Description
Reinsurance Australia Corp is a workout situation which I believe offers the prospect of a 25-40% annual return.
The company currently is listed on the Australian stock exchange (www.asx.com.au). It has a market cap/enterprise value of A$Xm (nil debt)
It's net assets are A$75m; franking account balance of A$63m; estimated tax losses of A$150m
ALL figures are in Australian dollars
HISTORY:
During the late 90's there was a boom in reinsurance written out of Australia. Existing companies such as GIO expanded their inwards reinsurance operations and several new operations were floated. New Cap Re and REAC were pure-play reinsurers which after some reasonable years, were put into run-off after a string of horrible results.
REAC never quite became insolvent and has been running off and commuting contracts. Unlike New Cap Re, REAC was largely Australian domiciled which means that in addition to residual assets they also have tax credits for taxes paid in years to 1998 and tax losses (from 1999) which may be able to be used to offset future taxes.
NEWS
This is a news driven idea - on 22 October 2003 REAc announced a potential settlement of a large piece of litigation of film indemnity contracts. This settlement became effective on 24 November. Much of the infomation here is deran from these press releases.
Much of the disclosed increase in NTA has been factored into the share price, but perhaps due to the time sclae, the market has not factored in the value of tax-related assets.
NET ASSETS
Estimated 31 December net assets of A$75m come from the 22 October 2003 press release available on REAC's website. When looking at the accounts it is worth bearing in mind that APRA (the Australian insurance regulator) now requires reserves to be held so there is at least a 75% probability of sufficiency. Reinsurance liabilities of $56 m remain - all going well, some more surplus may emerge out of the insurance book as it runs off.
FRANKING CREDITS
REAC's franking account balance of A$63m relates to the period 1994-1998 when it reported profits and paid Asutralian tax on them. This number is, again, sourced from the 22 October 2003 press release available on REAC's website.
Franking credits are credits from the Australian government for taxes paid on reported profits. These franking credits can be attached to dividends and provide taxation relief for Australian investors (individual & institutional).
Roughly speaking, one dollar of franking credit satnds in for one dollar of tax otherwise paid by a receiving shareholder - so they're potentially worth $63m to a buyer.
TAX LOSSES
I'm not a tax lawyer & I'm not certain of all of the hoops that need to be jumped through to use all of these losses. I do know, that given this task to do, a reinsurer offers lots of possibilities for using up tax losses quickly.
From the accounts the tax loss figure is around $150m - this is pretty much in accordance with a back-of-the-envelope calculation laid out low.
The 1998 end of year book value was $516m. The company has estimated a figure of $75m for the end of 2003. So they lost about $440m. At a tax rate of 30% this is worth $132m.
Any buyer will need some structuring, etc to use these, but there are potential buyers who could use these losses up very quickly.
There is a nice summary of REAC's financial history here;
http://www.reac.com.au/dir125/financials.nsf/historicalfinancials/Re+AC+Historical+Financials+Document?OpenDocument
CURRENT OWNERSHIP
Current owners include:
Guiness Peat Group (GPG) - value investors with a great pedigree - see the COATS idea for background. They have had insurance operations (eg Tyndal) in the past and currently are involved with Tower Insurance
Hunter Hall - a value oriented fund manager (www.hunterhall.com.au)
I think the chances of REAC writing business again are slim - the tax-related assets are simply too valuable in a sale and it doesn't have the infrastructure left. The company will of course keep this option open and on the table to maximise their eventual sale value. A capital return of some of the net assets is a possibility, but capital would be required to maintain the run-off, etc and the tax losses & possibly franking credits would still be left. For financial sellers, a transaction with an insurer (eg, Promina, IAG or QBE) would probably produce the most value. QBE has been suggested (SMH article in October) as it has the lowest level of franking credits available (larger overseas operations)
VALUE
accounting numbers look something like;
Net assets - $75m
Franking Credits - $63m
Tax Losses - est $130m
conservative exit values (leaving plenty of upside for a trade buyer) might be;
Net assets - $75m
Franking Credits - $20m
Tax Losses - est $20m
this would give an exit price of around A$0.60 per share.
Depending on the transaction, the buyer, etc some more value is likely to be assigned to the tax losses.
FURTHER INFO:
Company's website - www.reac.com.au
Australian stockexchange - www.asx.com.au - contains archive of releases
Catalyst
The catalyst has already occurred, negotiations should begin in earnest after the 2003 accounts are signed.