intrinsic business value per share.

I assume many investors find it odd that a company claims to have no strategic plan, but I believe it makes a lot of sense: The lesser strategies made, the more options kept, and they can evaluate options as they come. There is no need or hurry to proceed in a certain direction, which often leads to ill-fated M&A, but rather focus on what makes sense for the owners at the time. This is no different than Berkshire. After re-reading all of Buffet's annual letters, I can't remember ever reading about strategy. Besides, many companies started in a completely different business than where they are today: Coca-Cola (NYSE:KO) as a pharmaceutical company, for example. At the end of the day, an investment in White Mountains is an investment in its people and management.

The description from the management letter can be narrowed to the following, at least up until now: to make opportunistic and value-oriented acquisitions in the insurance and financial sector (a few of them could be labelled "turnarounds"), and exit those businesses when valuations are attractive, whenever that is. However, they take a hands-off approach in running the underlying businesses, as decentralization is part of the strategy, just like Berkshire, Markel (MKL) and Alleghany (Y), but of course give a lending hand from headquarters in terms of management, knowledge and capital.

Despite having insurance in their name, much of the insurance business has been sold off over the last couple of years, meaning they have very little traditional insurance liabilities. We can rather say they own "adjacent" insurance businesses, less so "real" insurance with future liabilities.

As an example of their business, we can look at their purchase of One Beacon in 2001, bought at less than book value. This transaction was partly financed by Berkshire, and, I believe, because of the trust Buffett had in Byrne (Byrne reorganized GEICO in the '70s). Berkshire sold the position after Byrne retired, an incredible well-timed sale in 2008.

One Beacon was a somewhat troubled insurer with combined ratios hovering at 100 or slightly above at the time. In 2017, the unit was sold at 1.7 times book value, generating a CAGR of 14% growth in book value over the period. How did they achieve this? The combined ratio shows why they managed to increase the price:

2001

121

2002

107

2003

98

2004

99

2005

98

2006

96

2007

93

2008

95

2009

94

2010

101

2011

92

2012

98

2013

92

2014

102

2015

96

2016

97

Both an improvement in the operating business and general higher valuation multiples made the management accept a pretty good offer.

So, what kind of businesses do they have right now?

  • BAM/HG Global: Build America Mutual (BAM) is the only municipal insurer in the US. HG Global underwrites reinsurance for policies underwritten by BAM. Premium income for 2018 was $111 million.
  • NSM: A niche insurer in areas like wine and brewery, school insurance, pet insurance (to name a few), all assumed inefficient niches. However, NSM is only a commission business, sending the business to underwriters who put up capital and reserves. WTM owns 95%, bought in May 2018. NSM received $782 million in commissions in 2018.
  • Kudu: Provides asset managers worldwide with capital solutions tailored to special situations. WTM owns 99%.
  • MediaAlpha: It's a marketing/technology company that makes technology/platforms to facilitate transactions between advertisers and publishers (income is fee-based). In February 2019, WTM sold part of the business, and it is no longer consolidated into the reports (ownership is 48%). Revenue grew from $163 million in 2017 to $297 million in 2018 (not directly comparable due to M&A).
  • PassportCard/DavidShield: This is a travel insurance company founded in Israel, but expanding to Australia. They also offer services in Germany, US, Cyprus, and Switzerland (via other insurance companies, Allianz, for example, in Germany). The idea is offering a card that you can activate whenever you need to travel, and it offers no paperwork, no out of pocket expenses, and no long claim process. DavidShield operates only in Israel and does expatriate medical insurance. Both businesses are based on commissions. Revenue increased from 84 million in 2017 to 110 million in 2018.
  • Other minority investments: Buzz, Wobi, Enlightenment Capital, Tuckerman Capital, WM Advisors (manages their investments), Noblr and Elementum.

Due to the fact that underlying businesses come and go, I believe it's futile to spend much time trying to figure out the prospects of the above-mentioned companies. However, the current business portfolio has deviated quite a bit from the historical ones because of its lack of insurance liabilities.

Management

The first CEO was the industry legend Jack Byrne (he died in 2013 and is the father of the eccentric Patrick Byrne, the founder of Overstock (NASDAQ:OSTK)). In 1975, Byrne became CEO of GEICO, now a part of Berkshire, a position he had until 1985. At that time, he was headhunted as CEO of the Fireman's Fund, and from 1995, he served as CEO for White Mountains until he retired in 2007. He was replaced by Ray Barrette, who decided to retire in 2017, and since then, Manning Rountree has been running the business (employed since 2004). All are recruited internally, something I personally like (given a successful business) and should bode well a long-term owner-mindset. There is no brand "that any idiot can run", and thus, you are basically investing in a "bunch of people".

The management has a stake in the business and as such is owner-oriented: Management are co-owners and clearly think like owners. Executives own about 2.5% of the company, and increasing because of the buybacks (see more later). This is what the management letter says about their long-term mindset:

Intellectually, we really don't care much about leaving our capital lying fallow for years at a time. Better to leave it fallow and to wait for the occasional high-return opportunity. Frankly, sometimes shareholders would be better off if we all just went to play golf. Overall, we should be students of capital and business.

The management is the main thesis for investing into White Mountains because of these reasons:

  1. Management has a significant stake in the business, and gains or losses to outside shareholders are mostly in proportion to management's.
  2. The management record has thus far been pretty good.
  3. They have managed, although to a lesser degree than Berkshire, to nurture shareholders that have a patient and long-term view.
  4. They clearly think like owners in capital allocations decisions:

Capital allocation

White Mountains pays a paltry yearly dividend of one dollar, but apart from that, allocations are based on what makes sense to optimize shareholder value. Over the last decade, a huge amount of capital is handed back to shareholders, almost exclusively in the form of buybacks. This has reduced the share count drastically from 9 million in 2009 to just 3 million shares today. Most of these buybacks are done via Dutch auctions, with many of the offers slightly above market price, which of course differs from most companies which normally buy back shares only on the open market. I believe buybacks are preferable to dividends if done at the right prices, and management has a clear understanding of the value of the business. I would say buybacks are less risky compared to buying new businesses because management knows what they are buying into.

However, the primary goal is to reinvest retained earnings back to the business, of course, depending on valuation and alternatives. Currently, White Mountains remains in a transitional period marked by very patient re-deployment of the capital generated from the sales of the businesses during the last four years, which sets the bar high for managing the undeployed capital intelligently.

White Mountain capital allocationSource: Annual investor meeting 2019.

As of summer of 2019, about 34% of shareholders' equity is undeployed. This is, of course, a drag on growth and most likely implies single-digit growth in the short term until it is redeployed or distributed back to shareholders.

What can we expect of capital allocations in the future? I believe we can expect much of the same: A gradual return of capital via buybacks to shareholders and careful deployments into new opportunistic investments.

Investments

Because most of the traditional insurance businesses are sold, there is little "float" to invest. This is, of course, quite a difference compared to Markel, Alleghany, and Berkshire which all have a huge insurance presence. This means the source of White Mountains' investments is mostly shareholders' equity.

White Mountains differs from both Berkshire or Markel because it's not trying to find the next great stock to own. They invest mainly in bonds and vary in average duration depending on their expectations, and the more risky assets are invested "passively" in common stocks, convertibles, private equity and ETFs (labelled as "risky assets" in their reports). Hence, a lower interest environment plays right into a lower bottom line, but this is hopefully offset by an increase in the more aggressive equity positions.

End of 3rd quarter shows a value of $1.2 billion for fixed maturity investments (duration of about 2.7 years), $0.6 billion for common equities and $0.75 billion in unconsolidated long-term equity investments. This means risky assets is 55% of investments, and 45% of shareholders' equity (which is $3.1 billion). They own thirteen private equity funds and one hedge fund, and the single largest investment in these is about $55 million. Furthermore, White Mountains has invested in insurance-linked securities (ILS), valued at about $40 million.

The annual CEO letter always emphasizes the possible risks facing the insurance industry and their investments. This is reflected in a falling equity investments ratio after 2008 and a shorter duration in their bond portfolio, a view they share with, for example, W.R. Berkley (NYSE:WRB). They always have a large cash holding in their balance sheet.

Their performance is summarized in this table (source is annual reports):

Total return (GAAP) Fixed income Risky assets S&P 500
2012 4.9 3.8 7.7 16
2013 4.1 0.5 18.9 32.4
2014 1.9 2.7 8 13.4
2015 3.6 1.1 3.3 1.4
2016 2.7 2.1 4 12
2017 5.6 3.5 20.1 21.8
2018 -1.7 1.2 -3.6 -4.4

Clearly, the risky assets have not managed to keep up with the stock market. However, I believe management is more focused on absolute performance than relative performance. Because management has a real skin in the game, they have incentives to be conservative.

Valuation

I believe the most relevant measure is price to book (and tangibles deducted for goodwill):

ChartData by YCharts

The last reported adjusted book value is 1,007 dollars.

Historically, the stock has traded at around book values:

White Mountain Stock price and book valueSource: Management letter of 2018.

Based on this, the stock seems to be slightly overpriced right now, but I believe a purchase around book values seems like a good long-term entry to add or initiate a position.

Opportunity costs

There are several "mini"-Berkshires, like for example, Markel and Alleghany, and I consider White Mountains as one. All companies have beaten the S&P 500 over the long term. However, most investors have a limited source of capital, and no one aims to make "diworsification". The relevant question is thus: does it make sense to invest in White Mountains instead of one of the other "Berkshires"? Why put money into a business that is only your xth choice? All of these stocks have a pretty good diversification in their underlying businesses and function more or less like a mutual fund, but with much lower "fees".

Conclusion

The case for White Mountains is its modest size: Just $3.4 billion (Alleghany is $10 billion, and Markel is $15 billion), and just a fraction of Berkshire. We all know it's easier to grow a small capital base than a big one. Another thing to consider is that White Mountains as of now has very little risk exposure to insurance liabilities, thus most likely less prone to "black swans".

The company has still undeployed capital, and I expect buybacks if the price drops below book value, which looks like a good entrance point for outside investors as well.

At the end of the day, you invest in the capabilities in the management, more so than in most other companies, in my opinion. As usual, any investment into the "Berkshires" comes at an opportunity cost at the time of purchase, and this, of course, is a personal preference.

Disclosure: I am/we are long BRK.B,MKL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion - they are not suggestions to buy or sell any securities.