Description

Triple-S Management (GTS) is an under-the-radar Puerto Rican managed care provider whose stock offers a compelling absolute value.  The stock is safe and cheap and there are multiple ways to win from today’s depressed price with little risk of permanent impairment.  Triple-S Management is a $502MM market capitalization company with an enterprise value of $531MM.  Triple-S has over a fifty-year legacy as a health insurer in Puerto-Rico with leading market share of 27% of the healthcare dollars spent in the territory.  The company also has smaller life and P&C subsidiaries which are immaterial to the investment thesis.  

Historically Triple-S was structured as a non-profit that was owned by the physicians and dentists who provided medical services to members.  In 2004 Triple-S converted to for-profit status and completed an initial public offering in December of 2007.  Importantly, Triple-S has the exclusive right to use the Blue Cross and Blue Shield name and mark throughout Puerto Rico and the U.S. Virgin Islands.  Long-time followers of the managed care industry will recall that there have been multiple publicly-traded Blues and all of them with the exception of Triple-S have been consolidated over the years, primarily by WellPoint/Anthem.  Post-IPO many believed that Triple-S was a likely takeover candidate.  As the years have passed this “chatter” has abated and the stock is now orphaned.

Triple-S has largely been a disappointment as a public company, sharply underperforming both the managed care comp group and the aggregate market.  Earnings have been wildly inconsistent on a quarterly basis, the company has made several small, but dilutive acquisitions, commercial membership has fallen, and there has been a consistent lack of expense control.  Combining the company’s erratic performance with a domicile in a troubled (and perhaps bankrupt) U.S. territory, with a management team that has been a poor allocator of capital has led to Triple-S being a wholly orphaned stock.  Street coverage is limited and peppered with “hold” ratings. 

INVESTMENT POSITIVES:

1.  Valuation – Triple-S stock is extremely undervalued trading at 60.3% of tangible book value and 11.3x my estimate of 2014 earnings.  For reference, the average publicly traded managed care stock trades at 350% of tangible book value.  In contrast to traditional financial stock investors, managed care investors do not consider tangible book value as a primary valuation metric.  This is one of the reasons the opportunity exists.  Importantly, I believe that in this case tangible book value is a very reasonable proxy for liquidation value. 

2.  Consistent Profitability – Despite a high degree of quarterly earnings variability, Triple-S has been profitable every year since its IPO.  GAAP EPS from 2009 to 2013 was $2.33, $2.28, $2.01, $1.90, and $2.01. 

3.  Tremendous Excess Capital – Per the company's 10-K, at year-end 2013 Triple-S had risk-based capital of $646 relative to stated RBC requirements of $205MM, implying excess capital of $441MM  relative to the EV of the company at $531M.  Worth noting is that Triple-S is required to hold additional capital due to its BCBS affiliation.  I still believe the company easily has between $250MM and $350MM of excess capital that could be distributed to shareholders while maintaining a large cushion of excess capital over and above its BCBS requirements. 

4.  Low debt – In addition to the tremendous excess capital position of Triple-S the company has only $88MM in debt – a gross debt to capital ratio of 9%.  Other publicly-traded managed care peers have debt/cap ratios between 22% and 40%. 

5.  Book value growth – From December 2007 to June of 2014, tangible book value increased from $14.93 to $30.70 per share.  The closing price on the day of the IPO was $15.15 and today the stock is $18.53 per share.

POTENTIAL CATALYSTS:

1.  AGGRESSIVE SHARE REPURCHASE COMBINED WITH COST RATIONALIZATION

A look at the 2013 statutory statements of the five subsidiaries of Triple-S confirm the company’s excess capital position.  Total adjusted capital in the five subsidiaries was $648.2MM relative to the authorized control risk-based capital level of $106.4MM per the combined statutory statements.  For perspective, excess capital relative to this level was $542MM at YE 2013 – in excess of the enterprise value of the entire company.  Theoretically a strategic buyer of the company could purchase the company, drop the BCBS affiliation, strip out the excess capital and own the underlying business for free.

I believe a reasonable RBC target for the company that strikes a fair balance is as follows:

Triple-S Salud –                             Target 450% RBC ratio

Triple-S Propiedad -                       Target 300% RBC ratio

Triple-S Vida-                                Target 300% RBC ratio

American Health-                           Current capital unchanged

Atlantic Southern-                          Target 300% RBC ratio

Utilizing these target RBC ratios that still provide a significant capital cushion, YE 2013 "distributable excess capital" was $248MM.  In reality these numbers are understated due to the fact that a) capital has increased meaningfully YTD and b) fixed income securities are valued at cost in statutory statements.  At quarter-end unrealized gains on the securities portfolio of GTS equaled $125.8MM.  Additionally tangible book value increased $72MM in the first two quarters.  Triple-S could likely distribute in excess of $300MM to shareholders while still maintaining tremendous excess capital.

The accretion from a theoretical $250MM share repurchase is tremendous.  Assuming a 15% premium to the current stock price, the company could retire 11.45MM shares.  This RISK FREE ACTION would be 73% accretive to earnings – taking my $1.76 2014 estimate to $3.05 per share.  I estimate these actions would be 26% accretive to book value – increasing tangible book value from $30.70 per share to $38.80 per share.  I was encouraged by management’s language in the second quarter conference call and press release which appeared to indicate a more thoughtful approach to capital allocation.  Specifically on the second quarter conference call CEO Ramon Ruiz-Comas noted that:

“Regarding capital management, we bought back approximately 184,000 shares during the quarter.  Under the current program, we still have $5.5 million for share repurchase with the ultimate goal of enhancing shareholder value.  Management and the board are evaluating the best use of our capital and remain clearly focused on improving the performance of our core business.”

In addition to the obvious tremendous capital allocation opportunity Triple-S has a bloated cost structure.  From 2010 to 2013 SG&A at the company increased from $304.9MM to $474.9MM, a 56% increase while revenues increased only 19% and commercial enrollment actually fell by 9%.  From 2009 to 2013 the average expense ratio of the publicly traded comp group increased from 14.4% to 15.1%.  During this same period, Triple-S saw their expense ratio increase from 14% to 19.5%.  I believe that much of this is due to the American Health acquisition and very poor cost control on the part of the company.  A de-minimus 5% cut in SG&A expenses equates to $24.25MM in pre-tax income or $.89 per share. 

A combination of the share repurchase outlined above combined with a 5% SG&A cut leads to $4.16 in EPS.  A PE of 11x points to a stock price of $45.76, or 147% upside.  This price target implies only a small premium to the "new" TBV post repurchase.

2.  SELL THE COMPANY

There are many logical financial and strategic buyers for Triple-S.  WellPoint and Triple-S are the only publicly traded Blues.  Humana already has operations in Puerto Rico and I believe that many buyers could use the Triple-S franchise as a beachhead for expansion in the Caribbean and South America.  It simply would not be a sizeable expenditure for most domestic competitors and the amount of excess capital that could be extracted could potentially cover much of the cost of the deal. 

On a per-member basis, historical transaction comps have been $2,733 per member.  Assigning no value to the life insurance business, no value to the P&C business, and no value to the company’s ASO Medicaid contact the current stock price implies $470 per member.  A heavily discounted price of $1,000 per member (again, no value is assigned to the P&C business, the life businesses, nor the Medicaid contract) points to a value of $40 per share.  At a minimum a buyer would be willing to pay tangible book value or $30.70 per share, offering 66% upside. 

RISK FACTORS:

While I believe the risk of permanent impairment is extremely low there are multiple risk factors regarding an investment in Triple S:

• Investment Portfolio - The Company has a $1.1B fixed income portfolio and a $232MM equity portfolio.  Puerto Rican debt accounts for only $47.6MM, or 3% of the portfolio.  Under a stress test I have marked down the fixed income portfolio by 10% and I have marked down the equity portfolio by 50%.  In this scenario (a 50% equity market correction) tangible book value falls from $30.70 to $24.56, still well above the current trading price of the stock.

• Medicaid contract - Puerto Rico is currently evaluating bids to move their Medicaid business from an ASO contract of which Triple-S currently controls 100%, to a risk contract.  While this could potentially lead to higher earnings for the company, it also would require additional capital and potentially the terms could be unattractive.  On a year-to-date basis this contract accounted for 18% of EBIT and in all likelihood it will account for a larger proportion of full year earnings. 

• The operating environment in Puerto Rico remains difficult.  Medicare pricing is under pressure, the Medicaid business is up for bid and the company continues to lose commercial lives due to pricing pressure and the competitive environment in Puerto Rico.  In aggregate during the second quarter risk enrollment was down 6.8% and total member months fell 5.5%.  The caveat is that a lower number of risk members imply that excess capital is even more understated.

• Value destruction by management remains a clear risk.  Triple-S spent $83MM on the American Health acquisition and $10MM on Atlantic Southern.  While smaller deals, both have been very poor uses of capital.

While Triple-S is consistently very profitable on an annual basis, quarterly volatility versus expectations is tremendous.  In the second quarter the company reported $.89 vs. consensus of $.28 and in the first quarter GTS reported EPS of $.25 vs. consensus of $.14.  In the fourth quarter of 2013 GTS reported $.05 vs. consensus of $.60 and in the third quarter of 2013 EPS came in at $.22 vs. consensus of $.44.  Volatility in the MLR and the expense ratio are commonplace.  While I can stomach the volatility as long as tangible book value growth and FCF generation continue, the Street hates it and pines for Michael Pearson or Jack Welch.

CONCLUSION:

The bottom line is that Triple-S has a solid core franchise as the managed care leader in Puerto Rico with a fifty-plus year legacy and the valuable BCBS brand name.  The stock is unique in that the valuation is extremely depressed on a price to tangible book value basis, yet the integrity of tangible book value is high and transparent, and the company has a tremendous amount of excess capital which provides an opportunity to create value through positive capital allocation.   

Catalyst

• Aggressive share repurchase
• Cost rationalization
• M&A