TPRE - Third Point Reinsurance

[WolfOfMainStreet]

Gio, do you mind also taking a look at my write up and seeing what I did wrong/right?

[giofranchi]

Gio, do you mind also taking a look at my write up and seeing what I did wrong/right?

 

Hi,

Of course, why not?

I tend to agree with muscleman.

 

All the information I gather about a company have only one goal, and it is always the same: to know how and why that business might be able to generate strong results for many years to come. I am not interested in anything else.

 

If I can understand pretty well and easily enough how and why a business might be able to generate strong results for many years to come, I usually find also that:

1) Its price is undervalued by the market. The market is mostly made by bankers, traders, money managers, etc., whose time horizon is very limited indeed (2 or 3 years at best). Entrepreneurs, who are interested to own a business are still a minority. This makes the market quite inefficient in valuing a business with good prospects for value creation in the long run.

2) As a consequence of 1), usually a sound margin of safety is imbedded in my investment thesis: though not impossible (nothing can be utterly excluded...), it is difficult such a good business, and one which I think I understand well, blows up entirely... The downside scenario that usually happens is a much weaker performance than the one I had thought possible/likely.

 

Points 1), 2), 3), and 4) of muscleman's help me understand how and why TPRE might be able to generate strong results for many years to come... Instead, though accurate and well researched, I am not sure all the information in your write-up add much towards that goal. Hope you take this well. ;)

 

Gio

[muscleman]

I made a large sized investment in TPRE too and my thesis is:

1. Dan Leob's investment has low volatility, which is good for leveraging up.

 

Muscleman,

I wouldn't be so sure about that... According to Soros:

You can get either high returns or low volatility, but you cannot get both.

And Loeb is returning 18% annual for almost 20 years now... And his portfolio in 2008 has been very volatile...

I don't see TPRE (nor GLRE) becoming as levered as other insurance/reinsurance companies. Anyway, given Loeb's track record, it doesn't need to! ;)

 

Gio

 

What I like more about TPRE than GLRE is that Dan Leob is a bond expert as well as a stock expert. Most of the times distressed bonds are entirely event driven and not have much correlation to the market. This can make the return relatively high but the volatility not as high.

 

You could say that GLRE has a large short exposure so that may smooth the volatility, but sometimes short positions can go a little bit crazy. Who knows.

 

I prefer TPRE's bond+equity approach to reduce volatility than GLRE's large long + large short equity approach.

For insurance companies, you do need to manage the volatility. A 1.5x leverage in 2008 could result in a 50% loss.

[muscleman]

Gio, I wonder how would you compare TPRE with BRK?

BRK's trading at 130% of book value, but is BRK's book value mark to market? I know the securities owned are probably mark to market, but for the wholly owned subsidiaries, are they the book value of those subsidiaries? In that case, the book value could be much lower than intrinsic value for BRK, but the book value of TPRE is probably closer to its intrinsic value than BRK.

In addition, if BRK buy and hold a stock at $10 cost basis, and later it raises to $200, then it will not have $200 book value, but instead $200 minus the tax liability if sold at $200 today. But for TPRE, since it doesn't pay income tax to Bermuda, it will have $200 book value.

Therefore, it is possible that BRK at 130% book value is cheaper than TPRE at 110% book value.

Thoughts? :)

 

WolfOfMainStreet, I suggest your report include these kinds of discussions rather than numbers on the surface.

[giofranchi]

I prefer TPRE's bond+equity approach to reduce volatility than GLRE's large long + large short equity approach.

On the other hand GLRE has already been through a 2008 with very little damage. Einhorn's macro views are more in line with Watsa's, has a large investment in gold and other macro hedges... In general he is among the most cautious investors I know of... And I think he will be very well prepared, should another credit crisis come our way.

 

For insurance companies, you do need to manage the volatility. A 1.5x leverage in 2008 could result in a 50% loss.

Not for insurance companies only! Ask Berkowitz what volatility did to his fund in 2011... Most businesses are affected by volatility, let's face it! Yet, the fact you must manage volatility doesn't mean you can get both low volatility and high returns...

Personally, I think that for TPRE and GLRE these words of Watsa's will prove to be true: "Returns will be satisfactory, but lumpy."

 

Gio

[giofranchi]

Gio, I wonder how would you compare TPRE with BRK?

BRK's trading at 130% of book value, but is BRK's book value mark to market? I know the securities owned are probably mark to market, but for the wholly owned subsidiaries, are they the book value of those subsidiaries? In that case, the book value could be much lower than intrinsic value for BRK, but the book value of TPRE is probably closer to its intrinsic value than BRK.

In addition, if BRK buy and hold a stock at $10 cost basis, and later it raises to $200, then it will not have $200 book value, but instead $200 minus the tax liability if sold at $200 today. But for TPRE, since it doesn't pay income tax to Bermuda, it will have $200 book value.

Therefore, it is possible that BRK at 130% book value is cheaper than TPRE at 110% book value.

Thoughts? :)

 

I never compare two things that are orders of magnitude apart... It would be like comparing my boat to Abramovic's yacht... Just because they both float on water...

 

Buffett has bought his operating businesses for much more than their BV. In his ALs he has often said they are on BRK balance sheet at cost, less amortization of goodwill. Therefore, I think they are accounted for far less then their IV, but still more than BV.

 

This being said, the multiple of BV you want to pay for any business depends only on its rate of future growth: I think a 52 years old manager will find it much easier to grow something as small as TPRE, than an 83 years old manager to grow something as big as BRK... Even if the older manager is arguably more gifted than the younger!

 

Gio

[muscleman]

Gio, I wonder how would you compare TPRE with BRK?

BRK's trading at 130% of book value, but is BRK's book value mark to market? I know the securities owned are probably mark to market, but for the wholly owned subsidiaries, are they the book value of those subsidiaries? In that case, the book value could be much lower than intrinsic value for BRK, but the book value of TPRE is probably closer to its intrinsic value than BRK.

In addition, if BRK buy and hold a stock at $10 cost basis, and later it raises to $200, then it will not have $200 book value, but instead $200 minus the tax liability if sold at $200 today. But for TPRE, since it doesn't pay income tax to Bermuda, it will have $200 book value.

Therefore, it is possible that BRK at 130% book value is cheaper than TPRE at 110% book value.

Thoughts? :)

 

I never compare two things that are orders of magnitude apart... It would be like comparing my boat to Abramovic's yacht... Just because they both float on water...

 

Buffett has bought his operating businesses for much more than their BV. In his ALs he has often said they are on BRK balance sheet at cost, less amortization of goodwill. Therefore, I think they are accounted for far less then their IV, but still more than BV.

 

This being said, the multiple of BV you want to pay for any business depends only on its rate of future growth: I think a 52 years old manager will find it much easier to grow something as small as TPRE, than an 83 years old manager to grow something as big as BRK... Even if the older manager is arguably more gifted than the younger!

 

Gio

 

Regarding BV, when Buffet buy a business, if the business's book value is $10 and he paid $20, it will be recorded on BRK's balance sheet as $10 equity and $10 goodwill, and the goodwill portion will go down annually.

So when BRK's price is 130% of BV, it is actually cheap because of these accounting rules.

 

Agree with the size issue.

[thepupil]

that is not correct. the goodwill is not amortized. if you mean "the portion of a company that is goodwill will go down over time because earnings will be retained and bolt ons and capex will add tangible equity" then yes. But goodwill is not amortized unless it is related to an intangible with finite life.

 

http://beginnersinvest.about.com/od/incomestatementanalysis/a/goodwill-and-amortization.htm

[giofranchi]

Regarding BV, when Buffet buy a business, if the business's book value is $10 and he paid $20, it will be recorded on BRK's balance sheet as $10 equity and $10 goodwill, and the goodwill portion will go down annually.

So when BRK's price is 130% of BV, it is actually cheap because of these accounting rules.

 

If you mean that without amortization costs (or at least without part of them... Buffett himself thinks that only 20% of those costs are true costs) BRK earnings would be higher, and therefore BRK BV would be higher, then I agree with you: today you are paying a multiple of 1.3 x a BV that most probably is underrated.

 

Gio

[gfp]

Muscleman - Berkshire doesn't have to amortize goodwill anymore.  Goodwill doesn't go down every year like it used to, unless of course it fails an impairment test.  It is 'frozen in time' like at GEICO, but no longer amortized under GAAP.

 

Regarding BV, when Buffet buy a business, if the business's book value is $10 and he paid $20, it will be recorded on BRK's balance sheet as $10 equity and $10 goodwill, and the goodwill portion will go down annually.

So when BRK's price is 130% of BV, it is actually cheap because of these accounting rules.

 

If you mean that without amortization costs (or at least without part of them... Buffett himself thinks that only 20% of those costs are true costs) BRK earnings would be higher, and therefore BRK BV would be higher, then I agree with you: today you are paying a multiple of 1.3 x a BV that most probably is underrated.

 

Gio

[giofranchi]

Muscleman - Berkshire doesn't have to amortize goodwill anymore.  Goodwill doesn't go down every year like it used to, unless of course it fails an impairment test.  It is 'frozen in time' like at GEICO, but no longer amortized under GAAP.

 

See page 14 of 2013 BRK AL:

I don't understand, how could you declare in the Income Statement Amortization Costs, without a corrisponding loss in value on the Balance Sheet? How are those costs justified?

 

Gio

[peter1234]

Muscleman - Berkshire doesn't have to amortize goodwill anymore.  Goodwill doesn't go down every year like it used to, unless of course it fails an impairment test.  It is 'frozen in time' like at GEICO, but no longer amortized under GAAP.

 

See page 14 of 2013 BRK AL:

I don't understand, how could you declare in the Income Statement Amortization Costs, without a corrisponding loss in value on the Balance Sheet? How are those costs justified?

 

Gio

 

thepupil

But goodwill is not amortized unless it is related to an intangible with finite life.

 

In a acquisition,

- some of the intangibles are determined to have infinite life, called GW, not depreciated but checked annually for impairment.

- some of the intangibles are determined to have finite life, called Intangibles and depreciated over expected life. Examples are customer relationships. You will see corresponding entries on the B/S for accumulated amortization decreasing net carrying value.

 

On page 47 of the 2013 AR you see accumulated amortization for Customer relationships increasing from 1,155 to 1,518.

 

Buffetts point is that he will keep these relationships and customers and this accounting entry for amortization is not an real economic cost.

 

;)

[giofranchi]

Yeah, I agree... Therefore muscleman is right: if you report costs that are no true economic costs, your earnings at the end of the year are lower than economic reality. As a consequence, also BV at the end of the year is lower than economic reality.

I guess this is muscleman's point.

 

Gio

[thepupil]

Yeah, I agree... Therefore muscleman is right: if you report costs that are no true economic costs, your earnings at the end of the year are lower than economic reality. As a consequence, also BV at the end of the year is lower than economic reality.

I guess this is muscleman's point.

 

Gio

 

Accumulated amortization (page 47 of 10-k) is like $5B, which is pretty small in the context of berkshire.  Muscleman said berkshire is cheap at 130% of book "because of these rules". In my opinion this line item is pretty much immaterial.

 

Far more material are the $60b deferred tax liability and $70b of float, which are 26x the size of the accumulated amortization of intangibles and goodwill. Also, burlington northern is worth 1.5-2x it's value on the BS because berkshire bought it well and UNion Pacific and Norfolk are up about that since purchase.

 

So I'll agree with muscleman that berkshire is cheap at 130% of book, but other things have far more of an impact than the amortization of goodwill/intangibles with finite life. I don't agree with that reasoning.

 

 

[gfp]

sure - sorry I missed that certain goodwill is still amortized.  The bulk of acquisition related goodwill (huge at BRK) stays put.  The "missing" goodwill from BNSF, GEICO, BRK RE group, Marmon, IMC, etc...  are much bigger numbers.  BRK paid $34 Billion for the railroad and UNP is valued at $90 Billion today.

 

BTW, BRK is pretty close to 1.4x book value today, not 1.3x.  It did trade at 1.2x in early February of this year and was a fantastic opportunity in low premium leaps.

[muscleman]

Yeah, I agree... Therefore muscleman is right: if you report costs that are no true economic costs, your earnings at the end of the year are lower than economic reality. As a consequence, also BV at the end of the year is lower than economic reality.

I guess this is muscleman's point.

 

Gio

 

Accumulated amortization (page 47 of 10-k) is like $5B, which is pretty small in the context of berkshire.  Muscleman said berkshire is cheap at 130% of book "because of these rules". In my opinion this line item is pretty much immaterial.

 

Far more material are the $60b deferred tax liability and $70b of float, which are 26x the size of the accumulated amortization of intangibles and goodwill. Also, burlington northern is worth 1.5-2x it's value on the BS because berkshire bought it well and UNion Pacific and Norfolk are up about that since purchase.

 

So I'll agree with muscleman that berkshire is cheap at 130% of book, but other things have far more of an impact than the amortization of goodwill/intangibles with finite life. I don't agree with that reasoning.

 

When I said:"because of these rules", I meant amortization + defered tax liability + float. :)

[giofranchi]

September 2014 Presentation

 

 

Gio

TPRE-Investor-Presentation-Sept-2014.pdf

[muscleman]

September 2014 Presentation

 

 

Gio

 

I have a question about the float. In the ppt, they said float/equity is now 18%, which means it is about 270 mn.

According to the latest 10-Q:

Reinsurance balances payable 26 mn

Unearned premium reserves 346 mn

Loss and loss adjustment expense reserves 184 mn

 

minus:

Reinsurance balances receivable 245 mn

Deferred acquisition costs, net 130 mn

Loss and loss adjustment expenses recoverable: 10 mn

 

equals:

170 mn float.

 

 

This is very far from their 270 mn number, unless I include Deposit liabilities 120 mn into the float. Should that be included or not?  ::)

 

Deposit liabilities

Certain contracts do not transfer sufficient insurance risk to be deemed reinsurance contracts and are accounted for using the deposit method of accounting. Management exercises judgment in determining whether contracts transfer sufficient risk to be accounted for as reinsurance contracts. Using the deposit method of accounting, a deposit liability, rather than written premium, is initially recorded based upon the consideration received less any explicitly identified premiums or fees. In subsequent periods, the deposit liability is adjusted by calculating the effective yield on the deposit to reflect actual payments to date and future expected payments.

 

 

[fareastwarriors]

Loeb’s Reinsurer Slumps as Hedge-Fund Investors Gain

 

 

http://www.bloomberg.com/news/2014-09-04/loeb-s-reinsurer-slumps-this-year-as-hedge-fund-investors-gain.html

[giofranchi]

This is very far from their 270 mn number, unless I include Deposit liabilities 120 mn into the float. Should that be included or not?  ::)

 

Well, it seems it should be included.

Are those deposits liabilities funds that can be retained for a certain amount of time and in the meanwhile be invested? If yes, they are float! ;)

 

Gio

 

[muscleman]

This is very far from their 270 mn number, unless I include Deposit liabilities 120 mn into the float. Should that be included or not?  ::)

 

Well, it seems it should be included.

Are those deposits liabilities funds that can be retained for a certain amount of time and in the meanwhile be invested? If yes, they are float! ;)

 

Gio

 

I need to learn more about this. What kinds of policies create deposit liabilities here?

 

In addition, I want to point out that even though the CR is only 102%, the cost of float right now is still pretty high. They are losing $6 mn per quarter in the insurance business, so the cost of float right now is actually 8.8%.

 

I hope next year they can keep growing and reduce the cost of float to minus. :)

[giofranchi]

In addition, I want to point out that even though the CR is only 102%, the cost of float right now is still pretty high. They are losing $6 mn per quarter in the insurance business, so the cost of float right now is actually 8.8%.

 

I think that will surely change as the % of float vs. equity increases… at 18% of equity float is still extremely small… and I would be very surprised if its cost were lower than it actually is!

 

Gio

 

[muscleman]

http://www3.ambest.com/ambv/displaycontent/video.aspx?vid=berger913

http://www3.ambest.com/ambv/displaycontent/video.aspx?vid=rendezvousdayone913

 

Certain interviews with John Berger.

I think if I have time, I would loop through most of these interviews here. General Re's CEO also spoke.

http://www3.ambest.com/ambv/displaycontent/MediaArchive.aspx

[ClientNine]

Thanks for posting these!

[muscleman]

Gio, it looks like TPRE has done a better job hedging the market downturns than GLRE.  :)

It is amazing that the stock is trading at almost book value now.