Summary:

The death two weeks ago  of Jack Byrne--the executive Warren Buffett called “the Babe Ruth of Insurance”--inspired this analysis. There is neither an apparent catalyst nor do I have any unique insights into the company.  But I do think that WTM is at least somewhat undervalued today: Year-end book was $588/share and I think the stock should command a modest premium to book. Just as importantly, a smart, patient and well-incentivized management team should be able to use the excess capital on hand and their deep knowledge of the industry to continue to compound intrinsic value at attractive rates going forward.

Note:

For those with any interest in the idea I would encourage you to read Scrooge 833’s analysis from last March, which incorporates a good history of White Mountains and an understanding of its business approach.  Since then the stock has performed well but not spectacularly.  Meanwhile there are a couple of corporate developments that I believe enhance underlying value--now and going forward. Furthermore, there is further evidence of broad improvement in the property-casualty cycle.

Key Business Units:

OneBeacon (75.2% owned by WTM; the balance public):

--$1.2 billion in net written premiums in 2012

--Combined ratio 98 in 2012 vs. 92 in 2011 largely due to Hurricane Sandy

--Announced a sale of its non-specialty runoff business last fall (transaction             should close in 2H:13, leaving it a pure specialty company)

--Good history of favorable reserve development in the core business

Sirius Group:

--Reinsurance

--Excellent record over time putting capital in at good points in the cycle and pulling it out at the peak (returned $1.9 billion in capital to WTM since 2006, including withdrawal from US casualty business)

--$948MM in net written premiums in 2012

--90 C/R in 2012 notwithstanding Sandy; management expectations are 91 over time

--Also houses White Mountains Solutions, which has a good track record, in buying runoff books of business

Financial Guarantee:

--Provided $600MM capital in Q3:12 to fund Build America Mutual, a start-up muni bond insurer

--Focus on small-medium size issuers aimed at retail buyers

--First deal article:  http://www.bloomberg.com/news/2012-09-27/build-america-mutual-insures-first-municipal-bond-offering-1-.html

--How it works:  http://buildamerica.com/advantage/

--Powerpoint:  

http://www.nlc.org/Documents/Find%20City%20Solutions/Enterprise%20Programs/BAM/BAM%20Overview%20-%20(Jan.%202013).pdf

Capital Management:

WTM has dramatically shrunk its share base over time.  A short hiatus followed the tender in the first quarter, in which the company repurchased 817K shares (almost 12% of outstanding) at $500/share.  In the 4th quarter, an additional 4% was bought back at $519.  CEO Ray Barrette is clear that every corporate opportunity is measured against share repurchase.  At the 2012 Investor Meeting (the transcript is well worth reading), he added, “When we invest in business the return has to be better than 12%.  We don’t go into business for 7% returns . . . In new business I would say that we wouldn’t look at anything that has a return of less than 15% and we get excited when it’s well above 20%.”  

WTM has higher than normal equity exposure in its investment portfolio. Most of this is managed by John Gillespie at Prospector Partners.  Though performance was subpar in 2012, the ten year record has been good in absolute terms and excellent in relative terms.

In the 4th quarter report Barrette suggested that WTM had about $1 billion in undeployed capital.  He has stated that he likes having $500MM on hand for emergencies, but also notes that he expects the underlying businesses to generate capital.  

Operating Principles:

Very few companies that I know of state these so plainly at the beginning of the 10-K:

Underwriting Comes First.  An insurance enterprise must respect the fundamentals of insurance.  There must be an expectation of an underwriting profit on all business written, and demonstrated fulfillment of that expectation over time, with focused attention to the loss ratio and to all the professional insurance disciplines of pricing, underwriting and claims management.

Maintain a Disciplined Balance Sheet.  The first concern here is that insurance liabilities must always be fully recognized.  Loss reserves and expense reserves must be solid before any other aspect of the business can be solid.  Pricing, marketing and underwriting all depend on informed judgment of ultimate loss costs and that can be managed effectively only with a disciplined balance sheet.

Invest for Total Return.  Historical insurance accounting has tended to hide unrealized gains and losses in the investment portfolio and over report 

reported investment income (interest and dividends).  Regardless of the accounting, White Mountains must invest for the best growth in value over time.  In addition to investing our bond portfolios for after-tax return, that will mean prudent investing in equities consistent with leverage and insurance risk considerations.

Think Like Owners.  Thinking like owners has a value all its own.  There are stakeholders in a business enterprise and doing good work requires more than this quarter’s profit.  But thinking like an owner embraces all that without losing the touchstone of a capitalist enterprise.

So What’s it Worth? 

Like almost everyone still reading, I look for investments with limited downside that can still produce meaningful (mid-teen) returns over time. 

Assume WTM can compound book value by 10%/year over the next 5 years.  I think management would regard that as mediocre performance.

At the Investor Meeting last summer, Barrette said, “I would be very disappointed if we returned only 8-9%/year over the next five years . . . our eyes are well above that level.”  But I believe that the market would reward that result, if not all of the time at least some of the time, with a small premium to book.  Here’s the math:  a 10% premium to book in late 2017 on Y/E 2017 book would produce a 14% IRR from current levels--pretty good in a low return world.