Description

American Physicians Service Group, Inc (AMPH) is a stock that has a number of characteristics appealing to the slothful investor - a price chart that begs for some defibrillator paddles, lumpy earnings, significant cash and marketable securities that are being saved for some unknown rainy day.

So what’s to like? Subtracting AMPH’s $6.46 per share in cash and cash equivalents from its $9.85 share price results in a market cap of $9.55 million for a company that generated approximately $2.8 million in earnings last year. Using AMPH’s relatively conservative, sustainable annual earnings stream of $2 million AMPH trades at an extremely low multiple of 4.77X earnings to enterprise value

The business value (excluding the non-operating cash and marketable securities portfolio) at AMPH resides in two operating subsidiaries - APS Insurance (insurance management services) and APS Financial (broker/dealer and asset manager).

Through APS Insurance, AMPH provides insurance management services to American Physicians Insurance Exchange (APIE), a regional insurance exchange that sells medical liability insurance to physicians. APIE in a reciprocal insurance exchange, wholly owned by its subscriber physicians. AMPH has no ownership or equity position in APIE and has no liability for losses or claims. AMPH’s contract with APIE is to exclusively operate and manage APIE. AMPH is compensated based on a percentage of premiums as well as a percentage of overall profits. AMPH’s lumpy earnings are partly a result of the performance of APIE as AMPH’s compensation is negatively impacted when APIE experiences a loss. Revenues from insurance services were $10.8 million in 2003. Earnings over the past 2 years on the insurance side have improved significantly over prior years. New tort reform passed in Texas for medical malpractice liability insurance and reduced liability limits obtained by insureds have assisted in this improvement in earnings. Revenues have continued to increase in 2004.

APS Financial is a subsidiary of AMPH that is a broker/dealer operation catering mainly to high net worth individuals and institutions. Fees are earned through trading commissions and to a lesser extent from asset management fees. Offices are located in Houston and Austin. Revenues for 2003 (a record year) were over $19 million.

According to management, this has been a good business for them over the past 23 years. The company doesn’t specifically break down earnings from either insurance or financial, but as with most broker/dealers, they did struggle during the 2000 – 2002 time period. Profits were a record in 2003 on the financial side and revenues have decreased in 2004. Let’s take a look at the balance sheet first and then attempt to determine future earnings.



In addition to the operations discussed above AMPH has significant cash and marketable securities holdings. So – the question is how good is the “cash”?

Actual cash balance as of 9/30/04 is $6.6 million. Fixed income investments as of 6/30/04 are $4.7 million. The other investments consist primarily of two publicly traded stocks – Financial Industries Corp. (FNIN.PK) and Healthtronics, Inc. (HTRN).

FNIN
In the second quarter of 2003, the company purchased 385,000 shares (4% of float) of Financial Industries Corp (FNIN.PK) at an aggregate cost of $5.6 million or $14.54 per share. FNIN is a holding company primarily engaged in the life insurance business through its ownership of Family Life Insurance Company (Family Life) and Investors Life Insurance Company of North America (Investors Life). Family Life specializes in providing mortgage protection life insurance to borrowers of financial institutions. Investors Life is engaged primarily in administering existing portfolios of individual life insurance and annuity policies. At the time of purchase, AMPH was given a board seat and currently the CEO of AMPH sits on the board of FNIN and is chair of the audit committee. They’ve got clobbered on this investment thus far as today it is trading at $7.75 resulting in a current value of $2.98 million.

FNIN has been delisted from NASDAQ and undergone a significant management change. All indications are that financials will be filed in the near future and soon thereafter the company will be re-listed. The prior management team’s missteps are still being felt as the company estimates that they will be taking writeoffs of approximately $50 million this quarter. Adjusting shareholder’s equity for this write-off and other one time consulting and professional fee expenses associated with the write-off results in a book value of $106 million. FNIN has 9.6 million shares outstanding resulting in a book value of approximately $11 per share – resulting in a P/B multiple of .70.

The investment in FNIN has recently been written down in their latest Q. All the figures in this writeup are based on current valuations of all investments.

HTRN
AMPH owns 555,000 shares of Healthtronics, which is currently trading at $7.17, creating a current value of $3.97 million. Originally AMPH had purchased the shares in Prime Medical Services (PMSI). On November 10, HTRN and PMSI merged and HTRN is the surviving company. Healthtronics and Prime Medical primarily provide lithotripsy throughout the majority of states and design and manufacture trailers and coaches for transporting high-technology medical devices and equipment designed for mobile command and control centers and the media and broadcast industry.

The total of cash and investments is the sum of the investments pieces is $18.3 million – or $6.46 per share. The tax impact of selling the assets would be nominal as the gain on PMSI would be offset by the loss on FNIN.

Subtracting the $18.3 million in cash/investments from the current market cap of results in an adjusted market cap of $9.54 million. I am using 2.832 million shares outstanding.


So, what will earnings be going forward? The short answer is I have no idea with any degree of specificity. Ongoing earnings are difficult to predict with any certainty for this company. 2003 was a record year and the first nine months of 2004 have been favorable as well. 2003 earnings were $2.8 million. If we just look at the operating earnings from the company, through the first nine months of 2004, you have $2.7 million in operating earnings, or 5% less than 2003. Attempting to be on the conservative end, I’ll assume that annual operating earnings will be $3.2 million and that after tax income will be approximately $2 million. This figure is about 15% less than the average operating earnings during the past 21 months. It is based on discussions with management that the two main business segments have a solid future and although earnings aren’t anticipated to exceed 2003 earnings, they should be profitable going forward. No doubt that earnings will fluctuate greatly and although earnings from operations in 2000-2002 were primarily negative, there is reason to believe that the insurance operations have made solid progress toward future profitability. It also takes into effect the eventual elimination of earnings they will receive from a previous sale-leaseback arrangement.


With sustainable earnings of $2 million AMPH is trading at a P/E of 4.77 on enterprise value– too cheap even for a mini, micro cap. Using actual trailing earnings would result in an even lower p/e multiple

Catalysts?
First, lets address the typical micro cap dance . . .
1. AMPH shouldn’t be public so lets speculate that management takes the company private. Ummmmm, no. This company has been around too long that this should already have happened if it was going to. So I don’t expect this as an option.
2. They may get acquired. Not a horse I’m going to back given the odd mix of the two primary businesses.

So why am I posting this? The primary catalyst to me is AMPH’s recent decisions regarding cash and investments. In mid-August, the company announced that it will pay a $0.20 dividend and buy back $2,000,000 of stock, which is about 7.5% of the current number of diluted shares. Now we'll see if they actually buy them. I wish they’d quadruple that stock buyback, but it is significant start. The announcement of the dividend was rather vague and upon questioning of management, it has been classified as a one-time dividend for now, but they have admitted to continuing to evaluate their upcoming dividend policy. Given the excess cash / investments on the balance sheet, they would be able to pay a $0.20 quarterly dividend for over 7 years without relying on any future cash flow from operations to pay the dividend. Another potential catalyst (which I am not banking on) is FNIN’s re-listing leads to a rise in FNIN’s stock price and the corresponding impact to AMPH. Finally, I am getting into a boat (yes a very small boat – even a dinghy perhaps) with a fund that I have a healthy amount of respect for (First Wilshire owns 9.3% of the company)

Yes there is the risk they make another poor FNIN type investment. But the CFO does not strike me as the type of guy who has enjoyed the experience with FNIN. Dilution was big last year . . . but future dilution should be much smaller and will be offset by the buyback.

Last comment - the CEO is 55 years old and owns 18% of the float and continued buybacks/dividends would be a viable “liquidity factor” for him (if realizing a good price for selling the company doesn’t happen) and a value unlocking proposition for all shareholders.

So, to summarize, this is a company with a net market price of $3.38 trading at 4.77X sustainable future earnings. Cash/investments provide a pretty clear picture of the downside – which is limited. Any demonstration of sustainability of dividends/buybacks will likely lead to a significantly higher share price.

Catalyst

Completion of share repurchases
Continued announcements of future dividends
Re-listing of FNIN
Continued cash flow from operations