sg & us equity analysts · 2014. 4. 15. · ezra holdings (neutral, tp: s$1.09) 2q14 results...

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8.15am/11.15am Morning Call & Webinar, 14th Apr 2014

Market StrategistsJoshua Tan, Head of Research

Kenneth Koh, Market Analyst

SG & US Equity Analysts Nicholas Ong, O&M & CPO

Lucas Tan, Real Estate

Wong Yong Kai, US Equities

Colin Tan, Telcos

Caroline Tay, Real Estate

Benjamin Ong, Financials

Richard Leow, Research Associate

By Phillip Securities ResearchMr. Chan Wai Chee, CEO

Jermaine Tock, Operations Exec



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Disclaimer

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China – Upgrade from UW to NW

• CN slowing but still expansion (full year

target for 2014: 7.5%) Reforms in progress, pro-growth stimulus

package rolled out

Improving macro fundamentals

• Stock market Moving sideways, but earnings growth is

picking up and valuations are low

Cross-border equity trading between

Shanghai and HK in next 6 months

(investment opportunities!)



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China – Upgrade from UW to NW

• Key risk remains the shadow banking industry

and a sharp property market correction vowed to set a timetable concerning

regulation over shadow banking

outlined targets to fix overcapacity issues

new-home price growth slowed in Feb and

more cooling measures to come (differential

approach via subsidized housing program)

• ETFs that proxy China: China A shares CSI300 (83188.HK) / SSE 50

(JK8.SGX)

China H shares HKCEI (2828.HK)

• Mutual funds that proxy China: Fidelity Greater China

First State Regional China

Schroder Greater China Fund



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• Securities Daily Average Value recovered marginally by 8.5% q-q to S$1.087 billion but deflated 37.4% y-y based on SGX figures. Persistently lower than expected securities activity level for financial year till date led us to revise our full year forecasted SDAV downwards

• Derivatives Daily Average Volume grew marginally by 7.1% q-q to 0.452 million contracts but softened slightly by 5.8% y-y. Derivatives volume expected to increase further, but at a gradual pace.

• Expect that SDAV to pick up more in FY15 and FY16 with recoveries in major markets and positive macro outlook for Singapore. Near-term, the weak securities activities level continue to pose a short-term headwind for SGX. Derivatives business a key growth driver in mid to long-term.

• Downgrade to “Neutral”, with a revised Target price of S$6.89

• Key note: SGX announced that securities clearing fee revision will be effective 1 June 2014.

Update: Singapore Exchange Limited(S$6.97, Neutral TP S$6.89)



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Ezra Holdings (Neutral, TP: S$1.09)

2Q14 results miss on margins pressure

• 2Q14 ‘reported’ net profit of US$19.6mn (-34% yoy), boosted by US$16.6mn one-off gain from associate’s sale & leaseback of Lewek Champion 2Q14 core net profit = ~US$3.0mn

• Overall gross margin decreased from 17.1% in 2Q13 to 15.9% in 2Q14, on higher Subsea contribution and weaker Offshore support margins (due to higher operating costs and lower AHT utilization)

• We expect stronger performance in 2H14 due to seasonality of its subsea biz

• We cut our FY14E/15E earnings estimates by 7%/6% to factor in the 1H14 results

Potential upside risks

• Substantial improvement in subsea execution/profitability

• Stronger-than-expected new order wins

Investment actions

• Muted subsea outlook in the near-term. Maintain Neutral, TP S$1.09.



National Interstate (Nasdaq: NATL)

Failed buyout highlights 29-56% upside

Wong Yong Kai

Phillip Securities Pte Ltd

Phillip Securities Research

14 APRIL 2014



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Company Snapshot

Share Price: $27.25

52-Week Range: $21.18 – 36.36

Market Capitalization: $540 million

Annualized Dividend: $0.48/share



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Company Background

• National Interstate (NATL) is an US property & casualty (P&C)

insurer set up in 1989, and rated “A” (Excellent) by A.M. Best

Company. $632m gross premiums written in 2013, which has

increased by 12.9% CAGR in the last ten years.

• Excellent track record. 1 out of 10 years underwriting loss.

• Risks generally considered “short-tail”, ie. claims are usually filed

during the policy term, or shortly after the policy expires. Hence

loss reserves can be estimated with relatively high certainty.

• NYSE-listed American Financial Group (AFG) owns 51.7% NATL.

NATL founder Alan Spachman and his family own 12.2% stake.

Investment manager T Rowe Price owns another 8.0%.



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Company Background

• NATL also over-provisioned for loss reserves in past 9 of 10 years,

which buffers its balance sheet against occasional higher claims.

• The parent company AFG provides actuarial services to NATL and

reviews the adequacy of its loss reserves. Throughout 2013, NATL

increased prior year loss reserves by unusually large $23.1m,

leading to its first underwriting loss in ten years.

• AFG then offered to buy NATL for $30/share in Feb 2014.

Multiple lawsuits were filed, including by founder Alan Spachman,

alleging unfair offer price among other points of contention.

• Tender offer eventually terminated 1 month later after the Ohio

federal judge granted preliminary injunction to halt the takeover.



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Company Background

• As part of its acquisition of Vanliner Insurance Co (“Vanliner”) from

Unigroup in July 2010, NATL entered into 54-month balance sheet

guarantee agreement whereby loss reserves development, both

favorable and unfavorable, would be assumed by Unigroup.

• Agreement expires in Dec 2014. Meanwhile, Vanliner recorded

$20.8m and $19.0m favorable developments (ie. actual losses turn

out to be lower than originally estimated) in 2013 and 2012.

• Accordingly, excluding the one-off $23.1m reserves strengthening

and including Vanliner’s results going forward, NATL 2013 pre-tax

income would have tripled to $65.6m, all things held constant.

• Management also prepared five year projections, where 2015 net

income was $59.8m. If true, NATL trades at 9.0x forward P/E.

• We have a $42.43/share target price, 55.7% higher than today.



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Company Background

Brief Summary

• NATL is P&C insurer based in US. $632m gross premiums written

in 2013, which has increased by 12.9% CAGR since 2003.

• In the last ten years, NATL only had 1 year of underwriting loss in

2013, and over-provisioned for loss reserves in past 9 of 10 years.

• Founder Alan Spachman and his family owns 12.2% of NATL.

American Financial Group (AFG) owns controlling 51.7% stake,

and made a failed attempt to take over NATL for $30/share in Feb

2014 after NATL loss reserves escalated much higher in 2013.

• $20.8m favorable development from Vanliner could flow to NATL

bottomline starting 2015. If management five-year projections are

regarded reliable, NATL could be trading at 9.0x forward P/E.



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Business Overview



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Business Overview

• NATL business is geographically diversified across many states.

Other than California, no other state contributed > 10% revenues.

• Most of its premiums are transportation related, as illustrated above.

NATL is the primary or only provider for certain product lines.

Geography

15%

7%

6%

5%

5%

4%4%4%4%

46%

California

Texas

New York

Florida

North Carolina

New Jersey

Ohio

Missouri

Illinois

All Other States

Insurance Type

54%

30%

13%

3%

Auto & Other

Liability

Workers'

Compensation

Auto Physical

Damage

All Other Lines



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Business Overview

• In last ten years, NATL only had 1 year underwriting loss

(Losses & LAE Ratio + Expenses Ratio > 100%) in 2013.

• Gross Premiums Written grew by 12.9% CAGR since 2003.

• In the 5-year financial projections prepared by management,

Loss & LAE Ratio was forecasted to be 72.0%, in line with

2010-11 and below 2003-09. We think it is reasonable.

$0

$150

$300

$450

$600

$750

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

$'m

0%

20%

40%

60%

80%

100%Gross Premiums Written

Losses & LAE Ratio

Expense Ratio72%



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Business Overview

* Excluded Vanliner favorable developments as it doesn’t accrue to NATL for now.

• NATL also over-provisioned for loss reserves in past 9 of 10

years, meaning that actual losses turned out to be lesser.

• “Prior Year Developments” were favorable until the last two

years, especially in 2013 where an unusually large provision

of $23.1m was booked, vs the $1-10m range in earlier years.

Acquisition

of Vanliner

$0

$100

$200

$300

$400

$500

$600

$700

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

$'m

($24)

($16)

($8)

$0

$8

$16

$24

$32Loss Reserve: Original Estimates

Re-Estimated on 31 Dec 2013

Prior Year Developments

$'m



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Is NATL undervalued?



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• Lawsuit alleges unfair offer price, flawed process, coercion, and inadequate disclosures when AFG launched its tender offer for NATL. Contention illustrates how AFG is eager to control NATL Board, and NATL is likely worth beyond $30/share.

• 5 out of 10 NATL directors are or were AFG officers. Another director is CEO of NATL, and thus by association affiliated with AFG who is the controlling NATL shareholder with 51.7% stake.

• However, Ohio corporation law provides for cumulative voting when electing the Board. If 6 directors are to be elected, the shareholder holding 100 shares (1 share = 1 vote) can choose to give one candidate as many as 600 votes (no. of directors to be elected x no. of votes) to increase his odds of success.

• Exception to above can be made if the contrary is specifically provided for in the Articles of Incorporation (“Articles”), but it can only be amended by shareholders holding 66.7% of the shares.



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Contention: Inherent Coercion

• On 05 Feb 2014, AFG launched a tender offer to acquire the rest

of NATL at $28/share. AFG warned of possible consequences if

its NATL ownership increases from the current 51.7% to 66.7%,

such as wielding sufficient voting power to unilaterally amend

NATL Articles to eliminate cumulating voting rights (thus paving

the way for AFG to gain ultimate control of NATL Board).

• However, Alan Spachman and his family owns 12.2% of

NATL. T Rowe Price clients own another 8.0% of NATL. Both

parties publicly expressed their intention not to tender. As such,

15% of the remaining 28.1% public float (more than half) has to

tender in order for AFG to succeed, a relatively high hurdle.

• Minority shareholder interests aligned with these gatekeepers.



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Contention: Flawed Process

• The 6 NATL directors affiliated with AFG were obligated to refrain

from the decision-making process regarding the AFG tender offer

under the “Code of Ethics and Conduct”, but failed to do so.

Request to form independent special committee denied.

• Duff & Phelps was hired as the financial advisor to provide

fairness opinion. When it came back with an “unfair opinion”,

AFG (represented by AFG CFO cum NATL Chairman Consolino)

immediately increased the offer price to $30/share on the spot.

Revised offer initially contingent that NATL Board vote

neutral on the recommendation to accept AFG’s offer.

• After the 6 NATL directors affiliated with AFG voted for neutral

recommendation, Consolino promptly adjourned the Board

meeting, which had lasted for a whole of four minutes only.



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Contention: Inadequate Disclosure

• NATL management prepared two different copies of 5-

year financial projections, merely one month apart

(January & February 2014). Even NATL director Alan

Spachman was unaware that January projections existed.

• January projections were more optimistic and shared

with AFG, yet unexplainably withheld from Duff & Phelps

(who was only provided with February projections) and NATL

shareholders (until two weeks after launch of tender offer).

• Spachman testified in court that he would have expected

February projections to go up instead of down, as he now

knew what January’s results were. From this, we infer that

NATL possibly outperformed even the optimistic January

projections, which forecasted $65.6m net income in 2015.



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• Assumptions for January projections include 10.2-13.0%

growth in gross written premiums and 3.0-4.7% net investment

yield, all of which Alan Spachman believes are reasonable

given NATL decent track record over more than 20 years.

• Even if we base our valuations on the more conservative

February projections instead, NATL would still trade at a

forward multiple of 9.0x P/E based on 2015 net income.

Management 5-Year Projections

$49

$66

$100

$49$60

$77$87$88

$76

$68

$0

$40

$80

$120

$160

2014 2015 2016 2017 2018

$'m

$300

$400

$500

$600

$700Net Income (Jan)

Net Income (Feb)

Book Value (Jan)

Book Value (Feb)

$'m



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Contention: Unfair Offer Price

• Duff & Phelps concluded NATL was worth $29.51 to $35.72per share, based on the conservative February projections.It declined to deliver fairness opinion on the higher offer price.

• Indeed, Alan Spachman again testified that Duff & Phelps said “you shouldn’t take away from this meeting that the $30 offer would be deemed to be fair by Duff & Phelps”.

• Meanwhile, based on his experience as NATL founder & CEO (1989-2007), and NATL Chairman (2004-2013), Spachman “does not believe the Increased Offer Price reflects the fair value of the shares” and “wish they (shareholders) knew about some of the SEC information that I did not disclose”.

• For perspective, Spachman last divested a 3.1% stake at $30/share in 2007. Back then, NATL per share book value and gross premiums written were 38% and 45% lower than today.



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• Recall that NATL only had 1 year of underwriting loss in

the last ten years, booking unusually large provision in 2013.

• Interestingly, AFG provides actuarial services to NATL.

This means that it was in the position to influence NATL to

increase its provisions for loss reserves, which it did.

• While possible that NATL underwriting results deviated from

historical norms and deteriorated drastically over 1 year, it is

equally (if not more) likely that higher than necessary loss

provisions were recorded upfront. This depressed NATL

earnings and share price, enabling a low takeover bid.

• AFG launched takeover for NATL 5 days after NATL released

preliminary 2013 results. Even at 35% premium, the $30 offer

was below the 52-week high of $36 achieved in July 2013.



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Further Clues: NATL is undervalued

• AFG decided that increasing the offer price to $30 would also

make it possible to achieve its internal target threshold. If its

most recent $400m acquisition (Summit Holding Southeast) is

any indication, this threshold is min 11-12% after-tax return.

• If Duff & Phelps formula were applied to the optimistic January

projections, NATL shares would be worth $34-40 instead.

• P&C insurance market in the midst of hard market now. NATL

has increased its premium rates in 2013, averaging 5-10% on

most renewals, and non-renewed $65m of unprofitable policies.

Gross Premiums Written still increased by 14% in Q4 2013.

• Vanliner results will be consolidated into NATL from 2015.

• $12.0m long-term debt vs $352.3m shareholder’s equity.



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NATL Valuations



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NATL Valuations

• Duff & Phelps has supplied many of its own assumptions to

arrive at fairness opinion: (A) discount rates ranging from 9-13%

(B) 2016 net income terminal multiples ranging from 13-15x and

(C) NATL could, subject to the Board and regulatory approvals,

borrow $71m to pay $4/share extraordinary dividend in 2014.

• If conservative February projections were used, in conjunction

with 13% discount rate, 13x terminal multiple and the $4/share

dividend payout, NATL could be worth $42.43/share.

• Investors might be skeptical and thus apply additional 10%

haircut on projections for every year beyond 2014. Even so,

NATL would be worth $35.21/share, 29.2% higher than today.

• At the very least, AFG willingly offered $30/share for NATL.

That establishes a floor, and still implies 10.1% upside.



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Overall Conclusion



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Overall Conclusion

• Normally, investors ought to actively avoid a company whose

majority shareholder disregards minority shareholder interest.

• As previously mentioned, a quirk in the Ohio corporation law

ensures Board representation of minority shareholders. Alan

Spachman and T Rowe Price, together owning 20.2% NATL,

continue to prevent AFG from abusing its controlling stake.

• AFG has historically treated minority shareholders fairly – NATL

consistently paid out dividends every year since its 2005 IPO,

culminating in a $2/share special dividend in 2012.

• While $35.21 to $42.43 per share target price were derived

using Duff & Phelps assumptions and conservative February

projections, upside could be higher if and when the market sees

merit in adopting the more optimistic January projections, based

on NATL’s financial performance over the new few quarters.



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Ask Questions!

Market StrategistsJoshua Tan, Head of Research

Kenneth Koh, Market Analyst

SG & US Equity Analysts Nicholas Ong, O&M & CPO

Lucas Tan, Real Estate

Wong Yong Kai, US Equities

Colin Tan, Telcos

Caroline Tay, Real Estate

Benjamin Ong, Financials

Richard Liao, Research Associate

By Phillip Securities ResearchMr. Chan Wai Chee, CEO

Jermaine Tock, Operations Exec

sg & us equity analysts · 2014. 4. 15. · ezra holdings (neutral, tp: s$1.09) 2q14 results...

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