Friday, May 6, 2022

Argo Group International: New Activist Pressure, Pursuing a Sale

This will be a brief post and not the most exciting idea given the current chaotic market backdrop, but I wanted to throw something out there as it has been a while since hitting publish. I've mostly just been sitting tight, waiting for events to play out and adding to a few current positions during this downturn.  I also don't have much experience with insurance companies so be easy on me in the comment section.  

Argo Group International (ARGO) is a specialty insurer (~$1.5B market cap) that first popped up on my radar screen in 2019 when it faced a proxy contest from Voce Capital, their largest shareholder (9-10%), which eventually added three representatives to the board.  Voce put out an entertaining deck that outlined the now ex-CEO's lavish lifestyle (corporate penthouses, art collection, sailing sponsorships, private jets, etc.) that was essentially being expensed through Argo.  

In the ~2 years since Voce refreshed the board and the ex-CEO resigned, Argo has gone about shedding unprofitable or volatile business lines to highlight the strong U.S. focused specialty insurance business. 

The crown jewel is their excess and surplus business line that focuses on risks that standard insurance markets are unwilling or unable to underwrite.  This the non-commoditized, less regulated corner of the insurance market and thus should be more profitable.  The transformation goal has been to uncover and highlight this business: 

However, the perceived slow speed of the transition and a surprise reserve adjustment in February brought forward another activist pushing for board representation in Capital Returns Management, an insurance focused hedge fund.  Capital Returns has also insisted the company put itself up for a sale and the board agreed last week to run a strategic alternatives process which includes exploring a sale of the company.  While, Capital Returns argues the board doesn't have skin in the game (in aggregate they own ~1% of the company), there are three Voce representatives on the board and they've moved the business down Voce's suggested path.  My guess is Voce is in agreement that now is a good time to pursue a sale and the board is unlikely to resist a reasonable offer.  In short, this may go from semi-hostile to friendly, the verbiage from the recent earnings call seems to imply that as well:

Thomas A. Bradley Argo Group International Holdings, Ltd. – Chairman of the Board & Acting CEO

Thank you, Greg, and thank you to everybody for joining us today. Before I jump into our results for the quarter, I'd like to take a moment to discuss our announcement last week. Over the last year, Argo has instituted a number of substantive strategic initiatives, actions that we believe have positioned the company for a clear and consistent long-term path to stable growth and profitability. The Board of Directors and management team, however, do not believe these initiatives are adequately reflected in the company's current market valuation.

After much thoughtful and deliberate discussion and analysis, our Board with the assistance of our advisers has initiated an exploration of potential strategic alternatives. In this review process, our objective is simple: to maximize the value of the company's strategy and its considerable long-term prospects for the benefit of all shareholders. To that end, the Board will consider a wide range of options for the company, including, among other things, a potential sale, merger or other strategic transaction.

What would be a reasonable valuation in a sale?  Again, I've only looked seriously at 1-2 insurance companies here in the last decade.  But below is a list of U.S. based peers that I took from Capital Returns' proxy, and the data is from TIKR.
This is admittedly rudimentary, but for a business that's proforma combined ratio should be in the low 90s, a 1.5x book valuation seems reasonable for a strategic buyer?  Kinsale Capital (KNSL) is a pure play excess and surplus insurer which trades for a high valuation, there's a KNSL short thesis on VIC worth reading, giving a little bit of comfort that other players will be interested in ARGO and that it should trade at a reasonable premium to book.

The sale process could take some time, maybe we hear something in 5-7 months, so again, there are likely more immediate/actionable opportunities in the current market dislocation, but keep this one on the watchlist.

Disclosure: I own shares of ARGO

16 comments:

  1. Thanks Matt. Kinda like CDOR. If I have this right, estimates are for 15% eps and 5% premium growth next few years. Does that sound right?

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    1. Yeah, maybe if you squint it is a similar situation and sounds about right on the estimates.

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  2. A brief exchange with a friend who knows something about the space says he thinks the reason they trade below BV is due to a need to increase reserves. Since the peers (Bermudan reinsurers') trade at 1.2x he thinks there may not be as much upside possibly (does not know the too well). That said if they are truly a niche provider, then I would think that would provide a premium but I don't know the space well at all

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    1. Thanks, that's good color, appreciate it. As I repeated, I don't look at insurance companies often so I could be way off.

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    2. Transverse SliceMay 16, 2022 at 9:35 AM

      The Bermuda reinsurer "issue" isn't really an issue - the main desirable asset in here is the US E&S business. I.e., this is not primarily a Bermuda reinsurer. However, there is a bit of an issue with any whole buyer would have to deal with the bits that they don't want (but this is not that large a company, relatively speaking)

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    3. Transverse SliceMay 16, 2022 at 9:36 AM

      Note: there is also a third activist/special situations group in the mix here, namely Enstar.

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  3. Hopefully, the review process is not undertaken for the purpose of avoiding the shareholder meeting that the Board deferred into the fall?

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  4. You are going to end up with the same chains that Buffett is stuck wearing if you keep chasing giant cap stocks like this. I predict your time beating the market will soon end, in no more than 50 years. Then you better hope a cult has grown up around your blog that shows up at your home once a year to hear you talk regardless of returns.

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    1. Ha, yeah no where near that popular. And like many others, down on the year, but just continuing to march on as usual.

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    2. You are so polite, MDC. Keep up the good work; I love your blog.

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    3. If he can continue posting these kinds of returns for 49 years, I'm sure he'll be fine. Thanks for the idea MDC

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    4. Good write up. Pathetic to stay anonymous when heckling someone. At least MDC is out there doing the work and publishing.

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  5. Transverse SliceMay 12, 2022 at 5:15 PM

    Their reserve issues are in a long tail line of business. In other words, an acquirer should (and probably will) haircut that BV. IMO the 1.5x hope on as stated BV is aggressive. That’s the sort of multiple you’d get for a decent franchise without any warts. I would probably consider 1.5x on BV appropriately haircut for these reserve issues to be close to the upper end of the price they can get. I need to look closer, but I think you are ok buying at pixel price - $40.70, but tempered expectations are probably in order.

    Regardless, I have not looked in any deep detail (on the list).

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    1. Thanks, I appreciate the feedback, makes sense.

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  6. You find some very interesting gems. Thank you for the writeup. Well done and interesting as usual.

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