Description

NI Holdings, Inc (NODK) is a cheap stock with an attractive risk/reward ratio and a clear catalyst that will likely occur in the next 12-24 months. NODK was written up on VIC two years ago by Robot1, who did an excellent job laying out the situation. I recommend reading that write up as well for additional color. 

NODK is a mutual holding company that owns several well run insurance businesses. It raised $93mm in an IPO in 2017 (first step mutual conversion; ~10% leakage). The stated purpose of the IPO was to raise capital to diversify its geographical exposure and its business line exposure through acquisitions. It has done just that.

At the time of its IPO, 75% of NODK’s business was in North Dakota. In 2018, NODK acquired Direct Auto for $17mm. Direct Auto is an Illinois based specialty auto insurer. On January 1, 2020, NODK acquired Westminster American Insurance Company for $40mm + a $5mm retention bonus for its president payable over the next 5 years. Westminster is a mid-Atlantic commercial multi-peril insurer. I estimate that these two acquisitions plus targeted organic growth have decreased NODK’s North Dakota exposure to ~50% of direct premiums written (see table below). Better than 75%, but still high. 

The critical development since Robot1’s write up is that the vast majority of the IPO cash proceeds has now been allocated to either acquisitions or the share repurchase program. The table below lays out the remaining HoldCo cash from the IPO. It is clear that in order to continue its diversification strategy, NODK will need to proceed with the second step conversion in the near future. 

At 3/31/20 there was still $45.7mm of HoldCo cash on the balance sheet; however, $20mm of that cash is spoken for by the Westminster Acquisition delayed payments. In addition, NODK spent ~$3mm repurchasing shares in April per Q120 10-Q. There is an additional $10.5mm of buyback authorization remaining, $10mm of which was announced 5/6/20. To date, management has taken advantage of its buyback authorizations, and repurchases accelerated in April to take advantage of the low stock price. 

If we assume that no additional buybacks are made (highly unlikely) then there is $22.9mm of HoldCo cash left, enough for one additional small acquisition to further NODK’s diversification goal. In this case, there might be a 24 month runway until the second step conversion. If all of the buyback capacity is used, they are down to $12mm remaining and the second step conversion will likely occur sooner. Either way, the war chest accumulated from the first step conversion is significantly depleted and must be re-upped in order to continue to make diversifying acquisitions consistent with the stated strategy. Furthermore, it is worth noting that management appears to be allergic to debt, so their most likely means of raising the capital to continue the diversification strategy is a second step conversion.

The table below shows why I believe this security is undervalued. 

Using the 3/31/20 Tangible Book Value, the stock appears to be reasonably valued at 1.1x TBV. This is how any formulaic screen would categorize the stock. However, pro forma a second step conversion transaction where Nodak Mutual Group sells its remaining shares at $13/share, Price / Pro Forma TBV drops to 0.7x, an easily apparent discount to fair value.

NODK is a well run business and should conservatively trade at 1.0x TBV after the eventual second step conversion. They have consistently made an underwriting profit with a combined ratio under 100% in 14 of the last 15 years. GAAP ROE has averaged 11% over the past 5 years despite the drag from the HoldCo cash balance and despite a conservative Premium to Surplus ratio of ~1.0x. 

Consistent with the above stated ROE figures, TBV per share has increased consistently since 2015 (note that the large bump in 2017 is from the first step conversion). 

Upside

The table below lays out the upside from a second step conversion at different multiples of TBV. Today, the mutual holding company, Nodak Mutual Group, owns ~57% of outstanding shares which would be sold in the second step conversion (up from 55% ownership due to repurchases). I think realistically there is 40% to 60% upside on 2nd step conversion. The key variables to determine the upside are the second step sale price and the pro forma trading multiple of TBV. Of course the timing of the second step conversion will dictate the IRR. 

Risks

There are several risks here:

1. The most likely risk is that a second step conversion does not occur in the next 24 months diluting the IRR.

2. Crop insurance accounts for ~15% of NODK’s net premiums but a disproportionate share of its underwriting profits (50-60% of underwriting profit in 2017 and 2018 when it was 33% of net premiums earned). Crop insurance is heavily regulated and has occasionally been a political football. There is some risk that NODK’s crop insurance business becomes less attractive in the future due to political machinations outside its control. 

3. There is the risk that management does a bad deal. This risk is attenuated by the lack of funds to do so (without first full conversion). It would also be out of character for a veteran management team that has shown extreme conservatism both in their gearing of the business as well as in their insurance underwriting track record. 

4. Coronavirus has decreased NODK’s premium volume, which will temporarily increase their expense ratio. They may post a few quarters with a combined ratio >100%. To sensitize this risk, if premiums dropped by 25% from pro forma 2019 levels for four straight quarters, I estimate a combined ratio of 106% and a ~1.3% hit to TBV (excluding any investment losses that may occur in this scenario). 

5. The investment book is another bucket of risk. I have laid it out at the bottom of this write up, but it is ~13% equities, 9%, ABS, 8% CMBS, 14% RMBS, 33% Corporate bonds, 17% municipal securities, and 6% US federal government obligations. Average duration for the fixed income book is 3.4 years. There is a lot to worry about there in a severe economic downturn. There is not a ton of additional disclosure on the portfolio composition other than sectors for the equity exposure (seem reasonable) and a few guardrails such as not purchasing sub i-grade debt. I also see no restrictions against holding downgraded securities which is worrying. I get comfortable with the portfolio risk because ultimately it is an well diversified, likely almost entirely investment grade portfolio run by a management team that has demonstrated extreme conservatism over a 10+ year time period. Furthermore, it seems to have performed OK during the Q120 volatility. 

Miscellaneous Items

Jeff Thorp (Ed’s son) filed a 13-D on March 5, 2020. He owns 5% of the company (~$15mm at market; cost basis ~$14/share). My recollection from Ed’s biography is that he and Jeff like to play the mutual conversion game. In late February, Jeff proposed to NODK mgmt that they buy back large quantities of the stock. On May 6, NODK re-upped their buyback authorization by $10mm, consistent with their “planned approach to capital deployment to create long-term value for our shareholders – through share repurchases and future strategic acquisitions” per the press release. Since Nodak Mutual Group controls the company, Jeff’s involvement is likely neutral at best. 

Catalyst

Second step conversion