Description

Maiden Holdings is a Bermuda-based reinsurer focusing on small-premium policies with high frequency and low severity in the extended warranty, workers comp and small business commercial p&c arenas. Maiden was capitalized with $500mm in capital in July 2007, comprised of roughly 52mm shares offered through FBR at $9.30 and a $50mm investment from the Karfunkels and Barry Zyskind , the CEO of Amtrust.

The downside of investing with a new reinsurance company is the lack of a track record to rely on. However, since Maiden has been founded by the same people who founded Amtrust Financial (AFS, $9.27), there is a track record going back several years to rely on that is pretty impressive. The upside to being a new reinsurance company is there are no legacy liabilities to bite you in the proverbial derrier. 

Relationship with Amtrust Financial will benefit MHLD

Until recently the bulk of Maiden’s business came from a quota share agreement with Amtrust Financial in which Amtrust cedes 40% of premiums to Maiden in return for a 31% ceding commission and 1.25% brokering commission. The agreement gives Amtrust the ability to scale it business more quickly and in a tax-advantaged way using Maiden’s favorable Bermuda structure. Without going into all the details, the agreement is structured to minimize the amount of liability to Maiden from any single claim so the likelihood of anything catastrophic hurting the balance sheet on the underwriting side is small. 

Amtrust today is a collection of insurance assets (typically buying renewal rights) assembled in the 90’s by its current CEO and the Karfunkels on the cheap to take advantage of an inadequately capitalized workers comp market and high loss/expense ratios at several companies. For more on a compelling AFSI story one can view a presentation at http://ir.amtrustgroup.com/events.cfm

Amtrust has beaten earnings estimates for several quarters straight and has earned a remarkable 20%+ ROE in the smaller premium extended warranty, non-catastrophic p&c and workers comp markets despite pricing pressure in workers comp in several states over last several quarters They have accomplished this by nimbly moving in/out of the right businesses and geographies as conditions change. In addition, their reserving is conservative (q3 had $15mm reserve release) and their expense management is outstanding with expense ratios under 20% most recently.

The table below shows the combined ratio history of Amtrust and by product line for last 3 years:

                                                2002     2003     2004     2005     2006     2007     9mths2008

Gross Premium Written ($mm)   27.5      97.5      210.9    286.1    526.1    839.4    817.0

AFSI Combined Ratio (%)         101.2    98.4      90.4      95.1      91.9      83.2      73.1

MHLD will benefit directly from what has been double digit organic growth at AFSI complemented by selective acquisitions. As an example, Amtrust closed on the purchase of Unitrin Business Insurance in June of this year and Maiden benefits from the premium ceded to it from this agreement. MHLD will get 40% of Unitrin business as well as $80mm of unearned premium in return for a 34.375% ceding commission and 1.25% brokerage commission. 

Amtrust recently signed a deal with CardinalComp,  which writes $150mm of workers comp to be the exclusive writer of business in several states. This will add meaningfully to Amtrusts top line as well as Maiden’s

Results at Maiden (3 quarters public) so far have been in-line/better than expected

 

                                                                                                           

2007    9mths’08         2009e 

 

Gross Premium Written($mm)                                                  247.4    386.9                1,200   

MHLD Combined Ratio (%)                                                     93.9      93.4                  96.0     

EPS ($)                                                                                     .43        .69                    $1.10

BVPS ($)                                                                                 9.02      8.17                  7-9

 

Maiden’s recent Acquisition of GMAC RE makes story more appealing

In what looks like a distressed sale of a noncore business by Cerberus, Maiden has bought GMAC re which includes $550mm in gross premium written, $750mm in loss reserves and $200mm of unearned premium for roughly $100mm. The business generated $65mm in net income in 2007. As important as the low price paid, MHLD got an excellent management team (confirmed from industry contacts), doubled the size of the business and diversified away from Amtrust in one fell swoop (from 95% to 50%). AM Best is requiring a $260mm capital raise to support the newly acquired business and maintain an A- rating. It is encouraging that the cash-rich Karfunkels (they recently sold American Stock and Transfer for $1b inc debt to Pacific Equity Partners) have agreed to backstop the rights offering.

Pro-forma, MHLD will have 4 segments 1) Treaty (63%): auto, homeowners, commercial multiperil and workers cop 2) Specialty (14%): commercial auto and workers comp 3) Accident and health (18%); medical stop loss and personal accident 4) SRS (5%); excess property

On the recent q3 conference call, management guided the combined entity for 2009 towards $950mm in net earned premium with a 96% combined ratio and $2b of average invested assets at 5.5%. generating approximately $150mm in net income. The real question is how many shares outstanding will the new Maiden have. Assuming a rights offering at $3.75 adds an incremental 69mm shares and gives us $1.19 in EPS and $5.95 in book value per share (38% discount). My guess is MHLD will be able to raise private capital more attractively and limit the dilution to book value. If for example half the $260mm was raised in a private offering of trust preferred or convertible securities at an illustrative 12% interest rate and assuming the same $3.75 share price for the remaining balance, MHLD could earn more like $1.38 and book value dilution would be limited to 2%. Under that scenario, the stock trades at a 52% discount to book. 

Investment Portfolio

The combined Amtrust and MHLD portfolios are being managed internally by capable manager who used to run a much larger operation at Safra Bank and then HSBC. Having said all that, the portfolio has been a source of frustration since it has held back book value growth in the face of excellent operating results. Both Amtrust ($45mm pretax charge in q3) and Maiden ($42.5mm charge) got stuck with Lehman and Washington Mutual bonds in their portfolios that had to be written down (the bonds were rated AA at the time they were purchased). Clearly, Maiden had too many of these bonds in its portfolio since it took a comparable charge to Amtrust despite having a smaller portfolio. As the combined portfolio approaches $1.7B with the addition of GMAC Re, it would make sense to add some credit analysis to the team rather than solely relying on ratings as an indication of value. 

As of end of Sep quarter there was $67mm in unrealized losses in the portfolio predominantly concentrated in corporate bonds. With corporate spreads the widest in many years, this represents a potential swing factor for Maiden in adding to book value as the company has the ability to hold these securities to maturity. 

In general, the portfolio looks fine with 78% of fixed maturities in AAA, US Govt and Agencies (which are effectively govt guaranteed). Corporate fixed maturites are 22% of all fixed maturities and 93% of corporates are A rated or better. Maiden also has $400mm in cash.

Valuation

Depending on how many shares are issued in a capital raise, MHLD trades as high as 3.4x 2009e EPS of 1.12 and as low as 2.8x assuming half the capital is raised through non-equity securities and in a range of a 38-52% discount to book value. Both multiples are very cheap even for a reinsurance company and in relation to some peers in the table below, especially given MHLD’s growth prospects.

-6.4% dividend yield; dividend increased nominally to .06 a quarter in q3. Not many insurers are increasing dividends in this environment.

-Private market value: Anacomp, a workes comp insurer, was bought for 1.2x book value in October

Ticker	Ticker	Stock Price	Market Cap $MM)	Price-To-Book	Dividend Yield	Forward P/E	ROE
PRE	PRE	71.14	$3,916,211	0.93	2.7	7.2	15.3
VR	VR	22.99	$1,721,448	0.9	2.6	4.7	10.4
ZNT	ZNT	31.40	$1,169,776	1.12	8.2	11.9	11.8
EIG	EIG	15.43	$753,449	1.91	1.4	8.9	11.1
MXGL	MXGL	11.75	$657,877	0.52	1.6	3.7	NA
CPHL	CPHL	10.11	$387,271	1.01	1.4	5.8	NA
MIG	MIG	5.40	$311,278	0.74	0.9	6.4	11.5
AMSF	AMSF	16.73	$315,215	1.3	0.0	7.5	20.6
EIHI	EIHI	8.33	$79,412	0.51	1.9	6.8	2.8
MHLD	MHLD	3.88	$231,054	0.48	6.6	3.4	11.8

Price Target

-Assuming the most draconian case for dilution from a rights offering and adding in my low end estimate of $1.1 for 2009 earnings and assuming a neutral contribution to book value from the investment portfolio, gets us to a little over $7 in book value. That is a double from these levels. Assuming what is a very reasonable case of lower dilution and higher earnings gets us to over $9 in book value. Even if this were to happen in 2 years, we would still be compounding at close to 60% for that time.

Concerns

-Overlap between MHLD and AFSI management and boards. A member of Board is son-in-law of George Karfunkel. Mr Zyskind is CEO of AFSI as well as chairman of board of MHLD and son-in-law of Michael Karfunkel. This would all bother me a lot more if not for the fact that they all have their own skin in the game. Founding shareholders of MHLD and CEO of AFSI collectively own 13% of MHLD shares, 19% including warrants as well as 59% of AFSI. The backstop of a rights offering by the same people also gives me comfort that these guys believe there is value here and are long-term players.

-Forced to due full capital raise with stock in low $3 range would dilute book value further than expected; stock would still be at a sig. discount to book value after 2009 earnings come in

-Other corporate bonds could face further writedowns; believe likelihood of this is small post Lehman bankruptcy as govt has signaled it will step in where system might be at risk

Catalyst

Potentially less dilutive capital raise to fund GMAC Re

-Fund liquidations ease-crowded holding for hedge funds on FBR deal

-Hardening market in workers comp

-Cardinal comp deal will accelerate premium growth at AFSI and benefit MHLD

-Book value growth starts to match or even outpace growth in earnings