July 17, 2009
Value is Harder to Find

In my last blog, I noted that the markets' distress had created good opportunities, and said that I had bought the securities of 10 insurance businesses during the previous five months. I mentioned three: shares of IPC Holdings Ltd., and bonds of White Mountains Insurance Group Ltd. and Montpelier Re Holdings Ltd. My other investments went unnamed, for a variety of reasons. I assumed, however, that curious investors might give me a call, and that I'd have fun talking to them. It turned out that few people called; perhaps the then-pervasive fear overwhelmed investors and turned them off to the allure of cheap, safe securities. So it goes.

Since March 2, Mr. Market has re-evaluated insurance securities—and the overall markets. The SNL Insurance Index has risen 37.3% and the S&P 500 is up 34.2%. A good number of insurance securities have gone from being dirt cheap to being sort of cheap (but not necessarily compelling). Bargains don't abound the way they did several months ago.

Some of the biggest rallies (100% to 300%) have been in large companies that have dicey assets and a high degree of operating leverage: The Hartford Financial Services Group Inc., MetLife Inc., Principal Financial Group Inc. and Prudential Financial Inc. For the most part, I eschew companies like these, even if they appear to be cheap. Instead, I go for clean companies with strong, easily understandable balance sheets, and businesses that aren't especially risky. Zenith National Insurance Corp. is such a company. It's a careful workers' compensation underwriter with an extremely conservative balance sheet that is trading at $20.99—about 80% of tangible book value. While I don't expect Zenith to make a lot of money this year or next—comp is in a down cycle—business conditions will eventually improve, and when they do Zenith will probably generate significant earnings.

I originally mentioned IPC Holdings in this blog on October 10 when the stock was at $21.50 (62% of book value). The sheer cheapness of the company did not go unnoticed, and it garnered several takeover offers before agreeing to be acquired by Validus Holdings Ltd. Despite a considerable run-up in price, the stock, at $28.15, is still modestly attractive, and I'm holding my shares. Here's the math: In the takeover, IPC shareholders will receive $7.50 in cash and 0.9727 Validus share for each IPC share they own. Validus' tangible book value is $24 per share, therefore each IPC shareholder will receive stock "worth" $23.34 (based on that figure). Their "cost" after deducting the $7.50 cash payment will be $20.67. Thus, they are setting up their investment at 88% of tangible book value—not a steal, but not bad. And, if for some odd reason the deal doesn't go through, that's OK with me. IPC is trading at 83% of book value and should continue to have satisfactory results over time.

Investors Title Co. is another reasonably priced stock I own. This conservatively run (albeit very small and thinly traded) title insurer has a really clean balance sheet and is selling for $28.04, which is 72% of book. Of course, business conditions in the real estate market are far from ideal, but that won't always be the case. I suspect that Investors Title could sell its business for a significant premium to book value if it wanted to. That said, I don't expect the company to be sold any time soon. But I do expect good long-term returns based on the current price.