Description

White Mountains Insurance Group, Ltd., through its subsidiaries, engages in the property and casualty insurance, and reinsurance businesses. The company’s OneBeacon segment offers professional liability products, marine insurance, collector cars and boats insurance, property and inland marine insurance, tuition reimbursement, and excess property and accident and health products, as well as property and casualty insurance coverages tailored to industry groups, such as technology, financial services, entertainment, sports and leisure industries, and government entities. Its White Mountains Re segment provides reinsurance coverage for property, accident and health, aviation and space, trade credit, marine, casualty, agriculture, and other exposures. The company offers its products and services primarily in the United States, Europe, Canada, the Caribbean, Bermuda, Latin America, and Asia. White Mountains Insurance Group, Ltd. was founded in 1980 and is headquartered in Hamilton, Bermuda. White Mountains Advisors invests the firm's capital and manages more than $20 billion of client assets.

An investment in any Property & Casualty insurance company is a bet on the management’s ability to underwrite competently and invest at an above average rate.  White Mountain has a team that is great on both counts. The team’s roots can be traced to Jack Byrne, who ran Fireman’s Fund for Warren Buffett back in the 1980s.  The company went public in 2007.

The secret to the team’s success rely on a few factors:

1.)    Understanding of insurance operations – Jack Byrne and his team turned around several insurance businesses while running Fireman’s Fund for Berkshire Hathaway. They have the veteran experience, the unique insights that enable them to turn around insurance businesses unmatched by other firms.  

2.)    Contrarian value investing approach - WTM’s disciplined, contrarian long-term approach of buying insurance firms at distressed prices and turning them around.

3.)    Incentive System – Management team is rewarded for long-term growth in intrinsic value per share--a proprietary measure that incorporates economic value, tangible book value, and market value during rolling three-year performance periods. This incentive structure demands profitable underwriting and actively discourages unprofitable underwriting, which can rapidly boost sales and earnings per share but eventually will obliterate capital. Managers eat their own cooking--salaries and bonuses reflect value created, and directors and officers collectively own about 14% of the firm.

4.)    Buy back shares when it makes sense – Since 2007, the company has reduced shares outstanding from 11 million down to 8 million.  After this tender offer, it will be reduced to under 7 million shares.

5.)    Tax-advantaged structure – being located in Bermuda, WTM has certain tax advantages than other firms located in the USA.

6.)    Remove the institutional imperative - The team does not do things conventionally and have the guts to do what is not popular but do what is good for the long-term.  They are willing to sit tight on their excess capital for years without acquiring any insurance operation because the price is not right.  On the other hand, they are willing to be venture into new methods of distribution at a time when it was unpopular to do so. For example, in the early 2000s, the company started Esurance, an online insurance operation. At that time, it was a very nontraditional move by a brick and mortar insurance player.   10 years later, the company sold its Esurance business for a realized gain of nearly $700 Million.

With the exception of a couple of legendary value investors,  most value investors did not escape the 2008 crisis unhurt.   White Mountain is not exception.  Their book value decreased nearly half in 2008.  Book value growth has returned at White Mountains, and I  think it can continue over time.

Catalysts and valuation:

In October 7, 2011, AllState closed its acquisition of ESurance from White Mountain.  The purchase price was approximately $1 billion. The consideration paid was $700 million plus the tangible book value at the closing of the entities being sold.  The sale resulted in a realized gain of approximately $678 Million for White Mountain.

Share buybacks:

White Mountains repurchased and retired 646,502 of its common shares for $253 million in 2011 at an average price per share of $391. White Mountains repurchased and retired 52,862 shares for $23 million in the fourth quarter of 2011 at an average share price of $441, or approximately 81% of White Mountains' December 31, 2011 adjusted book value per share.

Tender Offer:

 In 2012, the company announced a tender offer. The results of the tender offer were announced just last week. The company will spend $408,511,000 to tender for 817,022 shares. After the tender the adjusted book value of the company rises to $547 per share.

Valuation:

 Using an 11$ ROE for the next three years and applying a 1.2 times book value (3 years from now) multiple yields a value of $873 per share. In my base-case forecast, I expect the combined ratio--expense divided by earned premium--will average 96% during the next three years. I forecast revenue growth averaging 6% during the next three years. My long-term return on equity assumption is 11%.

Catalyst