United American Indemnity INDM
November 22, 2005 - 11:50am EST by
2005 2006
Price: 18.98 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 691 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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United American Indemnity, LTD (INDM) is an insurance company in the E&S (Excess and Surplus) lines business with a cheap valuation and several upside catalysts. I expect the stock to hit $25 in the next 12 months for a 30% return.


Most look at insurance companies on a Price/Book basis and INDM is pretty darned cheap even for an insurance company on this basis. E&S writers tend to have better ROEs and Combined Ratios so they usually have better valuations. There are only a few other publicly listed E&S insurers and the best known are WR Berkley (BER) and Markel (MKL)

BER - P/E ’06 10.5X, P/B (3Q05) = 2.4X, market cap = $5,928M
MKL - P/E’06 13.1X, P/B (3Q05) = 2.0X, market cap = $3,130M
INDM – P/E ’06 9.3X P/B (3Q05) = 1.1X, market cap = $692M

Clearly INDM is smaller cap, and a firm called Fox Paine owns 60% so a limited float reduces the P/B vs. competitors but this should only count for a small amount of the valuation differential. I believe that the multiples on INDM will expand over the next few quarters.


There Primary Catalysts are as follows:

1) Improving Balance Sheet which will lead to a higher P/B multiple.

2) Likely upside to 2006 EPS estimates.

3) Sale of the company.

Let’s look at these in order:

1) Improving Balance Sheet which will lead to a higher P/B multiple – One concern for INDM over the last few years is that in 2000-2002 the company ceded a significant amount of its business to reinsurers. This led to a very large reinsurance receivable as a percent of book value. Such a condition logically led to a discounted valuation as investors had to worry about underwriting losses AND credit risk on the underlying reinsurance payments. At the end of 2002 INDM’s reinsurance receivable asset was 650% of book value. However, by the end of the third quarter this ratio had fallen to a more reasonable level of 110% which is in-line with other E&S peer ratios. Management also stated on its most recent conference call that it expects this ratio to continue to fall over the immediate future. This improvement has been achieved by a) merging with PNG in January which had lower receivables of this type, b) ceding less new business as older contracts expired, and c) collecting more collateral on these receivables.

Almost all of INDMs reinsurance receivables are from companies rated ‘A’ or better for claims-paying ability. The big hurricanes of this year hurt some reinsurers badly but they do not seem to have had any trouble raising new capital (MRH as an example), and INDM does not expect any losses collecting on these assets at this time.

Thus this perceived weakness in INDM’s balance sheet has largely already been solved but the P/B ratio has not yet recovered. The multiple on the stock should improve over the next year as investors digest this change.

Another positive for INDM’s P/B is that most Property and Casualty (P&C) insurance companies recorded large losses from hurricanes Rita, Katrina, Wilma, etc. in 3Q05. INDM was one of the few companies in the space to report net profits in the period and book value per share actually grew by 1.5%. INDM’s underwriting skill has been solid in the past, and this extreme ‘stress-test’ may lead to a stronger outlook and a higher P/B going forward.

INDM is earning 11-12% ROE currently. Most insurance companies with such profitability trade on 1.5X- 1.75X. If INDM can just trade up to an undemanding 1.25X P/B over 2006 the return on the stock will be in the range of +30%.

2) Likely upside to EPS estimates from higher than expected revenues..

The impact of hurricane Katrina, Rita and Wilma has removed a significant amount of capital from the Property and Casualty insurance space. This should be positive for INDM for two reasons –

A) Many insurance companies suffered huge losses from the hurricanes and it is expected that renewal rates will be higher across the industry when renewal season starts in January. As of now, the three sell-side analysts that follow the stock have not yet raised INDM’s estimates.

B) Before Katrina hit, the hard market of rising insurance rates that started in 1999-2000 was starting to soften and ROEs were falling. Historically when this happens many of the large ‘standard lines’ insurance companies start to write business in the higher margin but tricky niche ‘specialty lines’ (where INDM competes) areas which drives down ROE for everyone. These ‘standard lines’ companies usually withdraw back to their traditional markets after a major disaster as standard lines premium prices rise and industry profitability recovers. Management stated on its most recent conference call that prices are strengthening. Again, despite the impact of Katrina, Rita, etc., estimates for INDM have not yet increased.

In addition, the merger of the old United American and PNG took place in 1Q05.
Some cross sell synergies are expected as PNG agents sell UA products to their clients and visa versa. As much of INDM’s business is written in January of each year we have not yet seen much of this upside and it should be more apparent in 1Q06.
Putting together higher rates and less competition post-Katrina as well as some cross sell from the merger the 10-15% increase in total premiums 2006 over 2005 expected from the sell side is likely too conservative.

Finally, rising short-term interest rates have a positive effect on the investment income line for INDM. Despite the Fed’s active campaign to raise rates, the sell side only has about a 10% increase in interest income baked into their models. If short rates continue to creep up into 1Q06, we will likely see interest income grow more than expected.

3) Investment firm Fox Paine owns 60% of INDM and is likely to want to sell the company eventually. They have already generated significant gains on their investment and larger E&S writers such as BER and MKL could be interested in an acquisition as neither has done one of size for several quarters.

Ed Noonan, the interim CEO of the company, recently decided (or was told) to move on to other pursuits. Saul Fox (of Fox Paine & Chairman of INDM ) recently stated in a press release, “the Board does not believe there is the need for the immediate appointment of another Acting Chief Executive Officer and President. Those individuals who reported to Mr. Noonan will now report to the Board of Directors through its Chairman.”.

On the most recent quarterly conference call Mr. Fox stated that the Board has been unable to find the right CEO outside the firm and are now considering internal employees for the position. While INDM may find a new CEO soon, it is also possible that the Board is shopping the company around for a sale.

In a sale to MKL or BER, INDM could go for 1.5X P/B (or even higher) and still be accretive to the acquirer’s book value on EPS (after some limited cost saves). While I believe INDM will fetch a higher price if sold at the end of 2006 with a recovered P/B ratio and a BVPS that is 10-15% higher than it is today, a sale in the immediate future seems possible and would most likely result in a high return on an investment in the stock.


INDM is an attractive investment based on a strong expected book value per share growth and a P/B ratio that should expand as past concerns regarding reinsurance receivables dissipate.

Estimates are likely conservative and room for upside surprises exist throughout 2006.

The 60% owner of the company is running the company without a CEO and may be considering a sale of the firm.

If INDM grows its BVPS by 15% in 2006 (versus sell side expectations of 12.5% and the P/B recovers to a still cheap 1.25X a one year investment will net more than a 30% return. If the P/B remains stagnant and hurricanes reduce EPS by about the same amount as what has occurred in 2005, an investment in INDM will still yield a one year return in line with a 10% increase in book value. I believe INDM represents a strong investment opportunity with significan


1) Improving Balance Sheet which will lead to a higher P/B multiple.
2) Likely upside to 2006 EPS estimates.
3) Sale of the company.
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