Description

Platinum Underwriters Holdings—NYSE—PTP_ $29.19

Platinum Holdings is a Bermuda P&C Reinsurer which St. Paul’s formed and spun-out to the public in October 2002. It is one of a number of new such companies that were created post 9/11 without any legacy issues. The stock came public in 2002 at $23. Recently, after trading as high as $34, the stock has traded down to just north of $29 on a few issues.

1) St. Paul announced the sale of ½ their holdings… or roughly 6mm shares—of the roughly $48mm FD shares. The plan has been for them to ultimately sell their entire holdings.
2) Pricing in the property side of the business has started to decline for the entire industry.
3) This morning, Converium Holding, a casualty reinsurer announced very negative reserve developments, taking the whole sector down. I would note that their disclosed issues pertained to reserve years 2001 and before; PTP has no pre-2002 exposure.

Let’s start out with the negatives that I see.

1) I have no particular love for the P&C business, primary or reinsurance, as it is very hard as an outsider to discern the quality of the book. It is in effect, a business that sells options, a business which can often be troubling.
2) Previous to 2002, St. Paul did not have a great track-record. Since then, there has been management turnover, which we see as a plus, although the 2002 underwriting year took place when the company and staff was undergoing a lot of change. The potential offset to this is that pricing was incredibly strong in 2002, which hopefully means that there is room for error if there were problems.
3) As a relative new-comer to the business, if interest rates back up, while the company’s float becomes more valuable, they have less float than some of their competitors have, which makes them relatively more vulnerable if rising interest rates allows the industry to price to a lower combined ratio.
4) They clearly are vulnerable to catastrophes, with the 1 in 250 year scenario having the potential to wipe out about 30% of total capital.
5) Modest 1.1% dividend yield

As for the positives:

1) Valuation which I will address below
2) The entire business was cherry picked from scratch in 2002. The business was started with no prior year obligations, but PTP chose the people it wanted and the client relationships it wanted. So in theory, it was able to have all the benefits of being a start-up while maintaining whatever relationships and value-added that had been built up over the years.
3) Renaissance Re owns 14% of the company (including options) and has a 5-year advisory arrangment with PTP. RenRe is a premier operator, so this is an excellent relationship. The most important part of this relationship is that PTP uses its proprietary risk models to review PTP’s property cat treaties twice a year.
4) Although the company should have been able to during its short history, it has operated extremely profitably. There has even been market chatter about the possibility of releasing some reserves.
5) Going through the company’s convention blanks, it appears as if the company has been managing its portfolio in a prudent fashion—in other words, it appears not to be stretching too hard for yield.
6) Casualty pricing, their biggest exposure, has held firmer than property pricing.
7) While the odds of their being major change going forward may not be too great, the increase in number of states limiting the impact of lawsuits through measures such as capping the multiple of punitive damages to compensatory damages and the general back-lash against the trial lawyers and class actions seems to represent a growing trend that might over time favorably impact the risk of this business.
8) Tax advantage of being Bermuda based.

PTP’s business is as follows: 29% property, 40% casualty, 31% finite. The company is A rated. It’s book is 60% short tail and 40% long tail. I prefer short-tail; as it should be less volatile, and the numbers are less vulnerable to judgment calls. For comparison sake, Arch is 19% short tail, but Montpelier is 95% short tail. Endurance, Axis, and Aspen range from 49%-79% short tail. Within the above break-downs, cat represents about 35% of the property book, and the biggest piece of the casualty book is excess.

As for the valuation, the stock is priced relatively in line with the above comparables on a PE basis. (I actually think the whole sector is inexpensive here). It is either in line or less expensive on a price to book basis, an important metric in this business. The reason why its return is lower is partially a result of the size of its investment portfolio, the conservative nature of the portfolio, and more importantly the size of the finite book, which is a lower risk but lower return business. In other words, I like the structure of PTP’s business in relation to the business overall as it relates to its risk profile. It is no more expensive, but I think the risk profile better.

Fully diluted, tangible book value (including about $1.66 of deferred acquisition costs) is $26. This is the most important metric to me as over time, I believe that insurance is an ROE business. So the company is trading at 1.12 times book. Some adjustments are needed to get to this value. Of importance, statutory surplus is only roughly $1.50 less than GAAP book.

The company has 43mm shares outstanding. They have a mandatory convertible preferred that given the trust structure shows up as debt. Next year, the debt will disappear, and the preferred will convert to $5mm shares. Including both strategic partner and employee options, there are about 13mm options exercisable at an average of roughly $25.50 which I have included in the book value calculation.

Earnings wise, the diluted numbers the company presents includes the preferred stock share conversion but not the options. The company is expected to earn north of $3.60 this year and $4.00 next year. If you assume exercise all of the options and the consequent reduced interest payments and reinvestment of the cash at 3%, earnings are $3.00 this year and $3.30 next year. (I have not done the same dilution exercise for the competitors although it is worse here.)

Net-net, with the stock at $29.15, this stock is 6-9 months from trading at 1x book value and less than 9x earnings. Although I don’t see dramatic, fast-paced appreciation, I see substantial margin of safety (if there is a problem) with the potential for the stock to work towards $35 over the next year in the absence of a major problem.

In terms of what will drive the stock, I think there are a few variables: 1) stock is cheap, and if there is no change in execution or dramatic change in business pricing, perception of the company will improve and the stock price will follow, 2) a release in reserves will help, although I won’t hold my breath, 3) Stock has had a larger recent drop than its competitors, which gives it elements of a busted offering, and I think that this is a market inefficiency that will work its way out over the couple of months.

Catalyst

1) stock is cheap, and if there is no change in execution or dramatic change in business pricing, perception of the company will improve and the stock price will follow, 2) a release in reserves will help, although I won’t hold my breath, 3) Stock has had a larger recent drop than its competitors, which gives it elements of a busted offering, and I think that this is a market inefficiency that will work its way out over the couple of months.