Investment Highlights.* ROE of 40% and ROE of over 100% excluding excess cash
* Tripled earnings over 5 years ($0.33 per share in 2005 to $0.99 per share 2010)
* Wide economic moat
* Fully audited by top auditing firm
* Current PE of 9
* No debt
* Dividend yield of 2.8%
* Dividend increase from $0.15 per share in 2005 to $0.34 per share in 2010
* No direct competitor
* Company has reduced share count over the last five years
* Actionable idea for small investors with a trading volume of $7,000 per day
* Strong future growth opportunities
The strong economic moat is a network effect -- which is one of the strongest kinds of economic moats, ensuring a sustainable competitive advantage.
This company is fully reporting and audited. It is audited by the 20th largest auditor in the world. The company is ordered by UHY, LLP which is the 20th largest worldwide independent accounting Association. According to capital IQ, UHY audits 74 companies in the U.S.
The name of the company is The Marketing Alliance (MAAL), or TMA. Introductions are available here and here.
What does it do?
TMA provides two essential services to small independent insurance agents.
1. It aggregates small insurance agents into one buyer to negotiate with the insurance carriers so the small insurance agents have more buying power and can negotiate better terms (i.e., commissions for selling the carrier's insurance) when they purchase insurance product from the insurance carrier. Examples of insurance carriers are Prudential or ING.
2. It provides back office support and automation systems for the small insurance agents. It also takes charge of marketing the product on behalf of the insurance agent. These both save costs. TMA, by aggregating these costs, charges a small fee but achieves economies of scale.
So, if you are a small insurance agent it really benefits you to belong to this network.
1. You can negotiate higher commissions on the insurance that you sell because TMA represents you along with other insurance agents in one large pool.
2. You can save money on back office requirements because TMA handles this for you.
3. TMA is a completely independent organization. It does not have its own set of agents as a side-business which are competing with you.
4. The fee that TMA charges you is less than the extra money you make in commission from TMA negotiating you a better deal with the large insurance carriers and the money you save on TMA running your back-office requirements.
The network effect is very strong. The bigger that the network gets, the greater the benefit to insurance agents -- and the more difficult it is to leave. A growing network gives more leverage to TMA, more bargaining power, and greater and greater profits. So, the network creates a captive agent and better and better margins for TMA.
This has been borne out by the results.
If you are an insurance carrier, TMA also helps you.
1. By aggregating small insurance agents you only have to deal with one customer for your insurance product.
2. By supporting the profitability of the small insurance agents, TMA ensures that more of your insurance product can reach the market.
3. TMA provides new sales outlets and markets for the insurance carriers.
4. Carriers want the fixed cost distribution to be variable. In other words, they only want to pay the insurance agent can really produce.
How has this translated into the financials?
Note: TMA invests its considerable excess cash in the equity market. Therefore, its net income is sometimes distorted by gains or losses in the equity market. So the most appropriate measure of true company profitability is its net operating profit after tax (NOPAT)
This has grown from roughly $666,000 at the end of 2005 to the current trailing 12 month figure of $2.5 million. This is an approximate growth rate of 29% per year over the last five years.
The majority of this growth, although not all of it, has come from margin expansion from the fixed cost nature of the network adding more agents.
Revenue (3/31 2006) = $15.9 million Revenue (Dec. 31 2010) = $20.9 million
TMA does not add all agents to its network. It only allows profitable agents to join. Unprofitable agents are removed.
There are no direct competitors.
However, one could expand the competition to include traditional larger brokers and other financial distributors such as -- Aon Corp. and Brown and Brown. TMA compares favorably to these in terms of profitability and valuation.
Strategies for Future Growth.
When you have a strong economic moat, you basically have options. It is not just about lowering costs and trying to out-innovate your competitor. TMA has multiple directions in which it can grow. The existence of the network moat gives it a platform to explore ways to increase high-margin revenue. They have already begun an annuity line in addition to life insurance.
The following are some strategies that TMA plans, and has already begun, to use.
Addition of More Carriers (Suppliers) [Revenue Growth]
TMA has begun to recognize measurable revenues from the addition of new
carriers. It typically takes 18 to 24 months for new carriers to be profitable as it takes a lot of time for the agents to fully understand and market the products.
Will continue to pursue new carriers in order to maximize revenues, attract new
agencies and fuel growth
Expansion of Services Provided
Through the addition of services such as TMA’s annuity business and business
service center based in Omaha, NE, as well as the expansion its product matrix,
brokers are encouraged to drive more business to TMA
Incentive Plan for Brokers
Flexible program where TMA agencies can deliver specific insurance products and
services tailored to the needs of the customer
Management feels that this program has gained traction by increasing TMA’s share
of business with existing members and encouraging more profitable prospective
agencies to join the Company.
In fact, the latest quarterly earnings report makes strong mention that one of the main drivers of increased operating income has been some of the agents utilizing the additional services of the TMA network. This can be seen here.
Clearly, a company of this quality with this growth should be trading at a much higher ratio than 9 times earnings.
I use a forward valuation method to value TMA.
First, take the current trailing twelve months earnings (in this case NOPAT).
= NOPAT TTM (after tax) $2,508,039 / 1,901,578 shares = $1.319 / share
At the current price of $12, this equates to a NOPAT ratio of 9.1.
Let takes some examples to project a five-year price target (the dividend which will increase returns further is ignored here. Negligible share dilution is also assumed, and in fact the share count has been reduced over the years.)
1.5 year compounded growth of 8%. Future NOPAT ratio of 12.
= 1.319 x 8% over 5 years = 2.124.
2.124 x future NOPAT ratio of 12 = $25.49
$25.49 compared to $12 now is a double over 5 years.
2. 5 year compounded growth of 12%. Future NOPAT ratio of 14.5
= 1.319 x 12% over 5 years = 2.54.
2.54 x NOPAT ratio of 14.5 = $36.83.
$36.83 is slightly more than a triple over 5 years.
3. 5 year compounded of growth of 16%. Future NOPAT ratio of 16.
= 3.017 x 16% over 5 years = 3.018
3.018 x NOPAT ratio of 16 = $48.29
$48.29 is slight more than a quadruple in today's price over 5 years.
My opinion lies somewhere between Scenario 2 and 3 (as a conservative assumption given past earnings growth and the quality of this company).
The risks with TMA, in my opinion are not insignificant, but are quite manageable.
Increasing internet distribution of insurance is possible. but with a "high touch," one-time expensive purchase such as life insurance, clients normally prefer having a agent explain the options. Furthermore, life insurance policies require medical documentation and verification. Actually, TMA's back office supports these tasks.
2.) Key Man risk.
The CEO Tim Klusas' arrival at the company coincided with better performance. Losing him would not be helpful.
3.) Overall, the number of new individual policies being written is in decline -- from an average of 17,000 per year in 1980 to 10800 in 2007.
Mitigating this is:
a) the face value of each policy has been rising.
b) TMA is not an insurance agent but an aggregator of the best agents taking some cream off the top.
c) TMA has entered and will enter other business lines e.g., Annuity.
4) Significant excess cash allow for the possibility of misallocation of capital. I would argue that having significant cash is a lovely problem to have! They have recently made a new position especially devoted to how to invest all the extra cash they have.
5.) The overall agent base is aging.
I am long MAAL.