WED - Westaim Corporation

[Philbert77]

Yes, it is a very fascinating read.

 

I found the below chart very interesting. They have grown the fully diluted book value per share (FDBVPS) in recent years while the stock price has languished and declined.

 

                FDBVPS    Share Price

                USD CAD  USD CAD

 

2014 - Q2 2.00 2.13 3.00 3.20

2014 - Q3 2.36 2.64 2.68 3.00

2014 - Q4 2.34 2.71 2.63 3.05

2015 - Q1 2.33 2.95 2.65 3.36

2015 - Q2 2.33 2.91 2.61 3.26

2015 - Q3 2.31 3.09 2.09 2.80

2015 - Q4 2.27 3.14 1.97 2.73

2016 - Q1 2.28 2.96 2.08 2.70

2016 - Q2 2.24 2.91 1.99 2.59

2016 - Q3 2.22 2.91 2.06 2.70

2016 - Q4 2.21 2.97 2.09 2.80

2017 - Q1 2.23 2.97 2.01 2.68

2017 - Q2 2.24 2.91 2.45 3.17

2017 - Q3 2.27 2.83 2.39 2.98

2017 - Q4 2.33 2.92 2.48 3.11

2018 - Q1 2.35 3.03 2.20 2.83

2018 - Q2 2.37 3.12 2.45 3.22

2018 - Q3 2.40 3.10 2.48 3.21

2018 - Q4 2.42 3.30 1.89 2.58

 

The section about Arena was also very interesting. The details about their proprietary IT systems and how many deals they analyze before actually funding - "In 2018, Arena’s investment teams reviewed ~10,000 potential investments, eventually funding 68".

 

 

https://westaim.com/wp-content/uploads/03.-Westaim-2018-Annual-Letter-v11.0-FINAL_signed.pdf

[doc75]

Enormous volume yesterday and looks like it will be very high again today.  The stock hasn't moved much at all so I guess these are some type of cross trades?

 

 

 

[doc75]

I just caught the following headline in a Google search. The article is behind a paywall so I can't access it.  Does anybody have any insight/access? 

 

https://www.theinsurer.com/news/westaim-q1-profits-leap-as-it-prepares-to-exit-stephen-ways-hiig/3644.article

 

I'm curious as to whether there's any new scuttlebutt or if they're just assuming a HIIG exit is in the cards since they announced "unsolicited interest" about a year ago.

 

Parag Shah (formerly of Bridgewater) has been buying shares in the open market recently. This could simply be to satisfy a share ownership requirement and is not necessarily a bullish signal. But it does suggest that a material announcement is not imminent.

 

[LightWhale]

Is anyone attending the AGM today?

[chompsterama]

This is an incredibly frustrating business to watch and own.  It's proving that SOTP (almost) never work (not that I needed any additional proof!).  For two boring industries like asset management and insurance, it seems only the income statement flowering can change the perception of value in the business...or the very unlikely sale of HIIG at 1.4x+ book.  Considering HIIG is planning on going public, that's almost surely not happening.  Just a rant  :D

[Philbert77]

I feel your pain. Westaim is pretty much my largest position. I would encourage you to stick it out. Management is savvy and this is not Westaim’s first rodeo. I am curious - what makes you say HIIG is going public?

[NBL0303]

This is an incredibly frustrating business to watch and own.  It's proving that SOTP (almost) never work (not that I needed any additional proof!).  For two boring industries like asset management and insurance, it seems only the income statement flowering can change the perception of value in the business...or the very unlikely sale of HIIG at 1.4x+ book.  Considering HIIG is planning on going public, that's almost surely not happening.  Just a rant  :D

 

Are you currently frustrated with the operations and/or management of the company or is the current frustration due to the disappointing stock price?

[chompsterama]

Yes. I should just leave it there :)

 

Of course, it's difficult not to be frustrated with the stock price - which you alluded to in your question.  Further, the business hasn't exactly fired over the past few years despite the perma-optimism from management.  HIIG has struggled to gain its footing over the past three years through reorgs and personnel issues - though today seems to have finally found solid ground.  Despite the ground and market hardening (which Steven Way has been publicly waiting for), HIIG is still ceding a lot of business and doesn't seem too confident in holding their own underwritten risks.  And interested parties obviously haven't been too interested in Way's business - which perhaps is the largest flag. 

 

At Arena, things will probably work out though I still have some concern that Arena at $1 billion of AUM can't really show profitability.  I get what they are doing is special and takes considerable niche skill but I can't help but wonder if Zwirn is building an empire (hiring lots of employees, multiple offices in various countries, marketing departments, etc.) for the sake of sitting atop an empire.  Just concerns.

 

Other than that, it would sure be nice to see insiders buying shares at less than 80% of BV.  Really nice.

[chompsterama]

I feel your pain. Westaim is pretty much my largest position. I would encourage you to stick it out. Management is savvy and this is not Westaim’s first rodeo. I am curious - what makes you say HIIG is going public?

 

https://www.bizjournals.com/houston/news/2019/06/12/houston-insurance-holding-co-raises-20m-ahead-of.html

 

"Houston International Insurance Group Ltd., a Houston-based insurance holding company, is raising money ahead of a planned initial public offering.

 

Houston International Insurance Group, or HIIG, completed a $20 million subordinated debt offering, according to a June 3 press release from the company. HIIG used the services of New York-based advisers Stonybrook Capital.

 

HIIG raised the $20 million in debt from three unnamed investors, according to a June 11 filing with the U.S. Securities and Exchange Commission. The company accepted minimum investments of $4 million from investors and made its first sale on May 24, per the SEC filing. The 20-year subordinated debt offering is listed as long-term debt for accounting purposes.

 

Stephen Way, chairman and CEO of HIIG, said in the release that the additional capital will aid the insurance firm on its path to an IPO in 2020.

 

“Although a relatively small amount, this hybrid note allows us additional flexibility in planning our long term capital structure as we prepare for an IPO next year,” Way said in the release. “Our total debt to capital ratio remains conservative and well within our planned range.”

 

HIIG is raising between $50 million to $75 million ahead of its planned 2020 IPO, according to a May 21 report from The Insurer on the HIIG website. Should the company go on to raise $75 million, it would equal roughly 20 percent of HIIG’s year-end book value of $329.9 million, the report notes.

 

While HIIG is planning for an IPO, Canadian investment firm The Westaim Corp. — HIIG’s largest shareholder — was reported to be in advanced talks with at least one private equity buyer for its indirect 43.9 percent stake in HIIG, according to The Insurer."

[chompsterama]

Progress report out last night.  On the surface, the business grew overall book value a bit and the discount to book widened further as the share price has continued to look like a sabertooth in La Brea.  Underneath, the performance was only meh considering the backdrop.  HIIG is starting to retain more risk, but as they retained more, their loss ratio (and combined) slipped.  They just eeked out an underwriting gain while the rest of the insurance industry is firing on all cylinders.  Hmm.  Basically, all growth in book value at HIIG was due to investment returns (falling rates and one-off gains) which will not be repeated.  If they can't get their underwriting to a place they feel REALLY good, then they shouldn't be retaining more risk.  It's as if Steven Way is just relying on the industry tightening to bail him out and not on his teams own underwriting ability.  Prior period loss developments went up quite a bit (HIIG has a history with this happening) which basically offset all the profitability growth via risk retention.

 

Arena has had a very lackluster year so far (at least according to the numbers - which obviously don't communicate everything).  Returns YTD are something like 3.9% net and AUM is up less than 10% - ie lower returns and slower AUM growth compared to almost all past periods.  Of course, the business is growing (and compensation!) so expenses are higher as well. 

 

Overall, nothing to puke over but nothing to celebrate considering the backdrop these two businesses have.  BV will likely remain (almost) meaningless until the income statement gets some steady growth.  I sound more negative than I am, but it's worth pointing out that these businesses could (and ought to) be doing much better.   

[chompsterama]

Just a quick thought on valuation here. 

 

Today's price is CAD $2.55 or CAD $365m market cap.

Book Value - with basically no intangibles and holding HIIG at 1x book (WED carries it at 1.1x) is something close to CAD $450m. 

So today's price assumes something like the following:

1. HIIG is doomed to forever earn a sub-par ROE or the reserve portfolio is full of surprises (possible).  So...shall we say 70% of book value?  CAD $1.02/share

2. WED's investment in Arena Finance and Origination becomes impaired with Zwirn losing some money in the credit portfolio.  So maybe 90% of book value.  CAD $1.73/share

3. Arena Investors (the actual 3rd party asset manager) is a skunk and worth nothing.  $0.00

 

There are other assets of about $0.16 per share and liabilities of $0.41 per share (CAD $0.05/share in site restoration and $0.36/share in preferreds).

 

Do those combined scenarios look like a pretty good bear case?  That's what today's price is saying.

 

Just a thought exercise FWIW.

 

What if Arena Investors actually works?  What if HIIG is actually worth BV or greater? 

 

Please correct me where I might be wrong.   

 

 

 

 

[Spekulatius]

I agree with above bear case. When the credit environment gets tough, I could see that Arena could be worth less than book value, it has happened before with asset managers. For now, the marks seem conservative. I added to my smallish position a couple of days ago.

[matts]

I agree with above bear case. When the credit environment gets tough, I could see that Arena could be worth less than book value, it has happened before with asset managers. For now, the marks seem conservative. I added to my smallish position a couple of days ago.

 

Agreed. Arena would be under a lot of pressure in a tougher environment. Also, when doing a sum of parts valuation, one should account for the corporate overhead, non-share comp, other potential dilution etc.

 

[chompsterama]

I agree with above bear case. When the credit environment gets tough, I could see that Arena could be worth less than book value, it has happened before with asset managers. For now, the marks seem conservative. I added to my smallish position a couple of days ago.

 

Agreed. Arena would be under a lot of pressure in a tougher environment. Also, when doing a sum of parts valuation, one should account for the corporate overhead, non-share comp, other potential dilution etc.

 

Ignoring the potential dilution from the fairfax deal, the business in 2018 had G&A of $1m and comp of $3.7m.  How would you capitalize those costs and at what multiple?

[kab60]

I agree with above bear case. When the credit environment gets tough, I could see that Arena could be worth less than book value, it has happened before with asset managers. For now, the marks seem conservative. I added to my smallish position a couple of days ago.

 

Agreed. Arena would be under a lot of pressure in a tougher environment. Also, when doing a sum of parts valuation, one should account for the corporate overhead, non-share comp, other potential dilution etc.

 

Ignoring the potential dilution from the fairfax deal, the business in 2018 had G&A of $1m and comp of $3.7m.  How would you capitalize those costs and at what multiple?

Maybe just slap a 10xmultiple on 4,7m and substract from NAV?

[Cigarbutt]

I agree with above bear case. When the credit environment gets tough, I could see that Arena could be worth less than book value, it has happened before with asset managers. For now, the marks seem conservative. I added to my smallish position a couple of days ago.

Agreed. Arena would be under a lot of pressure in a tougher environment. Also, when doing a sum of parts valuation, one should account for the corporate overhead, non-share comp, other potential dilution etc.

Ignoring the potential dilution from the fairfax deal, the business in 2018 had G&A of $1m and comp of $3.7m.  How would you capitalize those costs and at what multiple?

Maybe just slap a 10xmultiple on 4,7m and substract from NAV?

I think the above is a reasonable rule of thumb. If chompsterama wants to align his sum-of-the-parts valuation to his underlying assumptions, even if a floor valuation using balance sheet items is defined, the discount rate used for future implied cashflows should also be used to discount the future costs of corporate activity which is basically equivalent, in this specific case, to a growing money-losing sub that will offset other positive cashflows going forward from the insurance and Arena subs.

[Spekulatius]

Aren’t these guys late with the Q3 financials? Last years Q3 was filed on 11/8 and we are a couple of days past that.

[deseretalts]

Was filled on the 11/12 in 2015

[Philbert77]

Results are out https://westaim.com/wp-content/uploads/Westaim-Q3-2019-press-release-FINAL.pdf  - I am a bit confused though - what is this HIIG rights offering all about?

[Spekulatius]

Results are out https://westaim.com/wp-content/uploads/Westaim-Q3-2019-press-release-FINAL.pdf  - I am a bit confused though - what is this HIIG rights offering all about?

 

Apparently they raise capital for the insurance business, which means the sub that holds the insurance company (together with a partner) needs to raise capital too. hopefully this doesn’t mean that Westaim needs to raise capital..

[Cigarbutt]

^This was expected. In fact, despite more significant hardening and higher growth in gross premiums and retention, they are raising equity at the lower bound of their previously planned range, as disclosed last May.

Their legacy business is relatively poor, the benefit of premiums growth will only show up over time and the regulators are focused on capital adequacy.

https://hiig.com/wp-content/uploads/2019/05/HIIG-in-50mn-fundraise-ahead-of-slated-2020-IPO.pdf

 

[chompsterama]

^this.  I'm also scratching my head a bit about committing more funds to a business that really hasn't proven it knows how to underwrite with any type of consistency.  I thought they were trying to lessen their HIIG exposure while deploying more to the Arena Group (hence the sale process, plans for HIIG IPO, etc.)  Meanwhile, HIIG continues QOQ and YOY to retain more risk on the backdrop of this hardening market (the best in years) while their underwriting isn't noticeably more accurate despite the backdrop.  Adverse development continues its one-way path - and that's the most damning part.  It would seem more prudent to ensure your underwriting is up to snuff before holding onto more risk which you have proven you're not pricing correctly.  Sure, this adverse development is likely going on in one or two lines and they probably believe they're incrementally bumping up assumed risk in lines that are unrelated, but on a whole, they haven't proven that out very well. 

 

On the Arena side, there is still concern about who the economic spoils of a growing fee income stream go to.  As management and incentive fees go up, comp and benefits predictably rise.  Although Arena might be a great business someday, the capital providers might not benefit as much as those who ride the elevators (and definitely not as quickly). 

[doc75]

Westaim should report Q1 this coming week.  Here's a snapshot using numbers as of Dec 31 in case anyone is interested.

 

Assets (USD):

 

HIIG................. 165m (at 1.1x book)

Arena FINCOs.... 206m (at 1.0x book)

Arena Investors.. 12m

Arena SOF..........2m (investment in Arena Special Ops Fund)

Cash..................22m

 

Against these are liabilities of $18m plus preferred shares of CAD$50m.  There are roughly 143m shares outstanding + 3m RSUs + 25m warrants.  Approx 10m warrants have a strike in the CAD$3.00-3.25 range, and 15m warrants (owned by Fairfax) have a $3.50 strike.

 

Converting to Canadian dollars at $0.72, taking HIIG at 1.0x book, and averaging over 146m shares (including RSUs, excluding warrants) gives the following per share values (all CAD):

 

HIIG.......... $1.43

Arena........ $2.07

Cash+SOF.. $0.23

Liabilities.... $0.51

NET...........  $3.22

 

Purely on a BV basis,  you're getting the HIIG stake for free at current WED prices of $1.60-1.70.  Westaim spent another $4.7m on  G&A + comp in 2019 and one can capitalize that as desired. 

 

Here's a quick summary of recent events:

 

 

HIIG

 

- The rights offering was upsized to $100m and closed April 24.  Westaim committed $44m, keeping their 44% effective interest intact.  They only had $22m in cash on the books at end of Q4 so it's unclear how this was funded.

 

- HIIG has committed to an LPT transaction whereby they'll cede $119m of reserves (primarily 2017 and prior) and obtain reinsurance protection for $127m above this amount (subject to co-participations at certain levels). The LPT is expected to close in Q2 and should result in a post-tax charge of approx $34m.  Westaim booked their share of the loss against HIIG's carrying value in Q4, which led to a YoY decrease in BVPS.

 

- Q4 numbers were good, with a combined ratio was 96.9% with no further adverse development booked (though the LPT indicates they expect more negative surprises to come)

 

- Since beginning of March, HIIG has added 2 seasoned industry specialists to its board and appointed 3 new executives including Chief Actuary and Chief Risk Officer.

 

- See https://hiig.com/wp-content/uploads/2020/04/hiig-appoints-great-american-veteran.pdf for a summary

 

 

Arena

 

AUM was at $1.3B at end of year, up approx 30% YoY. About $150m of that came in December.  The following article suggests that current AUM is in the $1.6B range and could be up near $2B by Q3/4. 

 

https://www.privatedebtinvestor.com/arena-investors-has-secured-300m-for-credit-opps-fund-sources-exclusive/

 

Arena Investors lost $0.5m in Q4. Revenue was up 25% YoY as AUM has grown but expenses were up 65% (biggest increase was compensation, which doubled from $2.7m to $5.4m).  That said, Q4 was an improvement on Q3. 

 

Based on AUM growth I expect Arena Investors to be marginally profitable in Q1 of this year. But  I have trouble seeing how they plan to scale this operation significantly, let alone efficiently, when their whole investment thesis  seems to revolve around small deals.  So I don't put a lot of faith in Arena Investors being a huge engine of growth for Westaim. 

 

I assume WED intends to sell its stake in the Arena FINCOs at some point in the not-too-distant future. That's a lot of capital they've got tied up there that isn't making much return.

 

 

 

[chompsterama]

Westaim should report Q1 this coming week.  Here's a snapshot using numbers as of Dec 31 in case anyone is interested.

 

Assets (USD):

 

HIIG................. 165m (at 1.1x book)

Arena FINCOs.... 206m (at 1.0x book)

Arena Investors.. 12m

Arena SOF..........2m (investment in Arena Special Ops Fund)

Cash..................22m

 

Against these are liabilities of $18m plus preferred shares of CAD$50m.  There are roughly 143m shares outstanding + 3m RSUs + 25m warrants.  Approx 10m warrants have a strike in the CAD$3.00-3.25 range, and 15m warrants (owned by Fairfax) have a $3.50 strike.

 

Converting to Canadian dollars at $0.72, taking HIIG at 1.0x book, and averaging over 146m shares (including RSUs, excluding warrants) gives the following per share values (all CAD):

 

HIIG.......... $1.43

Arena........ $2.07

Cash+SOF.. $0.23

Liabilities.... $0.51

NET...........  $3.22

 

Purely on a BV basis,  you're getting the HIIG stake for free at current WED prices of $1.60-1.70.  Westaim spent another $4.7m on  G&A + comp in 2019 and one can capitalize that as desired. 

 

Here's a quick summary of recent events:

 

 

HIIG

 

- The rights offering was upsized to $100m and closed April 24.  Westaim committed $44m, keeping their 44% effective interest intact.  They only had $22m in cash on the books at end of Q4 so it's unclear how this was funded.

 

- HIIG has committed to an LPT transaction whereby they'll cede $119m of reserves (primarily 2017 and prior) and obtain reinsurance protection for $127m above this amount (subject to co-participations at certain levels). The LPT is expected to close in Q2 and should result in a post-tax charge of approx $34m.  Westaim booked their share of the loss against HIIG's carrying value in Q4, which led to a YoY decrease in BVPS.

 

- Q4 numbers were good, with a combined ratio was 96.9% with no further adverse development booked (though the LPT indicates they expect more negative surprises to come)

 

- Since beginning of March, HIIG has added 2 seasoned industry specialists to its board and appointed 3 new executives including Chief Actuary and Chief Risk Officer.

 

- See https://hiig.com/wp-content/uploads/2020/04/hiig-appoints-great-american-veteran.pdf for a summary

 

 

Arena

 

AUM was at $1.3B at end of year, up approx 30% YoY. About $150m of that came in December.  The following article suggests that current AUM is in the $1.6B range and could be up near $2B by Q3/4. 

 

https://www.privatedebtinvestor.com/arena-investors-has-secured-300m-for-credit-opps-fund-sources-exclusive/

 

Arena Investors lost $0.5m in Q4. Revenue was up 25% YoY as AUM has grown but expenses were up 65% (biggest increase was compensation, which doubled from $2.7m to $5.4m).  That said, Q4 was an improvement on Q3. 

 

Based on AUM growth I expect Arena Investors to be marginally profitable in Q1 of this year. But  I have trouble seeing how they plan to scale this operation significantly, let alone efficiently, when their whole investment thesis  seems to revolve around small deals.  So I don't put a lot of faith in Arena Investors being a huge engine of growth for Westaim. 

 

I assume WED intends to sell its stake in the Arena FINCOs at some point in the not-too-distant future. That's a lot of capital they've got tied up there that isn't making much return.

 

Thanks for this and I agree it's cheap, but SOTP won't really matter until cash flow actually arrives.  Who knows when it arrives.  Arena probably reinvests for some time and HIIG continues to have PPD's worsen (most of these books only go one way once a trend is established).  It's also worth noting that while HIIG was shopped in 2019 there was basically no industry interest over 80% of BV.  HIIG is definitely not worth BV.  But still, it seems hard to permanently lose money at today's prices.  Though it's really tough to tell how and when the cash flow to the HoldCo actually moves up and stays there.   

[doc75]

Chompsterama: Thanks for the comments.  What's your source behind your claim that there was no interest in HIIG at  > 80% BV?  Not doubting it, but I've been trying to piece together some info on that sales process with no luck.  Westaim made a semi-cryptic PR about unsolicited interest, but I read somewhere they had engaged Credit Suisse to shop their stake. 

 

HIIG seems determined to IPO at some point.  May not be at the valuation they'd like, but won't be at < 50% book, certainly not 0. Any reasonably valued IPO should catalyze Westaim shares.

 

Arena somewhat stalled out on fundraising through the first 3/4 of 2019.  Seems to have picked up a bit but I do have questions about scale.