LRE.L - Lancashire Holdings Ltd

[thefatbaboon]

Gio,

 

I don't really understand your point.  I wasn't saying don't have a "case" with 20% roe.  I just said don't have a case with 25% roe.  And certainly not with a bull case with an infinite series of 25% roe and 25% reinvestment!  Given that we are in a soft market that is softening I think it would be prudent to use a base case underneath long term returns. 

 

An investor in LRE, to get to the land of good returns, needs to get through these soft years, and then cross whatever event destroys enough capital to harden the market without getting hurt.  Furthermore, time value is very important in a business that cannot reinvest and compound - just like it is in a bond.  The close coupons are more valuable than the distant coupons.  So, as we are in a market where LRE has gone from 15.8% to 15.3% to 12.5% - and with pricing taking another big step down this year - I think it looks more likely than not that the close coupons are going to be significantly below long term historical returns.

 

So to come back to your Klarman comparison.  If I knew Klarman was full of Lehman paper, that had rallied 100% over the last 3 years, that was now close to par, and that he was in the process of liquidating and holding a lot of cash.  Then I would not invest with the idea that he would be earning me 20% off the bat.  1. I would probably wait till events gave him opportunities to invest 2. If I didn't, because I was eager to get in, or because he was open temporarily, then I would assume that there would be a number of front-end years where my returns would be significantly under average historical returns.

 

Back to LRE, my bull thesis would be an immediate return to 19% historical returns (unlikely but possible), my base would be an ultimate return to historical returns (19%) but climbing up over a number of years from 12%, and my bear would be would be using current weak returns (13%) (not really because I think it would happen, that he would earn 13% for ever  - but because there is a chance that the hardening event takes a 25% chunk out of LRE's capital)

[twacowfca]

hmmm….I find your base calculations quite bullish!

 

Last years ROE was 12.5%, the year before 15.3%, the year before 15.8%. 

 

You also assume in your bull case that they can use a retention/reinvestment ratio of 25% and get a 25% return on it, i.e. g of 6.25%.  Whereas they haven't been able to retain earnings and grow their tbv at all over the last 5 years.

 

I think you need to get rid of that bull case, make your base the new bull case, the bear the new base, and estimate a new bear case that assumes a soft market that continues for a while.

 

I continue to believe it is dangerous to value an asset with a duration of 50 years or more on the basis of last 3 years results.

 

Think of it this way: Mr. Brindle is among the best in the world in what he does, Mr. Klarman is among the best in the world in what he does. Mr. Brindle looks for the best bargains in global insurance and reinsurance markets, Mr. Klarman looks for the best bargains in global equity and distressed debt markets.

 

Just because Mr. Klarman suffers 2 or 3 years of subpar performance, would you then infer that he is destined from now on to underperform? Or would you think more likely that his average performance in time will be more or less like the one he has experienced during the last 20 years? Or, put differently, why disregard the possibility that 3 years of underperformance might be followed by 3 years of outperformance?

 

Mr. Brindle long-term performance has been ROEs around 19%-20%, and it has been very lumpy. I assume his future long-term performance will stay around 19%-20% and will keep on being lumpy.

 

Gio

 

Good long term perspective, Gio.

 

In truth, They have had only one year(2013)  in the last three of underperformance with reference to their peer group, the Bermuda and London market (re)insurers.  And that was only  "underperformance" when measured by earnings, not by growth in fully diluted book value per share plus equity that was paid out as dividends (18+%), their preferred metric, and Warren 's too for that matter.  By that measure, they were still above average in a low cat year when less careful competitors would be expected to outperform.  :)

 

It's always helpful to look behind the headline earnings numbers. Board members may recall the end of Q2 of last year where almost all insurers, with a handful of exceptions including Lancashire, took a big hit to their surplus when interest rates popped up.  Allstate, took a hit to their surplus of over 16% because of the risky high yield assets they held, but reported good earnings by GAAP because they didn't mark to market.  After that, they quietly strengthened their balance sheet by issuing preferred stock even as they paid dividends.

[giofranchi]

So to come back to your Klarman comparison.  If I knew Klarman was full of Lehman paper, that had rallied 100% over the last 3 years, that was now close to par, and that he was in the process of liquidating and holding a lot of cash.  Then I would not invest with the idea that he would be earning me 20% off the bat.  1. I would probably wait till events gave him opportunities to invest 2. If I didn't, because I was eager to get in, or because he was open temporarily, then I would assume that there would be a number of front-end years where my returns would be significantly under average historical returns.

 

Yes! You are right! A ROE of 25% is too optimistic!

 

My point was that 3 years of subpar results might happen to anyone. Even to Mr. Klarman or Mr. Brindle. But who knows?! Mr. Brindle has often said “we create our own hard market”, and right now high-yield debt is not a very attractive market, but Mr. Klarman has repeatedly shown to be able to swim against the tide, hasn’t he? Therefore, I am never comfortable thinking I can outsmart great entrepreneurs and capital allocators… Hey! If I could stay with them only when they outperform, and stay away from them when they underperform, I would probably be richer and more successful than Mr. Klarman and Mr. Brindle!! ;)

 

Keep it easy: find great entrepreneurs and partner with them at fair prices. I guess it is difficult enough! ;D

 

Gio

 

[thefatbaboon]

twa,

 

there's a good chunk of forex gain in that '13 number!

[giofranchi]

twacowfca,

I am having difficulties to find the number of diluted shares outstanding… where can I find that number? ???

 

Thank you!

 

Gio

 

[twacowfca]

twa,

 

there's a good chunk of forex gain in that '13 number!

 

If I'm not mistaken, forex gain is a very small part.  Most of the difference in the Fully Diluted Book Value Per Share plus dividends gain, (18+%) compared to tangible gain in FDBV/SH plus divs  relates to the accounting goodwill in the Cathedral acquisition.  In my opinion, they got a gem in Cathedral, and the prices now being paid for not so good companies in the Lloyd's and London market indicate Cathedral could now sell for perhaps as much as  $100 million more than what Lancashire paid.

  :)

[thefatbaboon]

twa,

 

there's a good chunk of forex gain in that '13 number!

 

If I'm not mistaken, forex gain is a very small part.  Most of the difference in the Fully Diluted Book Value Per Share plus dividends gain, (18+%) compared to tangible gain in FDBV/SH plus divs  relates to the accounting goodwill in the Cathedral acquisition.  In my opinion, they got a gem in Cathedral, and the prices now being paid for not so good companies in the Lloyd's and London market indicate Cathedral could now sell for perhaps as much as  $100 million more than what Lancashire paid.

  :)

 

Pretty sure it's just two things: selling shares at a high multiple & the forex. 

[twacowfca]

twacowfca,

I am having difficulties to find the number of diluted shares outstanding… where can I find that number? ???

 

Thank you!

 

Gio

 

It's not a particular fixed number.  It's what would happen at any given point in time if all warrants and related options were exercised.  The calculation is tricky and time consuming and it's easy for an outsider to make a mistake because the input variables are continually changing as exercises take place and current vesting may kick in as certain events occur.  once I worked through my errors, the effect was about the same as what management reported and the bottom line calculation was accurate.

 

The bottom line for that calculation is the FDBV/S or the closely related FCBV/SH number that they report conservatively each quarter, rather than merely increases in BV/SH.  It's what would happen if those vested securities were exercised instantaneously, considering the stock price at that time and the strike price ($5.00/SH for the great majority which expire in less than two years).  The large number outstanding until then is mostly related to what sponsors got at their IPO, not management overreaching. :)

 

[giofranchi]

twacowfca,

I am having difficulties to find the number of diluted shares outstanding… where can I find that number? ???

 

Thank you!

 

Gio

 

It's not a particular number.  It's what would happen at any given point in time if all warrants and related options were exercised.  The bottom line for that calculation is the FDBV/S or the closely related FCBV/SH number that they report conservatively each quarter, rather than merely increases in BV/SH.  It's what would happen if those vested securities were exercised instantaneously, considering the stock price at that time and the strike price ($5.00/SH for the great majority which expire in less than two years).  The large number outstanding until then is mostly related to what sponsors got at their IPO, not management overreaching. :)

 

Ok! But I am trying to understand something I found in the Westhouse latest report on LRE:

Total PTP for FY2013 is $218.1 million, and Diluted EPS are $1.17.

Then, they estimate Total PTP for FY2014 of $247.1 million, and Diluted EPS of $1.11.

The only possible explanation to this “riddle” is that diluted shares outstanding in FY2014 will be much larger than they were in FY2013… Yet, at year end 2013 all new shares to acquire Cathedral had already been issued… Probably they used an “average diluted shares outstanding” for FY2013. But I cannot find that number, nor the number to use for FY2014…

 

Gio

 

[twacowfca]

twacowfca,

I am having difficulties to find the number of diluted shares outstanding… where can I find that number? ???

 

Thank you!

 

Gio

 

It's not a particular number.  It's what would happen at any given point in time if all warrants and related options were exercised.  The bottom line for that calculation is the FDBV/S or the closely related FCBV/SH number that they report conservatively each quarter, rather than merely increases in BV/SH.  It's what would happen if those vested securities were exercised instantaneously, considering the stock price at that time and the strike price ($5.00/SH for the great majority which expire in less than two years).  The large number outstanding until then is mostly related to what sponsors got at their IPO, not management overreaching. :)

 

Ok! But I am trying to understand something I found in the Westhouse latest report on LRE:

Total PTP for FY2013 is $218.1 million, and Diluted EPS are $1.17.

Then, they estimate Total PTP for FY2014 of $247.1 million, and Diluted EPS of $1.11.

The only possible explanation to this “riddle” is that diluted shares outstanding in FY2014 will be much larger than they were in FY2013… Yet, at year end 2013 all new shares to acquire Cathedral had already been issued… Probably they used an “average diluted shares outstanding” for FY2013. But I cannot find that number, nor the number to use for FY2014…

 

Gio

 

I saw that too, and I didn't dig deeper because I thought their whole analysis was superficial.  What actually happened with the Cathedral acquisition is that the potential dilution as a percentage of shares outstanding after the acquisition went down because the 10% increase in their shares that funded half their purchase price did not include extra goodies like warrants.

 

Their misleading take may have been as you suggested by some weighting of shares outstanding for last year.

[giofranchi]

I saw that too, and I didn't dig deeper because I thought their whole analysis was superficial.  What actually happened with the Cathedral acquisition is that the potential dilution as a percentage of shares outstanding after the acquisition went down because the 10% increase in their shares that funded half their purchase price did not include extra goodies like warrants.

 

Their misleading take may have been as you suggested by some weighting of shares outstanding for last year.

 

Ok! Thank you! :)

 

Gio

[giofranchi]

Keep it easy: find great entrepreneurs and partner with them at fair prices. I guess it is difficult enough! ;D

 

Also my experience, though I might be wrong here, is that usually, when you partner with the best in the world, good unexpected things tend to happen, rather than bad unexpected things. :)

 

Gio

 

[bookie71]

RIGHT ON !!!

[gary17]

I am wondering if anyone has bought Lancashire via the OTC exchange....  and has gotten the dividends.......  TIA :)

[fareastwarriors]

I am wondering if anyone has bought Lancashire via the OTC exchange....  and has gotten the dividends.......  TIA :)

 

Not yet, Gary. I'm with E-Trade. I will update when I do.

 

EDIT: According to E-trade, Dividend Payable Date is 4/16/14.

[fareastwarriors]

Lancashire

(LRE.LN, 664p, Outperform, Target: 765p)

Upgrade to Outperform

 

 

KBW

LRE-LN_-_4-7-14_-_Upgrade_to_OP_-_KBW.pdf

[Myth465]

I owned via OTC and always got the dividend at a 10% tax rate.

I just sold last week to buy PWE and KMI leaps.

[original mungerville]

Lancashire

(LRE.LN, 664p, Outperform, Target: 765p)

Upgrade to Outperform

 

 

KBW

 

Based on a 13% ROE for 2014?

[racemize]

Brindle is retiring? 

 

http://www.lancashiregroup.com/media/releases/2014/16-04-2014.aspx

[giofranchi]

Brindle is retiring? 

 

http://www.lancashiregroup.com/media/releases/2014/16-04-2014.aspx

 

Yes! It seems he actually is retiring...

 

If this is the case, I must admit my thesis for Lancashire was completely wrong... And I will act accordingly. :(

 

Very bad news today...

 

Gio

[Ian L]

I wonder if this is to do with the soft market. Bad pricing must be very frustrating for someone looking for value.

[giofranchi]

Of course, I would like to know what twacowfca thinks about this most unexpected (at least on my part…) development.

 

Thank you in advance,

 

Gio

 

[pdoak]

This is clearly very disappointing news. My initial thoughts are:

 

Negatives

• Richard Brindle will be sorely missed. His outstanding record in the insurance industry over the last 30 years is fantastic;
  
• It is a surprise announcement. From an owners perspective, it would have been nice to know that he was thinking of retiring so that it was in our minds and we could evaluate the business with that knowledge.
  

 

Positives

• Alex Maloney has been with Brindle since the beginning of Lancashire. In fact, he was one of Brindle's first hires;
  
• Alex Maloney has been chief underwriter since 2009. Clearly, Maloney is an adept underwriter;
  
• Brindle has most of his wealth invested in Lancashire;
  
• Capital allocation decisions are not so much of an issue at Lancashire as it returns excess capital to shareholders. If this continues to be the case, there is no reason why returns should be very different, in the short run, from before.
  

[giofranchi]

I have just closed my entire position.

 

Without Mr. Brindle I am not interested.

 

It was a 25% position.

 

All in all since my first investment in LRE I have lost some money.

 

I will watch from the sidelines and see how this develops: if Mr. Maloney truly is a worthy successor to Mr. Brindle, I might get interested again and reinvest in LRE.

 

Now I have a mountain of cash and no idea. :(

 

Gio

 

[ASTA]

Well this really sucks I think I will wait and see how things turn out. Very strange that he is leaving but I hope I will learn something out of this hopefully positive :D 

P.S. I am part Swedish so not so hot tempered ;D