MKL - Markel Corp

[masseyrock]

I think the years of 20% CAGR over anything >3yrs is probably behind them unless we get a really hard market.  The 17% CAGR since '91 is heavily weighted towards those early years.  As they work off 2008 from the 5yr CAGR, it does look like that stat will be 15-17% by YE (knock on wood).  Bonus time for employees again at MKL.

 

I'm basing my assumptions more off the math of premium/float growth, 'on average' underwriting margins, portfolio returns and MKL Venture growth.  Lots of different scenarios but they generally point to low-mid teens as a prudent estimation.

 

As a bull scenario, 15% ROE/BV growth and a 10% required rate of return = 1.5x BV = $690.  I wouldn't want to base my investment on that scenario but that isn't a crazy outcome if premiums can grow with 5-10% underwriting margins. 

 

**EDIT - yes, I will be attending the breakfast.

[vinod1]

Since MKL is heavily exposed to stock market returns and arguably we are closer to the top of the cycle in terms of stock market, I would think book value is a bit overstated compared to a mid-cycle normalized scenario. A 30% drop in stock markets would easily reduce MKL book value by about 20% (65% of shareholder equity allocation to stocks would do that). Similarly the bond market also seems to be pretty expensively priced.

 

Do you guys try to make any adjustment to IV via a lower multiple to BV or reduce BV to normalize to a more mid cycle value? I understand if we are looking 10 years out we can ignore such short term considerations but I am trying to figure out the downside and it seems pretty considerable.

 

All this is just a long winded way of saying that I think MKL seems to be trading closer to IV.

 

Vinod

[ERICOPOLY]

A 30% drop in stock markets would easily reduce MKL book value by about 20% (65% of shareholder equity allocation to stocks would do that).

 

I think at a 28% tax rate the drop in BV would be 14%.  Not sure what the right tax rate is but it's just an example..

 

[masseyrock]

On Page 99 of the 2012 10K - 35% decrease in value of the equity portfolio = 15% decrease in BV.

 

And don't forget that as of tomorrow, the equity portfolio will only be 42% of BV, not 65%.  So a 30% drop in the equity markets would hit BV by <10%.  It will probably take some time (I'm guessing 2+yrs) for the equity portfolio to be recast to 60%+ of BV.

 

I agree that the fixed income portfolio is unlikely to achieve the types of returns they've enjoyed historically.  But it looks like their duration has shortened even further from the 2.7yrs from year end.

 

Also, my 4-5% total pre-tax return assumption assumes 3% fixed income and 7-8% equity returns.  Might be too optimistic for both asset categories - but if it is, I still like the 0.50-0.75 downside beta.

 

As long as they can underwrite and invest prudently, MKL should compound at better than average rates.  Structural alpha!

 

 

 

[WhoIsWarren]

Do you guys try to make any adjustment to IV via a lower multiple to BV or reduce BV to normalize to a more mid cycle value? I understand if we are looking 10 years out we can ignore such short term considerations but I am trying to figure out the downside and it seems pretty considerable.

 

All this is just a long winded way of saying that I think MKL seems to be trading closer to IV.

 

Vinod

 

Some downside mark-to-market "risk" here, it's true, but longer term I think their equity positions will do more than ok.

 

Offsetting this, I also keep in mind that Markel aims to be over-reserved for claims outstanding (this is not the case for Alterra, which aims just to be adequately reserved; be aware that Markel management will bring Alterra's reserving standards up to Markel's).

 

A quick look at the loss triangle (page 93 in 2012 AR) shows that past releases have been significant! For example, net reserves for all outstanding claims as at 2006 was $4,297m; six years later (year end 2012) this number was revised down to $3,360m. 

 

Is it possible that Markel is currently over-reserved to the tune of $500-1,000m, or 12-24% of Q1:13 equity (i.e. pre Alterra)?  Seems so to me.  But the insurance buffs among you likely know much more about this than me.  I'd be interested to know if anyone thinks I'm wrong on this.

 

[giofranchi]

On average and over time, I think they compound intrinsic value ~12-15%.  Assumptions upon assumptions to get there but 4-5% pre-tax portfolio returns, 5% premium growth, 97% combined ratio and low-teens EBITDA growth for MKL Ventures gets you to that range.

 

I look at P/BV as a result of the value, not the driver, but I think ~1.3x is appropriate.  If I sell in 10yrs at 1.0x BV, they can compound at 12-15% and I'd still get ~10% return.  But, like BRK, their BV will increasingly underestimate MKL's true worth so assuming 1.0x in 10yrs is probably conservative.

 

Based on the SOTP (value of insurance + portfolio returns + MKL Ventures), I think the stock is worth ~$600 but a wide range.  That would also coincide with 1.3x BV.

 

I don't think MKL is a $1 for 50c here but I do think my capital will have more purchasing power in 10yrs by owning MKL than most other areas of today's market.  And it compounds tax efficiently.

 

Finally, I like the optionality of the steady stream of excess capital going into Gayner's able hands. 

 

On that note, I hope to leave Omaha with a better understanding of the compounding opportunities in the MKL Ventures portfolio - is there a 100:1 return in there?  AMF seems to be doing several acquisitions and they cited it as having a terrific quarter.

 

masseyrock,

if you believe MKL can compound BV per share at 15% annual for the next 10 years, than liquidate the business and distribute the proceeds to shareholders, a simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 1.75 x BV. If you assume a discount rate of 9%, FV for MKL today is 1.88 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.38 x BV; with a discount rate of 9%, discounted value of equity equal to 1.48 x BV.

 

On the other hand, if you believe MKL can compound BV per share at 15% annual for the next 20 years, like I do, than liquidate the business and distribute the proceeds to shareholders, the same simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 2.62 x BV. If you assume a discount rate of 9%, FV for MKL today is 3.09 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.62 x BV; with a discount rate of 9%, discounted value of equity equal to 1.89 x BV.

 

Given its still relatively modest size, I believe MKL can go on compounding at very high rates of return, let’s say 12% annual, for the next 20 years. And I think the proper discount rate for such an outstanding business should be no higher than 9%. If on top of that you believe that MKL will still deserve a residual value 20 years from now, that is to say that 20 years from now MKL will still be worthier alive than dead (it would still be able to compound a bit above the minimum required rate of return, which we have assumed to be 9%), I get to a FV of more or less 2 x BV.

 

That’s why, imo, it is so difficult to value properly an outstanding business.

 

giofranchi

 

[giofranchi]

On average and over time, I think they compound intrinsic value ~12-15%.  Assumptions upon assumptions to get there but 4-5% pre-tax portfolio returns, 5% premium growth, 97% combined ratio and low-teens EBITDA growth for MKL Ventures gets you to that range.

 

I look at P/BV as a result of the value, not the driver, but I think ~1.3x is appropriate.  If I sell in 10yrs at 1.0x BV, they can compound at 12-15% and I'd still get ~10% return.  But, like BRK, their BV will increasingly underestimate MKL's true worth so assuming 1.0x in 10yrs is probably conservative.

 

Based on the SOTP (value of insurance + portfolio returns + MKL Ventures), I think the stock is worth ~$600 but a wide range.  That would also coincide with 1.3x BV.

 

I don't think MKL is a $1 for 50c here but I do think my capital will have more purchasing power in 10yrs by owning MKL than most other areas of today's market.  And it compounds tax efficiently.

 

Finally, I like the optionality of the steady stream of excess capital going into Gayner's able hands. 

 

On that note, I hope to leave Omaha with a better understanding of the compounding opportunities in the MKL Ventures portfolio - is there a 100:1 return in there?  AMF seems to be doing several acquisitions and they cited it as having a terrific quarter.

 

masseyrock,

if you believe MKL can compound BV per share at 15% annual for the next 10 years, than liquidate the business and distribute the proceeds to shareholders, a simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 1.75 x BV. If you assume a discount rate of 9%, FV for MKL today is 1.88 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.38 x BV; with a discount rate of 9%, discounted value of equity equal to 1.48 x BV.

 

On the other hand, if you believe MKL can compound BV per share at 15% annual for the next 20 years, like I do, than liquidate the business and distribute the proceeds to shareholders, the same simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 2.62 x BV. If you assume a discount rate of 9%, FV for MKL today is 3.09 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.62 x BV; with a discount rate of 9%, discounted value of equity equal to 1.89 x BV.

 

Given its still relatively modest size, I believe MKL can go on compounding at very high rates of return, let’s say 12% annual, for the next 20 years. And I think the proper discount rate for such an outstanding business should be no higher than 9%. If on top of that you believe that MKL will still deserve a residual value 20 years from now, that is to say that 20 years from now MKL will still be worthier alive than dead (it would still be able to compound a bit above the minimum required rate of return, which we have assumed to be 9%), I get to a FV of more or less 2 x BV.

 

That’s why, imo, it is so difficult to value properly an outstanding business.

 

giofranchi

 

Of course, put in other assumptions and you get completely different results… like they say: “garbage in, garbage out”! ;)

That’s why what I call “business judgment” is so important.

 

giofranchi

 

[jay21]

On average and over time, I think they compound intrinsic value ~12-15%.  Assumptions upon assumptions to get there but 4-5% pre-tax portfolio returns, 5% premium growth, 97% combined ratio and low-teens EBITDA growth for MKL Ventures gets you to that range.

 

I look at P/BV as a result of the value, not the driver, but I think ~1.3x is appropriate.  If I sell in 10yrs at 1.0x BV, they can compound at 12-15% and I'd still get ~10% return.  But, like BRK, their BV will increasingly underestimate MKL's true worth so assuming 1.0x in 10yrs is probably conservative.

 

Based on the SOTP (value of insurance + portfolio returns + MKL Ventures), I think the stock is worth ~$600 but a wide range.  That would also coincide with 1.3x BV.

 

I don't think MKL is a $1 for 50c here but I do think my capital will have more purchasing power in 10yrs by owning MKL than most other areas of today's market.  And it compounds tax efficiently.

 

Finally, I like the optionality of the steady stream of excess capital going into Gayner's able hands. 

 

On that note, I hope to leave Omaha with a better understanding of the compounding opportunities in the MKL Ventures portfolio - is there a 100:1 return in there?  AMF seems to be doing several acquisitions and they cited it as having a terrific quarter.

 

masseyrock,

if you believe MKL can compound BV per share at 15% annual for the next 10 years, than liquidate the business and distribute the proceeds to shareholders, a simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 1.75 x BV. If you assume a discount rate of 9%, FV for MKL today is 1.88 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.38 x BV; with a discount rate of 9%, discounted value of equity equal to 1.48 x BV.

 

On the other hand, if you believe MKL can compound BV per share at 15% annual for the next 20 years, like I do, than liquidate the business and distribute the proceeds to shareholders, the same simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 2.62 x BV. If you assume a discount rate of 9%, FV for MKL today is 3.09 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.62 x BV; with a discount rate of 9%, discounted value of equity equal to 1.89 x BV.

 

Given its still relatively modest size, I believe MKL can go on compounding at very high rates of return, let’s say 12% annual, for the next 20 years. And I think the proper discount rate for such an outstanding business should be no higher than 9%. If on top of that you believe that MKL will still deserve a residual value 20 years from now, that is to say that 20 years from now MKL will still be worthier alive than dead (it would still be able to compound a bit above the minimum required rate of return, which we have assumed to be 9%), I get to a FV of more or less 2 x BV.

 

That’s why, imo, it is so difficult to value properly an outstanding business.

 

giofranchi

 

Thanks for this gio.  If you can earn greater than average business results, the premium on the business should be pretty high.

 

What premium over book do you think it should get? It seems that they've grown BVPS at about 12% annually, so to get a good (>10%) return, it doesnt seem it would deserve a multiple more than 1.15BV....or am I mistaken?

 

It's higher than that as others have mentioned.  I think they can do 15%ish primarily due to float growth (which has been proven to be at least no cost over cycles).  Their large equity positions in very good companies and Ventures are extra kickers.  So, for myself,  I'm probably going to stop adding somewhere between 1.5x to 1.8x BV and probably won't sell until >2x BV. 

[ap1234]

I have attended the last several Markel breakfasts in Omaha. Tom Gayner has made a few comments in the past re: the current discussion:

 

-Over time, P/BV will become a less meaningful measure as Markel Ventures becomes a larger part of the intrinsic value of the business

-Markel will never invest in anything unless they can earn double digit returns on capital (that is their internal hurdle rate)

-Over the long-term, Markel should grow BV/share at mid-teens rate. It will be lower than in the past because the returns on the bond portfolio are diminished and underwriting level (premiums/capital) and margins are worse than they were in the past.

-Tom believes that the fair value of Markel is between 1.5-2x BV.

-In the old environment, the company generated 20% BV/share growth in a 7% risk free rate environment. Today, the RFR is 2-3%. Markel is generated mid-teens BV/share growth. In other words, historically they generated 2.5x higher return (20/7). Today, they are generating 5+x higher returns (15%/3).

 

I'm curious to know what people think Markel will generate on the investment portfolio? I noticed some people suggested 5% pre-tax. Given the mix of the investment portfolio, how do you get to 5% (i.e. what is the return on the 3 components - cash, bonds and stocks) given where int. rates are today?

 

Looking at historical returns on the equity portfolio seem to be a reasonable guage of the future. However, I'm not sure how Markel's bond returns (which will always be the majority of the portfolio given the 3-4x investment leverage) will be anything like they have been in the past.

 

Disclosure: I am a MKL shareholder.

[ap1234]

Jay21 said:

 

It's higher than that as others have mentioned.  I think they can do 15%ish primarily due to float growth (which has been proven to be at least no cost over cycles).  Their large equity positions in very good companies and Ventures are extra kickers.  So, for myself,  I'm probably going to stop adding somewhere between 1.5x to 1.8x BV and probably won't sell until >2x BV. 

 

I'm curious to know how you factor in float growth when modelling the business. For example, let's say I was doing a quick back of the envelope valuation of Markel looking at BV/share growth over the next 5-10 years. How do you incorporate the growth of the investment portfolio driven by the growth in premiums (i.e. more premiums = more float = more investment assets). In other words, for every $1 of premiums added how much does that contribute to the growth in the investment assets?

[jay21]

Do you guys try to make any adjustment to IV via a lower multiple to BV or reduce BV to normalize to a more mid cycle value? I understand if we are looking 10 years out we can ignore such short term considerations but I am trying to figure out the downside and it seems pretty considerable.

 

All this is just a long winded way of saying that I think MKL seems to be trading closer to IV.

 

Vinod

 

Some downside mark-to-market "risk" here, it's true, but longer term I think their equity positions will do more than ok.

 

Exactly, it's just a MTM loss imo.  The businesses they own are not at risk of impairment, agian imo.

 

Also, let's take a look at Ventures for the Q:

 

EBITDA: 19,360

Net Income: 3,644

Amortization:  (4,259)

 

I'll let you determine what multiples and metrics you want to use, but if we assume those are run rate numbers, that's a minimum $200m in "equity value" imo.

[Palantir]

masseyrock,

if you believe MKL can compound BV per share at 15% annual for the next 10 years, than liquidate the business and distribute the proceeds to shareholders, a simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 1.75 x BV. If you assume a discount rate of 9%, FV for MKL today is 1.88 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.38 x BV; with a discount rate of 9%, discounted value of equity equal to 1.48 x BV.

 

On the other hand, if you believe MKL can compound BV per share at 15% annual for the next 20 years, like I do, than liquidate the business and distribute the proceeds to shareholders, the same simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 2.62 x BV. If you assume a discount rate of 9%, FV for MKL today is 3.09 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.62 x BV; with a discount rate of 9%, discounted value of equity equal to 1.89 x BV.

 

Hey when you calculate the future value in ten years, are you just compounding BV*(1+g)^10 = FV? If so, are you discounting by 1/(1.1^10)? Just curious, as my nos. come out diff.

[vinod1]

Eric & masseyrock,

 

You are correct, I need to adjust for the tax rate.

 

WhoIsWarren,

 

Good point about adjusting for the reserves. MKL is probably slightly over reserved so it makes sense to adjust for it.

 

Vinod

[WhoIsWarren]

The other way to look at Markel's valuation is to add the value of the float to (adjusted) tangible book value.  I'll put some rough numbers on this and others can chip in if I'm way off.

 

Tangible (common) equity $3.1bn

Add back over-reserving for claims (say) $0.5bn

Size of float $4.9bn

10-yr combined ratio 96%

Investment returns (pre tax) 6%

Cost of equity 10%

Value of float (no growth) $4.4bn

 

Fair value (no growth) $8.0bn

Fair value (no growth) $775 per share

Fair value P/B (no growth) 1.9x

 

I think the cost of equity of 10% is probably a bit too high. But it's a nice round number to start with.  Also, not all the intangibles relates to insurance -- should add this back.  On the other hand, perhaps extrapolating the 96% 10-year CR is too aggressive, though I don't think so.

 

You can add on some growth factor if you like.  I just noticed that Markel's NPE has been more or less flat over 10 years, which I hadn't really thought much about before.  However, I know that the weaker economic environment has hurt them (e.g. housing contractors) so it's likely the numbers understate the underlying run rate.

 

Anyway, even though I'm putting down these numbers, I won't likely be a seller of Markel at $775 per share (perhaps not even at $1000).  Companies like this are rare and even if it gets a little expensive it'll grow into the valuation and your likely downside is it'll deliver a couple of years of subpar investment returns. 

 

An alternative scenario is you sell Markel and buy a subpar business that implodes!

 

[CorpRaider]

I'm lurking around this name.  Do you guys foresee much integration risk with the acquisition of Alterra?

[giofranchi]

masseyrock,

if you believe MKL can compound BV per share at 15% annual for the next 10 years, than liquidate the business and distribute the proceeds to shareholders, a simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 1.75 x BV. If you assume a discount rate of 9%, FV for MKL today is 1.88 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.38 x BV; with a discount rate of 9%, discounted value of equity equal to 1.48 x BV.

 

On the other hand, if you believe MKL can compound BV per share at 15% annual for the next 20 years, like I do, than liquidate the business and distribute the proceeds to shareholders, the same simple discounted value of equity analysis, assuming a discount rate of 10%, will show that FV for MKL today is 2.62 x BV. If you assume a discount rate of 9%, FV for MKL today is 3.09 x BV.

Use, instead, a compound rate of 12% annual, and what you get is: with a discount rate of 10%, discounted value of equity equal to 1.62 x BV; with a discount rate of 9%, discounted value of equity equal to 1.89 x BV.

 

Hey when you calculate the future value in ten years, are you just compounding BV*(1+g)^10 = FV? If so, are you discounting by 1/(1.1^10)? Just curious, as my nos. come out diff.

 

Sorry Palantir,

I was in a hurry this morning and I guess I made some mistakes… I attach a file with my calculations of the discounted value of equity. And the hypothesis you find is the one I have described as my basic assumption for MKL. Now I get to a discounted value of equity (VOE) that is 1.72 x BV, instead of 1.89 x BV.

Anyway, please consider this: starting from an equity base of $4 billion today, if MKL compounds equity at 12% annual for the next 20 years, by then it will have accumulated an equity of $38.6 billion. And it will still be a relatively “small” company… if compared, for instance, to the $191 billion of equity that BRK had accumulated by the end of 2012! It is just too conservative to think that 20 years from now MKL will be liquidated and the proceeds will be distributed among the shareholders! To me it simply makes no sense.

So, I stick to my 2 x BV estimate of intrinsic value today. :)

 

giofranchi

 

PS

Please, let me know if my numbers are the same as yours now. Thank you!

Value_of_Equity.xls

[giofranchi]

Q1 2013 Conference Call Transcript

 

giofranchi

MKL-Earnings-Call-Q1-2013.pdf

[jay21]

I'm lurking around this name.  Do you guys foresee much integration risk with the acquisition of Alterra?

 

Not really.  Good quote from the call today:

 

Yeah, what I'd say there is when we did our due diligence at Alterra, we felt comfortable with the reserve levels that there was a redundancy probably not at the same level as our reserving standard but solid reserve and that was very reassuring when we got through the due diligence. Obviously we've been spending a lot of time with the Alterra folks over the last four months and we haven't seen anything that would change our opinion of what we saw the due diligence and you know similar to other acquisitions that we've done in the past, it will be a you know Tom talked about methodical process, it will be a methodical process to bring them into line with Markel’s reserve and standards as we go forward.

 

And probably the best thing I would tell you in terms of purchase adjustments if you will is to look at the performance that were part of our debt issuance back in March. That would give you an idea of what we are talking about or thinking about doing, and I think that's pretty much in line with where our thinking is today.

[WhoIsWarren]

I'm lurking around this name.  Do you guys foresee much integration risk with the acquisition of Alterra?

 

Not really.  Good quote from the call today:

 

Yeah, what I'd say there is when we did our due diligence at Alterra, we felt comfortable with the reserve levels that there was a redundancy probably not at the same level as our reserving standard but solid reserve and that was very reassuring when we got through the due diligence. Obviously we've been spending a lot of time with the Alterra folks over the last four months and we haven't seen anything that would change our opinion of what we saw the due diligence and you know similar to other acquisitions that we've done in the past, it will be a you know Tom talked about methodical process, it will be a methodical process to bring them into line with Markel’s reserve and standards as we go forward.

 

And probably the best thing I would tell you in terms of purchase adjustments if you will is to look at the performance that were part of our debt issuance back in March. That would give you an idea of what we are talking about or thinking about doing, and I think that's pretty much in line with where our thinking is today.

 

One risk from my point of view is that Alterra writes a chunk of reinsurance (almost half of total premiums), whereas Markel does not (only tiny amount).  In effect this is a new business for Markel and it'll be run by the Alterra guys.  Even with oversight from HQ, will Markel management be sensitive enough to the risks being run?

 

I'm long MKL in fair size, so obviously I don't think it's a show stopper.  But it's certainly one I'll be keeping a watch on.

[vinod1]

I think most would agree with IV being in the 1.5 to 2.0 BV range. What I do not understand is why there is no adjustment being made to the book value to account for the market cycle. Since BV is levered to the investment portfolio, I would think such an adjustment is important (Howard Marks "Know where you are in the cycle" comes to mind). Otherwise, at the top of the cycle the IV would seem to be much higher compared to the IV at the bottom of the cycle.

 

Vinod

[giofranchi]

-Tom believes that the fair value of Markel is between 1.5-2x BV.

 

Then, either I am a bit too optimistic, or he is a bit too conservative…  :)

 

giofranchi

 

 

[giofranchi]

I think most would agree with IV being in the 1.5 to 2.0 BV range. What I do not understand is why there is no adjustment being made to the book value to account for the market cycle. Since BV is levered to the investment portfolio, I would think such an adjustment is important (Howard Marks "Know where you are in the cycle" comes to mind). Otherwise, at the top of the cycle the IV would seem to be much higher compared to the IV at the bottom of the cycle.

 

Vinod

 

Vinod,

first of all during the next 20 years we will have many cycles, and, as I firmly believe, even 20 years are not enough to calculate MKL intrinsic value. But you already know this very well.

Second, probably you already know this too, but you might have missed it, Mr. Gayner in the 2012 Letter to Shareholders made it very clear that their “opportunity cost” right now is extremely low, thanks to the acquisition of Alterra, that provides a lot of funds, held in cash or short term bonds, to be redeployed into stocks, when the cycle finally turns. That was perhaps the best piece of news in the Letter, at least imo! :)

 

giofranchi

 

[WhoIsWarren]

I think most would agree with IV being in the 1.5 to 2.0 BV range. What I do not understand is why there is no adjustment being made to the book value to account for the market cycle. Since BV is levered to the investment portfolio, I would think such an adjustment is important (Howard Marks "Know where you are in the cycle" comes to mind). Otherwise, at the top of the cycle the IV would seem to be much higher compared to the IV at the bottom of the cycle.

 

Vinod

 

What you're saying makes sense, but I'm just not that concerned right now as I look at their equity portfolio and I think there's a lot to like (thinking longer term, rather than relying on moody Mr. Market).

 

I would also say that while their equity investments are valued higher than they were a year or two ago, the insurance business is still operating well below potential.  Not just in terms of their financial capacity (measured by NPE / Surplus, which has been hovering at around 0.5-0.6x the last few years; it reached 1.3x in 2002), but in terms of their operational capacity (underwriters, assessors, claims handling etc.).  I wouldn't doubt they could double their premiums without too much growing pains.

[vinod1]

 

Vinod,

first of all during the next 20 years we will have many cycles, and, as I firmly believe, even 20 years are not enough to calculate MKL intrinsic value. But you already know this very well.

Second, probably you already know this too, but you might have missed it, Mr. Gayner in the 2012 Letter to Shareholders made it very clear that their “opportunity cost” right now is extremely low, thanks to the acquisition of Alterra, that provides a lot of funds, held in cash or short term bonds, to be redeployed into stocks, when the cycle finally turns. That was perhaps the best piece of news in the Letter, at least imo! :)

 

giofranchi

 

1. I am probably not conveying my point clearly. I agree we can never put a precise number on IV. What I am trying to get is at market lows, MKL book value would be marked down below normal level (normal market level defined as a level that produces historically generated returns of around 9%). For example, at market lows in 2008 I think MKL book value got around to $220 or so per share compared to around $280 or so when the market is at a peak a few months earlier. Applying any multiple to the reported book value number would mislead us to underestimate the IV at a market bottom and overestimate IV at market top. It results in about a 20-25% change to one's estimate of IV.

 

2. That comment surprised me. It was like a mutual fund manager saying he got a lot of money from investors at the top of the cycle to increase his percentage of portfolio in cash. Apart from tax considerations, MKL could have had the same result by reducing its stock portfolio. If he thinks he can take advantage of the opportunities and it is better to wait for the portfolio that he getting via acquisition, I do not see how it makes sense to sit with 65% of shareholders equity in stocks.

 

Vinod

[vinod1]

 

What you're saying makes sense, but I'm just not that concerned right now as I look at their equity portfolio and I think there's a lot to like (thinking longer term, rather than relying on moody Mr. Market).

 

I would also say that while their equity investments are valued higher than they were a year or two ago, the insurance business is still operating well below potential.  Not just in terms of their financial capacity (measured by NPE / Surplus, which has been hovering at around 0.5-0.6x the last few years; it reached 1.3x in 2002), but in terms of their operational capacity (underwriters, assessors, claims handling etc.).  I wouldn't doubt they could double their premiums without too much growing pains.

 

1. Regarding equity portfolio I am not talking just about a temporary market fluctuation. S&P is expected to return 3-4% per most estimates over 7-10 years. An alpha of 2% puts expected returns at 5-6%.  So I do not see the attraction.

 

2. Agree they can ramp up big time on the insurance business. Only caveat is that the underwriting profits add only I think about 1.5-2.0% ROE to MKL so would not be a big driver.

 

Vinod

 

Vinod