Description

Westaim has been written up by spike945 (in Sept 2017) and Poms (in Feb 2019) in the past - please refer to their write-up for the history of Westaim, the quality of the businesses, and the management team. I will focus on recent performance and near-term catalysts below.

Westaim Corporation (WED.CN): 

Westaim is a ~$280M market cap, Canadian investment company focused on providing long-term capital to businesses primarily within the financial services industry.  Westaim, via a slightly complex structure, has an ownership interest in two US-operated platforms: (1) 44% of Skyward Specialty (Skyward), a specialty property and casualty insurance company, and (2) 51% of Arena, a $2.6B AUM multi-strategy investment fund, focused on private credit investments.

Situation Overview:  

Over the past few years, both of Westaim’s holdings have slowly been executing towards scaling their operations and profitability. The insurance business, Skyward (formerly known as HIIG), was operating in a soft insurance rate market, with no or very low profitability and ROE. As such, it made sense for the business to trade at a discount to peers and even below book value. In addition, around the same period, Westaim’s second holding (Arena) was in the process of scaling AUM to a breakeven level. During this investment phase, it made sense for the stock to trade around or below book value.

However, things are shaping out to look different in 2022 and beyond. Below is a summary of what both businesses look like today and why Westaim should trade above book value.

Skyward: Under its new CEO, the insurance operation has been delivering increased gross/net written premium, while also improving its combined ratio. This improving underwriting profitability plus a reasonable investment performance should result with ROE in the high-single-digit to the low-double-digit range. Skyward is also enjoying a favorable pricing environment which is expected to continue. With these returns profile, Skyward should be worth +1.0x-1.5x BV, and in line with peers. 

Arena:  Arena is also performing well. AUM has doubled since 2019. More importantly, the operation seems to have scaled to break-even levels at ~$2.5B of AUM.  Arena should now have a long enough track record, a large AUM, and attractive returns to continue to grow its AUM over the next few years. I believe that CEO/CIO Dan Zwirn has the ability to continue to scale Arena. Future growth at Arena should come with no or minimal investment requirements and with very high incremental margins.

Arena has a complex ownership structure. A more simplistic view of Arena’s valuation would be looking out to $5B of AUM at which point the management buy-in max out and Westaim will control 25% of Arena. My expectation is that AUAM should scale to $5B over the next 12-24 months. 

At $5B of AUM, with 1.5%-2.0% management fees, Arena should generate a healthy ~$75M-$100M in recurring revenue without meaningfully increasing its operating expense (~$30M-$35M). In addition, assuming an incentive fee on a modest mid-to-high single-digit return, Arena should be generating healthy cashflows.  Westaim’s 25% ownership of Arena should be worth much more than the $20M book value today; particularly once the business starts generating enough profit to be valued on its earnings multiple.

Arena FINCOs:  Arena FINCO is on the balance sheet at 1x book value. Given the mid-single-digit returns on this capital, I think it is reasonable and should likely be the case going forward. 

Despite both Arena and Skyward holdings executing well over the past couple of years, Westaim shares continue to trade below book value. 

Valuation: Now that both operations are profitable and growing, I expect Westaim to start trading at or slightly above book value. Westaim is run by entrepreneurs with a meaningful alignment of interest and proven capital allocation skills. If valuation remains below book value, I expect the management team to execute on its share repurchase plans.

Overall, Westaim offers a 20%-45% upside today and should continue to compound book value at ~10% over the next few years.  

Catalyst

• Skyward delivering ~95% combined ratio and growing book value with ~10% ROE
• Arena starting to cash flow to Westaim and continue to scale AUM to $5B plus
• Westaim management team executing its repurchase program at a meaningful discount