Description

Recommending long position in Crawford & Company Class A shares (NYSE:CRD.A) with a 3-year price target of $23 (+42% IRR / 3.0x MoM) based on 8x ‘20E EBITDA

Please click on the following link for a .pdf version of the investment memo (https://www.dropbox.com/s/hdrm8cuuiuqd6ki/CRD.A%20VIC%20Investment%20Memo.pdf?dl=0)

Company / Situation Overview

Crawford & Company (“CRD.A”) is the second largest third-party insurance claims administrator in the U.S., providing P&C loss adjusting, workers comp & disability claims management, and legal settlement administration services

• >75 years of experience with strong global brand recognition

• Well positioned to benefit from outsourcing of claims administration by insurance carriers (e.g., QBE, AIG)

• New CEO, Harsha Agadi, focused on upgrading management team and increasing margins to peer average (11-14% EBIT target) – previously led successful turnarounds at Quiznos, Friendly’s, Church’s Chicken, and Little Caesars

Over the last 5 years, the runoff of its Deepwater Horizon settlement administration project and a large BPO contract has masked CRD.A’s transformation from a weather-dependent P&C loss adjuster to a high-quality, technology-enabled insurance services provider. CRD.A is thus at an inflection point where its high-growth, high-margin segments (Broadspire, Contractor Connection, WeGoLook) will begin to drive consolidated results. In fact, these high-growth, high-margin segments have increased from ~23% to ~40% of revenue over the last 4-5 years. Broadspire is also particularly well positioned to accelerate its growth given the expiration of a non-compete that had prohibited Broadspire from soliciting disability claims administration business.

Crawford’s stock traded off ~25% following Q3’17 earnings as illiquidity exasperated selling pressure from event driven investors that had bought following Hurricanes Harvey, Irma, and Maria. Crawford recognized less CAT revenue and profitability in the quarter than expected due to (i) only recognizing one month of hurricane revenues (majority of revenue and profitability is expected in Q4’17 with continued revenue through Q2’18) and (ii) the front-loading of investments in CAT personnel (hiring, training, travel). The short-term, non-economic selling has created an attractive entry point with both a short-term catalyst in Q4’17 earnings and a medium-term catalyst as Crawford’s high-growth, high-margin segments increasingly drive consolidated results.

Valuation Overview

CRD.A trades at only 5.7x LTM EBITDA and an 8% unlevered FCF yield despite:

• Precedent transactions: 8.5-13x LTM TEV/EBITDA

• March 2014: KKR acquired Sedgwick for ~11.5x LTM EBITDA

• October 2014: Sedgwick acquired VeriClaim for ~10x LTM EBITDA

• September 2016: CDPQ acquired a stake in Sedgwick for ~13x LTM EBITDA

• September 2017: Warburg invested in SCM Insurance at ~9x LTM EBITDA

• Public comps: 11.5-15x NTM EBITDA

• No publicly traded pure-play claims administrators exist so the multiples above are based on an imperfect comp set of insurance brokers – Arthur J Gallagher (NYSE:AJG) is the closes public comp as Gallagher Bassett generates ~15-20% of AJG’s EBIT.

• Levered share buyback: CRD.A’s balance sheet is significantly under-levered relative to peers. As shown below, a $100m and $200m levered buyback would be ~26% and ~75% accretive to shareholders, respectively. Note that the Board currently has a 2.0m share repurchase plan outstanding (~4% of TSO).

Sum-of-the-Parts (“SOTP”)

Based on an SOTP valuation, CRD.A’s shares are worth $18-21/share, or 2.4-2.8x the current share price.

• Loss Adjusting: 8.5-10x TEV/EBITDA based on SCM Insurance / VeriClaim acquisitions

• Contractor Connection: 10x TEV/EBITDA based on Angie's List acquisition

• WeGoLook: valued at $36m cost basis

• International Segment: 8.5-10x TEV/EBITDA based on SCM Insurance / VeriClaim acquisitions

• Broadspire: 11.5-13x TEV/EBITDA based on Sedgwick acquisitions

• Garden City: conservatively valued at 6x TEV/EBITDA

• Corporate: blended 9.5-10.5x TEV/EBITDA

Dual Class Share Structure

CRD is controlled by the Crawford family via a dual class share structure. Class A & B shares are substantially identical except with respect to voting rights and the company's ability to pay greater cash dividends on the non-voting Class A common stock. Importantly, in a merger or acquisition, holders of the Class A common stock receive the same type and amount of consideration as Class B holders, unless different consideration is approved by holders of 75% of the Class A common stock. Despite the above, the Class A shares trade at an inexplicable ~15-20% discount to the Class B shares. In fact, Crawford pays a higher dividend on the Class A shares ($0.28 per Class A share vs. $0.20 per Class B share). The new CEO Harsha Agadi has noted that he is interested in investor feedback regarding the dual class structure and recognizes that it adds complexity and restrains trading liquidity. Note that the management team’s LTIP is paid in Class A common stock.

Levered Buyback Analysis

CRD.A’s balance sheet is significantly under-levered relative to peers. Given that CRD.A’s shares trade at an ~12-13% FCF yield (~7.5-8x P/E multiple), repurchasing shares using debt with an after-tax cost of ~2.4% (4% pre-tax with a 40% tax rate) is highly accretive. In fact, given that CRD.A’s dividend yield exceeds its after-tax cost of debt, for every $1,000 of shares repurchased, Crawford actually saves ~$13.33 of net cash flow as they don’t need to pay the dividend on the repurchased shares. Note that Crawford & Company has ample capacity under its exisitng credit agreement to complete a sizeable levered share buyback.

Risks & Mitigants

• Recession risk: the U.S. is in the later stages of the economic cycle, creating risk of a recession during the hold period

• Gallagher Bassett’s revenues declined only ~2% during the financial crisis; workers comp claims frequency tends to be countercyclical; P&C loss adjusting activity (other than for auto) is largely uncorrelated with the economic cycle.

• Workers comp claims frequency: increased focus on workplace safety and shifts in the U.S. workforce away from high risk industries towards lower-risk occupations have caused the frequency of workers’ comp claims to decline

• Gallagher Bassett’s revenues increased at a ~7% CAGR over the last 15 years despite falling claims frequency; CRD.A continues to win new corporate and insurance clients, particularly from Gallagher Bassett.

• Technology risk: insurers have increased the threshold above which a field adjuster is required as customers can photograph the damage directly and submit the claims digitally, reducing the demand for field claims adjusters provided by CRD.A.

• CRD.A has invested heavily in technology to strategically position itself for this transition (WeGoLook, Contractor Connection, drone capabilities); carriers have increasingly outsourced field loss adjusting services as third-party administrators benefit from scale and geographic density.

• Sedgwick competition: Sedgwick acquired VeriClaim in October 2014, creating the risk that Sedgwick would aggressively compete for P&C loss adjusting contracts.

• Loss adjusting is a relationship-driven business, meaning Crawford benefits from its 75+ year history; Sedgwick’s TPA customers are self-insured corporations, not insurance carriers; the competitive landscape has remained stable.

Catalyst

INCREASED INVESTOR AWARENESS: CRD.A is likely to announce a strong Q4 '17 given that the majority of hurricane-related revenue and profitability will be realized in October - December 2017; management has noted that they plan to increase their focus on investor communication.

CORPORATE TAX REFORM: CRD.A will be a major beneficiary of corporate tax reform as it is a full U.S. corporate tax payer with a 40% effective tax rate.

ACQUISITION CANDIDATE: CRD.A is an attractive acquisition target for a private equity firm or a merger candidate for a private-equity owned portfolio company (e.g., Sedgewick, York Risk Management); runoff of Deepwater Horizon settlement administration project and large BPO contract has dramatically improved quality of earnings.

DUAL CLASS SHARE STRUCTURE: CEO Harsha Agadi has noted publicly that he is interested in investor feedback regarding the dual class share structure and recognizes that it adds complexity and restrains trading liquidity; Board has reviewed the value of the dual class share structure in the past.

CONSOLIDATED GROWTH: Crawford’s high-growth, high-margin segments are expected to increasingly drive consolidated results as results begin to lap the headwinds from the run-off of the Deepwater Horizon settlement administration project and large BPO contract; CRD.A is at a unique inflection point with performance in both Garden City and U.S. Services stable over the last three quarters