As last night’s entry can attest, the recent market ebb & flow has finally freshened-up my quant screens with some new names. My Negative Enterprise Value screen scored the following as the highest ranking outputs on 7/12:
- Interactive Brokers ($IBKR)- watch list
- Banco Macro S.A. ($BMA)
- HCI Group ($HCI)- watch list
- FXCM ($FXCM)- bought 6/21
- Bank of New York Mellon ($BK)
- Charles Schwab ($SCHW)
I’d like to highlight two of those names that are new to the list and earmarked for my watch list. The first is $IBKR. I spent the weekend reading call transcripts, Qs, and Ks to get familiar with it, and I have to say, the story is quite involved.
I’ve mentioned Thomas Peterffy, IBKR’s founder & CEO, before. The man is a legend, a trailblazer, and [seemingly] a righteous guardian of the electronic trading industry (ECNs and dark pools). Over 20 years ago, Mr. Peterffy founded a market maker called Timber Hill while he was a floor trader on the American Stock Exchange. The unit once accounted for 75% of IBKR’s profits, now down to a 20% contribution. Market making involves principal trading with proprietary capital and material market risk, hence this unit requires substantial regulatory capital reserves: the regulatory requirement for this unit is $241M of capital reserves and Timber Hill holds $913.8M (~$672.8M or 279% excess) as of Q1. Timber Hill is certainly not growing, and it actually lost $29M on the bottom line in the most recent quarter. The dead weight of regulatory capital combine with no growth have the Street prompting IBKR to determine the Timber Hill subsidiary’s fate, whether that be spinoff, privatization, outright sale, or wind up.
Part of the market’s hesitance may derive from the ownership structure of IBKR itself. The publicly traded shares are Class A stock, representing ~11.9% ownership of IBG; the balance is delineated in Class B shares, of which Mr. Peterffy owns/controls ~86%. Due to his controlling interest, he may choose to not act upon the Timber Hill issue out of nostalgia or ego, but he’s never been such a touchy/feely guy. Plus, a massive margin of safety exists in the stock, since IBKR has zero debt and $1.184B in cash (1.52x share price). That’s $24.95/share of cash, for a stock trading ~$16.4–hence the negative EV. Recall, again, that they have significant cash tied up in regulatory reserves, so were IBKR to do something, anything, with Timber Hill, they’d finally unlock significant capital for shareholders, who would likely realize the benefit via a big, special dividend.
I expect to buy IBKR on a pullback.
Next, let’s transition to HCI, formerly Homeowners Choice, a property & casualty insurer based in Tampa, Florida. Between 2002-09, a lot of large national insurers fled Florida due to the high cost of operating businesses in the state (e.g. natural disasters), culminating with the State Farm exit in 2009. That left the state-run, not-for-profit Citizens Property Insurance Corporation as the only backstop. Citizens’ balance sheet ballooned so quickly that state officials forced it to divest of a large portion of its policies. In comes HCI, who picked-off 60k “prime” policies shed by Citizens in 2012 and suddenly rose to become the 4th largest insurer in Florida.
On the surface, HCI seems to have adequately managed its risks, with $800M in reinsurance coverage (costs $130M in annual premia) on $403M in assets. Some investors claim that HCI’s fantastic return metrics and comps come from their cutting corners in reinsurance protection. For example, they lack “reinstatement clauses” on their reinsurance contracts, so were an early season hurricane to devastate their policies, HCI would have to pay their annual reinsurance premium ($130M total) all over again to assure “second event” coverage for the rest of the season. Further, HCI has no clauses enabling “third event” coverage, which many of its competitors do. For context, there has not been a major hurricane in Florida for 7 years. I suspect HCI would cite the geographic quality of its policies relative to peers as the reason for their lack of secondary and tertiary protection.
There’s another layer of known-unknown with HCI though. The state of Florida is deliberating whether or not to pare its subsidies for the local reinsurance market, which would raise the cost of hedging for someone like HCI. This is a small company ($400M market cap), which only files financials annually, so there’s some opacity to deal with here, which engenders murmurs of suspicious insider dealings. I’d have to get my arms around a lot of information were I to open a long position in HCI, so I doubt I’ll do anything unless I see something like strong insider buying.
At least right now, I don’t feel like managing the geopolitical risk surrounding the Argentinian bank BMA, which also appeared on this output.
I’ll disclose any upgrades or new positions on my trade reconciliation.
Here’s the performance from the one opened position off the prior list; buy executed 6/21:
Here’s a followup on the last Core Value screen 5/3:
Passive & Active +24.28% (alpha= +19.24)