Description

Hilltop has been written up several times before on VIC. For a full history of the company and its management, which is important to the investment thesis, please see the earlier posts. Since those write ups, HTH has made two acquisitions that have/will transform the business and because of these acquisitions a new updated write up of HTH is warranted.

Prior to the acquisitions, HTH derived all of its revenue from NLASCO – its property and casualty insurance business which it acquired in 2007 for $118mm.

As noted in the previous write ups, HTH had approximately $600mm in cash on its balance sheet which it was waiting to deploy on government assisted acquisitions of troubled banks – a strategy that HTH management (Gerald Ford) exceled in. After several years of waiting and presumably screening for attractive acquisition targets, HTH’s management announced two important acquisitions in the last eighteen months.

PlainsCapital Corporation Acquisition

In May 2012, HTH announced (closed Nov 2012) the acquisition of PlainsCapital Corporation (“Plains”) for total consideration of $700mm. Consideration consisted of cash, common shares and pref shares. Although Plains was not distressed, the deal was received favourably (HTH shares up 30% post announcement) due to Plains’ excellent track record – 12% ROAE since 2000 and 16.5% EPS CAGR. The transaction was seen as a source of liquidity for Plains – in 2009 it had attempted to IPO but given the poor market conditions this was abandoned. Following the Plains Capital transaction, HTH still had close to $200mm in excess capital allowing it to make further acquisitions. Deploying this capital would help reduce drag on its ROE.

First National Bank Acquisition

Even though in the last VIC write up one of the risks mentioned was: “Lack of acquisitive behaviour leads to hope of discounted transaction vanishing”, HTH was still able to find a distressed deal five years after the crisis (another tip to the quality of management). Not only was HTH able to find the deal, it was able to make the purchase through the FDIC with favourable conditions, reminiscent of 2008-9 (assumptions agreement and loss share coverage).  . On September 13, 2013, HTH (through Plains) announced the acquisition of certain assets of Edinburg, Texas-based First National Bank (“FNB”).  Details of the transaction can be found on HTH’s IR website. Ultimately, once the transaction closes, HTH will have purchased $2.6b of assets and added 51 branches, bringing the total branches to 84. The transaction will be immediately accretive to earnings. On the FNB acquisition conference call (HTH’s first conference call) management was elusive on providing any EPS accretion guidance besides stating: “This deal should be positive for the NIM.” However, assuming a ROA of 1.25% (compared to HTH’s 1.50%) we think this transaction should add at least ~$35mm in earnings.

Valuation

Prior to the FNB acquisition, HTH generated an ROA of approximately 1.50%, which should be a reliable go forward assumption given Plains’ long term operating performance. On $7.4b of assets, HTH was on track to generate net income of around $110mm this year. With an additional $2.6b of assets from the FNB transaction ($10bln total combined assets), and assuming an initial lower ROA on the FNB assets of 1.25%, earnings will increase to approximately $145mm.

Thursday’s, October 18^th, announcement to redeem the $90mm Sr. Exchangeable Notes will likely add an additional 6.2m shares to the share count – given the exchange terms and the current share price is above tangible book value. With the share count potentially increasing to ~90mm, we think the pro forma EPS for the combined business is around $1.60.  The current price of $17.27 values the business at 10.8x EPS – which is cheap for a business with excellent management who, over the long term, have demonstrated skilful capital allocation and operational performance. Additionally, its peer group trades at a median P/E multiple closer to 18x; these peers have a lower median ROA (~1.10%) and worse capital ratios than HTH.

Risks

• First National deal does not close
• Poor operating performance
• Note:  we do not consider Jeremy Ford, President/CEO and son of Gerald Ford, as a risk that some might.  It’s clear to anyone following the company that Jeremy is being closely groomed by his father and Vice Chairman Alan White (both of enviable long term track records).  We think it’s safe to say that these two are really driving the company.

Catalyst