Description

Thesis

PIH is selling its main business, a P&C insurer in Louisiana and Texas and Florida, to FedNat (FNHC) for cash and stock. PIH book value after the deal closes will be ~8.60 (consisting of cash and FedNat stock), so today you’re buying PIH at 56% of book.  

The FedNat stock you receive also could be cheap (I’d recommend the recent writeup by cablebeach for more details).

Why is it cheap?

Three factors contribute to the discount:

1. Uncertainty over the deal with FedNat closing, especially since it’s already pushed back.

2. PIH won’t liquidate. Instead, PIH Chairman Kyle Cerminara will invest the cash pile in an as-of-yet undetermined mix of direct and fund investments.

3. The involvement of Larry Swets, a polarizing figure for some investors.

I’ll address offsets to each of these factors below.

History

Despite its size, PIH has been written up on VIC a few times (most recently by ATM in 2015). Check out those write-ups for a longer history but the summary is as follows.

PIH was created by Kingsway Financial in 2012 with the purpose of insuring what at the time seemed like underserved homeowners in Louisiana. The idea then was that a long period of bad losses caused larger companies to pull back from that market.

Since the IPO the company and the stock have done nothing despite the belief by investors and management that the market PIH played in remained attractive.

On February 25th 2019, FedNat announced the acquisition of PIH’s P&C business (Maison) and related businesses (Maison Managers and ClaimCor).

The FedNat deal

The FedNat deal will leave PIH as a collection of cash and FedNat stock plus just enough reinsurance business to remain an operating company. FedNat is paying $51mm, consisting of $25.5mm of cash and $25.5mm worth of FedNat stock (with no collar) to PIH.

PIH had originally contemplated a deal close by June 30th, but we’re still waiting for the Louisiana Department of Insurance to approve the transaction.

I don’t question FedNat’s commitment to the deal though. Most of my confidence here relates to the fact that PIH and Fednat recently entered a reinsurance deal together: “Given the pending acquisition of Maison by Purchaser, the Company and Purchaser have agreed to combine their 2019-2020 excess of loss catastrophe reinsurance program into a single program (the “Program”) allowing Maison, FNIC, and Monarch to capitalize on efficiencies, spread of risk and scale. The Program provides approximately $1.28 billion of single-event coverage, and aggregate coverage of $1.84 billion.”

FedNat probably wouldn’t do this if they had cold feet.

The ongoing business

The ongoing business will consist of writing small amounts of reinsurance (enough to be an operating company) plus the investment portfolio run by Kyle Cerminara (of Fundamental Global).
The proxy gives a short (and relatively uninformative) description of the ongoing strategy: “We do not intend to liquidate following the Asset Sale. Our Board will evaluate alternatives for the use of the cash consideration, which are expected to include using a portion of the cash consideration to conduct the business of our reinsurance subsidiary, PIH Re Ltd. (“PIH Re”), and launching a new growth strategy focused on reinsurance, investment management and new investment opportunities. The Company may form an additional reinsurance subsidiary in a suitable jurisdiction.”

It’s tough to say how Kyle will perform in this strategy, but if our base case is market-ish (or something that isn’t a complete disaster) performance and no self-dealing, we should be fine. Kyle isn't some random executive with a hankering for managing money. He is a professional investor with a history of public and private investments. I also like the incentives: Kyle and Fundamental Global own almost a third of PIH.

Kyle will also be subject to a 3-year standstill with the FedNat stock, so for the time being you know what a decent portion of the portfolio will look like.
Because most of the employees go with the deal, cash burn should be low. The pro-forma income statement shows $1.6mm of G&A and the preferred (more on that below) costs $1.4mm, offset by 600-700k of dividend from the FedNat stock. So $2-2.5mm on equity of ~$70mm isn't a great expense ratio but it isn't a disaster either.

Larry Swets

I won’t get into Larry's history here or defend him other than to say that he isn’t in control of PIH and he won’t be managing the ongoing investment portfolio. When you read the background to this transaction you can see that Kyle Cerminara is in control and that he did all the negotiations. For more background on Larry, there are write-ups of Kingsway Financial and Itasca Capital on VIC that both provide a decent history of his public investments.

Valuation & Closing thoughts

Working from the March balance sheet, the key adjustments to make to cash (per 4/22 proxy) are as follows:

Cash consideration from Buyer: $25,500

Cash from Buyer for surplus note obs: $18,244

Less: cash at Maison, MMI, ClaimCor: ($27,236)

Less: Company acq. Of Funds from Maison: ($3,287)

Less: payment of interco obligations: ($1,763)

Less: transaction expenses: ($1,500)

Adjustment to cash -> $9,958

Note that these adjustments were building off the December balance sheet so it might be slightly different at the close.

At the close you will have the following balance sheet:

Assets:

FedNat stock: $22,283

Short-term investments: $7,168

Other investments: $4,188

Cash and equivalents: $36,250

Other assets: $353

Liabilities:

A/P and other: $918

Equity is $69,324 and you have the $17.7mm preferred ahead, so common equity is $51,824 or $8.62 per share (6,012,764 out as of the latest Q).

Short of outright fraud or a complete disaster investing the cash, PIH should do fine: even if we trade at 75% of cash & stock, we’re making 33% from here. IMO the biggest risk is that this deal doesn’t get done (or done at current terms), but there are no obvious reasons why this would be the case given the size of the players involved. I think once the deal closes and we have more clarity on the balance sheet and how Kyle plans on investing it, the stock should re-rate to a smaller discount to book.

It’s also worth checking out the preferred (PIHPP), which is a $17.5mm issue trading at par an 8% yield (not callable until early 2023). That’s a decent yield considering the big cushion below it.

Risks
The deal with FedNat doesn’t close.
A really bad hurricane season.
The deal does close and the investment strategy is completely disastrous. 

Catalyst

The deal with FedNat closes.