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Invest in Einhorn’s Portfolio Through Greenlight Re

June 04, 2014 | About:
Chris Mydlo

Chris Mydlo

41 followers

Using the S&P 500 Grid at GuruFocus I found David Einhorn’s Greenlight Capital Re (GLRE) near the top of the list for small cap net buys from the investing gurus. There were six buys and no sales from the gurus. Greenlight Capital Re is an interesting company because it is a way to gain access to Greenlight Capital’s portfolio without needing the typical $1 million to invest in most hedge funds.

Company Background

Greenlight Capital Re is a reinsurance company headquartered in the Cayman Islands. Reinsurance is the process by which the reinsurer takes on all or part of the risk covered under a policy issued by an insurance company in consideration of a premium payment. Greenlight Capital Re is a relatively new company that was incorporated in 2004. It was stated during their latest investor meeting that the company just starting underwriting in 2006. The company has hit some bumps along the way, but it has provided exceptional returns throughout its progression. The returns come from both the underwriting part of the business and the investment of the capital and float. The float is the amount of money on hand from collecting premiums but has not been paid out in claims.

Greenlight Re’s insurance writes property and casualty reinsurance business. It has the license to write long-term business (life insurance, long-term disability, long-term care, etc.), but to date it has not written any long-term contracts. The Cayman operating company is rated “A” by A.M. Best, and the Irish operating subsidiary is rated “A-. “ A.M. Best describes the ratings as “excellent” and “assigned to companies that have, in our opinion, an excellent ability to meet their ongoing insurance obligations.”

The investment side of the business is what makes the company attractive. DME Advisors is listed as the investment advisor for the float. Most reinsurance companies invest primarily in fixed-income securities. Greenlight’s investment strategy is to invest in long and short positions primarily in publically-traded equity and corporate debt instruments exclusively through DME Advisors LLC. DME is controlled by David Einhorn (Trades, Portfolio), the Chairman of the Board of Greenlight Re and the president of Greenlight Capital, Inc. Einhorn started Greenlight Capital, the hedge fund, in May of 1996. Since then, the fund has returned 19.5 percent annualized, net of fees and expenses. During the same time period (May 1996 – December 2013), the S&P 500 returned 7.8 percent annualized including reinvested dividends.

The investments by DME Advisors may include buying public or private corporate equities and current-pay debt instruments, selling securities short and investing in trade claims, debt instruments of distressed issuers, sovereign debt, arbitrages, bank loan participations, derivatives (including options, warrants, swaps and futures), commodities, currencies, leases, break-ups, consolidations, reorganizations and limited partnerships.

The company lists the following guidelines for its investments:

  • Quality Investments: At least 80 percent of the assets in the investment portfolio will be held in debt or equity securities (including swaps) of publicly traded companies (or their subsidiaries) and governments of the Organization of Economic Co-operation and Development, or the “OECD”, high income countries, cash, cash equivalents and gold. No more than 10 percent of the assets in the investment portfolio will be held in private equity securities.
  • Concentration of Investments: Other than cash, cash equivalents in the United States government obligations, no single investment will constitute more than 20 percent of the portfolio.
  • Monitoring: Greenlight Re will require the investment advisor to re-evaluate each position in the investment portfolio and to monitor changes in intrinsic value and trading value and provide monthly reports on the investment portfolio to Greenlight Re or as Greenlight Re may reasonably determine.
  • Leverage: The investment portfolio may not employ greater than 5% indebtedness for borrowed money, including net margin balances, for extended time periods. The investment advisor may use, in the normal course of business, an aggregate of 20 percent net margin leverage for periods of less than 30 days.

The investment guidelines for GRIL are identical to Greenlight Re’s except for concentration of investment, which for GRIL is as follows:

  • Concentration of Investments: Other than cash, cash equivalents and United States government obligations, (1) no single investment in the investment portfolio will constitute more than 10 percent of the portfolio, (2) the 10 largest investment shall not constitute more than 50 percent of the total investment portfolio and (3) the investment portfolio shall at all times be comprised of a minimum of 50 debt or equity securities of publicly traded companies (or their subsidiaries).

As of April 30, 2014, the current portfolio status is:

  • Portfolio currently 114 percent long and 66 percent short
  • Largest disclosed long positions are Alpha Bank, Apple, gold, Marvell, Micron and Oil States International
  • Long cash-rich technology companies and businesses benefitting from structural changes
  • Shorts include secular decliners, momentum stocks and iron ore related companies
  • Macro overlay due to monetary policy and unresolved imbalances

Management

David Einhorn (Trades, Portfolio) is the chairman of the board and has been with the company since it started in 2004. He is also in charge of the investment of the company’s capital and float.

All of the members of the executive management team have been with Greenlight Re since 2006. Bart Hedges has been the CEO since 2011. He started with the company as the president and chief underwriting officer. Hedges has over 20 years experience in property and casualty insurance/reinsurance industry. Prior to joining Greenligh Reinsurance, Hedges served as president and chief operating Officer of Platinum Underwriters, a property, casualty and finite risk reinsurer from July 2002 until December 2005, where he was responsible for the initial start-up of the company and managed the company’s day-to-day operations.

Len Goldberg was CEO of the company until his retirement in August 2011. He has maintained a position on the board of directors. Goldberg has had over 20 years of insurance and reinsurance experience.

Risks

Greenlight Re is a new business in the reinsurance industry and has been learning along the way. In order for the investment model to work efficiently, the company needs to earn an underwriting profit. Insurance companies use the combined ratio as their metric to display an underwriting profit. A reading over 100 is an underwriting loss and under 100 is a an underwriting profit. The company experienced high combined ratios in 2010 to 2012, indicating underwriting losses.

 

2007

2008

2009

2010

2011

2012

2013

Combined Ratios

92.2%

96.5%

95.5%

102.8%

103.8%

112.9%

97.1%

The losses were from contracts that were from commercial auto and general liability contracts written in 2009 and 2010. The relationships with those parties have been terminated, but it shows the risk of underwriting losses not becoming visible until after the contracts have been underwritten. The company’s focus on fewer, bigger deals makes the impact of an underwriting loss on a contract more prevalent on Greenlight’s bottom line.

There are two reasons why the underwriting profit is important. The first reason is that underwriting is the primary business of the company. The core operations should be profitable. The second reason is, as stated by Warren Buffett (Trades, Portfolio), the float acts as an interest-free loan as long as the combined ratio is not higher than 100. In its latest investor presentation, Greenlight Re displays how the combined ratio affects return on equity:

In 2010 through 2012, the high combined ratios led to considerable drops in earnings per share (EPS). Earnings dropped to a low of $0.18 per share in 2011 from $5.71 per share in 2009. In 2013, Greenlight Re became profitable in its underwriting again and EPS jumped back up to $6.01. Underwriting profits were positive in the last quarter with a combined ratio of 99.9 percent.

 

2007

2008

2009

2010

2011

2012

2013

Earnings Per Share

1.15

-3.36

5.71

2.44

0.18

0.39

6.01

The other risks associated with the company are similar to other reinsurers. Greenlight Re states that the cyclicality of the market may affect its profitability. The cyclicality of trends in the property and casualty reinsurance industry include the trends of courts granting increasingly larger awards for certain damages, natural disasters, fluctuations in interest rates, changes in law, changes in the investment environment that affect market prices of investments, inflationary pressures and other events that affect the size of premiums or losses companies and primary insurers experience. Greenlight Re expects to continue its concentrations in Florida homeowners (limited wind), employer stop loss, and non-standard automobile.

Financial Strength

Greenlight Re is very strong financially as portrayed by its “A (excellent)” rating by A.M. Best. It also receives a score of 8/10 from GuruFocus for financial strength. The company has no debt on its balance sheet and an equity-to-asset figure of 0.36, higher than 89 percent of the companies in the Global Insurance – Property and Casualty industry. A higher equity-to-asset figure indicates a lower amount of leverage. The industry median is 0.25.

Profitability & Growth

The company scores a 7/10 for profitability and growth. From its core business, premiums earned have been increasing at annual rate of 26.59 percent for the past five years.

1401831161365.png

Earnings were negative in the first quarter of 2014 with an EPS of $-0.24 due to the net investment loss of 0.7 percent on the investment portfolio. In the latest quarterly report, David Einhorn (Trades, Portfolio) stated, “Our investment portfolio had a small loss as we continue to be defensively positioned in an uncertain investment environment.” The investment portfolio’s loss portrays the risk of Greenlight Re’s investment strategy as opposed to more traditional insurance companies that invest their capital and float in fixed income. The underwriting income increased to $6.5 million from $1.9 million in the first quarter of 2013.

Valuation

Just like other insurance companies that have investing gurus at the helm, an increase in book value per share is the key metric. Book value per share has grown at an 11.1 percent compounded annual rate for Greenlight Re since its incorporation in 2004. Through the same time period, the S&P 500 returned an annualized 7.9 percent. Also the investment portfolio of the company has returned an annualized 10.2 percent with less than 60 percent of the volatility. The stock is currently trading at a price-to-book ratio of 1.10, the same as its medium ratio since the stock's IPO in 2007. With its strong growth prospects due to the superior handling of the investment portfolio, Greenlight Re should be trading at least at the industry average price-to-book of 1.28. If trading in line with the industry average, the stock would be priced at $35.90, making it undervalued by about 10 percent.

1401840270336.png

For my valuation, I used the residual income model. Using the ROE chart above, if Greenlight Re breaks even on its underwriting and the investment portfolio returns the historic market average of 10 percent, the ROE comes out to be 13 percent. I used a discount rate of 9 percent taking into account the stock’s beta of 0.79. The resulting value comes out to be $42.24 per share with a margin of safety of 23 percent making the stock undervalued. The stock closed at $32.44 today, June 3, 2014.

Conclusion

Greenlight Re is a great opportunity to gain access to David Einhorn (Trades, Portfolio)’s portfolio without needing the typical $1 million to buy into a hedge fund. Einhorn’s Greenlight Capital fund has returned an average of 19.5 percent since it started in 1996 compared to returns of about 8 percent by the S&P 500. The portfolio of Greenlight Re is managed in a similar way using a long/short strategy. You can follow David Einhorn (Trades, Portfolio)’s long portfolio at GuruFocus. He does not disclose his short positions, although he did recently disclose AthenaHealth (ATHN) as a short position.


Rating: 3.9/5 (8 votes)

Voters:

Comments

mistwraith
Mistwraith - 6 months ago

How do you come up with these figures in the sentences I've underlined and bolded ?

For my valuation, I used the residual income model. Using the ROE chart above, if Greenlight Re breaks even on its underwriting and the investment portfolio returns the historic market average of 10 percent, the ROE comes out to be 13 percent. I used a discount rate of 9 percent taking into account the stock’s beta of 0.79. The resulting value comes out to be $42.24 per share with a margin of safety of 23 percent making the stock undervalued. The stock closed at $32.44 today, June 3, 2014.

Conclusion

chris mydlo
Chris mydlo - 6 months ago

The beta is given at 0.79. The 9% discount was obtained from the CAPM model, 9 = 2.6 + 0.79*8.1 (R = risk free rate + beta * market premium). I used the DCF calculator on the website. I changed earnings to be $1.12 because of the residual income model ((ROE - R)*BV). I used 13 percent for an ROE in normal times. So with the DCF calculator, I imputted earnings as $1.12, discount rate as 9%, and added back tangible book value according to the model.

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