Years ago, a microcap specialty insurance company, Bancinsurance (BCIS, Financial), was involved in a bail bond reinsurance program that caused a 29% loss of shareholder’s equity.
Bancinsurance’s auditors resigned. A.M. Best cut Bancinsurance’s financial strength rating. NASDAQ delisted the stock. And the SEC sent a Wells Notice telling Bancinsurance the SEC was investigating the company's executives.
At this time – 2005 – I began following the stock. On February 3rd, 2010, the SEC told Bancinsurance it was not going to act against the executives. I decided to buy Bancinsurance stock.
I started selling other stocks I owned to round up cash. In March, Bancinsurance’s bid and ask prices were below $5. I started buying at $4.75.
On March 23, 2010, the Bancinsurance board announced the CEO – who owned 74.17% of all Bancinsurance shares – was offering to buy out other shareholders at $6 a share. I bid for all stock at or below $6 a share throughout this period. I probably accounted for the majority of Bancinsurance’s trading volume from this point on.
On April 7th, 2010, I sent a letter to Bancinsurance’s board of directors.
Geoff Gannon
April 7, 2010
Board of Directors
Bancinsurance Corporation
Gentlemen:
I am writing to you about the $6.00 per share proposal Mr. Sokol made to you on March 22nd.
Offer
Mr. Sokol is offering $6.00 in cash for each share of Bancinsurance he does not already own. In exchange for this $6.00 in cash shareholders are being asked to give up $8.52 in tangible book value, $1.22 in pre-tax earnings, and $0.97 in after-tax earnings.
I do not know of any acquisitions of adequately capitalized property/casualty companies with underwriting histories like Bancinsurance’s done at multiples this low.
Bancinsurance has operated at a combined ratio below 100 in 25 of the last 28 years. The company failed to earn an underwriting profit in 1982, 1995, and 2004. In all other years – 89% of the time – Bancinsurance earned a profit for its shareholders before including any of its investment income.
Here is Bancinsurance’s underwriting history:
It is a truism among investors that an insurance company that averages a combined ratio under 100 for a full cycle is worth more than tangible equity, because its cost of production is less than zero. Policyholders pay Bancinsurance to hold their cash. The company invests this negative interest loan in tax-exempt municipal bonds. It is a wonderful business. And it is worth more than book value.
Underwriting
From 2000-2009, Bancinsurance averaged a combined ratio of 96. This 10-year average includes (presumably non-recurring) losses from the discontinued bond program. Last year, Bancinsurance wrote net premiums of $7.96 per share. If the company maintains this same level of premiums and matches its underwriting performance of the last 10 years, it will earn an underwriting profit of $0.32 per share. If Bancinsurance matches its underwriting performance of the last 5 years, it will earn an underwriting profit of $0.47 per share.
Investments
At the end of last year, Bancinsurace had $17 per share in investments and $1.83 per share in cash. From 1995-2009, the company’s investments averaged 1.65 times its earned premiums. Net interest income divided by total investments averaged 0.67 times AAA corporate bond yields. Even if one assumes investments will fall from their current level of $17 a share to $13.14 a share – bringing investments in line with Bancinsurance’s historical ratio of investments to premiums – and one assumes yields on the company’s municipal bonds will fall to two-thirds of AAA corporate yields, Bancinsurance would still earn investment income of $0.47 per share.
Intrinsic Value
If the future unfolds along the tepid lines outlined above, Bancinsurance would earn between $0.79 a share and $0.94 a share in annual pre-tax profits. Even if one assumes this income is taxed at rates equal to other corporations (which is unlikely since 83% of the company’s investments are in tax-exempt municipal bonds), Bancinsurance is worth between $7.90 a share and $9.40 a share.
Book Value
Reasonable people can disagree about Bancinsurance’s intrinsic value. Reasonable people can not disagree about Bancinsurance’s book value. At the end of last year, it was $8.52 a share. I think Bancinsurance is worth more than tangible book value because the company has:
· A long history of above-average underwriting profits
· A long history of above-average book value per share growth
· Long-term customer relationships
· And a book of business focused on special products
But I could be wrong.
Therefore, it is reasonable to argue Bancinsurance’s minority owners are not entitled to a premium over the tangible book value of their investments. However, it is not reasonable to argue that Bancinsurance’s majority owner is entitled to buy out his fellow shareholders at a discount to the tangible book value of their investments.
Market Price
In his letter to the board, Mr. Sokol wrote that the $6.00 per share cash offer represented a 20% premium over Bancinsurance’s closing market price. That is true. However, as you know, the market price of Bancinsurance common stock has been unduly depressed since the company’s problem with its bail bond reinsurance program.
This is more than a case of irrational pessimism. The February 2005 letter from Ernst & Young set off a chain of events that decimated investor demand for Bancinsurance stock.
· Ernst & Young withdrew as the company’s independent auditor
· NASDAQ delisted the company’s stock
· The SEC began a formal investigation of Bancinsurance
· A.M. Best cut the company’s financial strength rating from A to B++ with a negative ratings watch
· Bancinsurance stopped sending regular reports to the SEC
· And the company’s stock dropped below $5 a share
Some of these problems have been fixed. Others have not. But these events did – and in some cases, continue to do – enormous harm to investor demand for Bancinsurance’s stock. Bad news always hurts a stock. This was more than that.
For example, many investors do not buy over-the-counter stocks. When NASDAQ delisted Bancinsurance’s stock, those potential investors were lost. Likewise, many investors do not invest in companies that are not current in their SEC filings. Bancinsurance has only fixed one of these problems. The stock still isn’t listed on a major exchange.
The combination of being traded over the counter and (until recently) having a market price under $5 puts a heavy cost burden on investors. Broker commissions are higher on OTC stocks. Commissions on low priced stocks are higher (in percentage terms) than commissions on high priced stocks. Some brokers do not accept stocks priced under $5 as collateral. And many firms have automated systems that make their brokers jump through more hoops to place a trade for any stock under $5.
For these reasons, the market price of Bancinsurance stock is not a good gauge of the company’s value. The stock is neither liquid nor listed. Therefore, the board’s own judgment of Bancinsurance’s value is needed.
Legal Risks
Selling the company to its majority owner at a price less than tangible book value will be seen by some – myself included – as unreasonable and egregious. There is not enough precedent within the industry for a transaction at multiples like those Mr. Sokol is proposing.
Because Bancinsurance stock is unlisted, illiquid, and has a majority owner, a court is unlikely to give the market price the weight it normally would. Other standards of value are more likely to be used.
An adverse judgment in a shareholder suit would result in millions of dollars of damages.
Alternatives
The Sokol family’s decades of stewardship made Bancinsurance what it is today. Mr. Sokol is the best manager Bancinsurance could have. He may also be the best owner. Going private will free Bancinsurance from the costs of being a public company. It will also free the company’s executives from the headaches that come from reporting to the SEC and dealing with outside shareholders.
There is nothing wrong with this transaction other than the price. If Mr. Sokol’s offer was increased to a cash payment equal to the tangible book value per share, it would be acceptable.
Because the investor group controls the vast majority (74.17%) of Bancinsurance’s common stock, raising the cash offer to tangible book value would be easy. The group is only seeking to buy around 1.345 million shares. I do not know how the company’s balance sheet has changed since December, but I believe raising the offer to tangible book value would require only $3 million to $4 million of additional cash.
I think a price equal to Bancinsurance’s per share tangible book value would be fair to both the buyers and sellers. There are at least 3 ways to structure such a transaction. I hope the board will consider them:
1. The investor group could raise additional cash themselves and increase their per share offer to $8.52 a share – or, more accurately, whatever the tangible book value per share is today
2. If the buyers do not have access to enough capital to close the deal at tangible book value, the board could agree to a two-step transaction in which a cash dividend – similar to the one the board declared last year – would be paid to all shareholders, thereby providing the buyers with cash while simultaneously lowering the tangible book value of the company’s shares. This would allow the deal to be closed at tangible book value albeit in a tax inefficient way.
3. Instead of getting cash, the minority shareholders could receive rights under terms like: “At time of transaction, each share of Bancinsurance common stock not held by the investor group will convert into right to receive cash equal to tangible book value per share plus interest. Interest will compound daily at Moody’s AAA corporate bond yield. Payment is due 3 years from time of transaction.”
There are other ways to structure a deal at tangible book value that would neither burden the investor group with raising the additional cash on its own nor risk Ohio Indemnity’s financial strength rating. I would be happy to discuss them with you.
I know receiving a letter like this is not an enjoyable experience. And I sympathize with the position this letter puts you in. I would not have written it if the problem was not as serious and clear cut as I present it to be.
Thank you for your time.
Sincerely,
Geoff Gannon
Bancinsurance’s auditors resigned. A.M. Best cut Bancinsurance’s financial strength rating. NASDAQ delisted the stock. And the SEC sent a Wells Notice telling Bancinsurance the SEC was investigating the company's executives.
At this time – 2005 – I began following the stock. On February 3rd, 2010, the SEC told Bancinsurance it was not going to act against the executives. I decided to buy Bancinsurance stock.
I started selling other stocks I owned to round up cash. In March, Bancinsurance’s bid and ask prices were below $5. I started buying at $4.75.
On March 23, 2010, the Bancinsurance board announced the CEO – who owned 74.17% of all Bancinsurance shares – was offering to buy out other shareholders at $6 a share. I bid for all stock at or below $6 a share throughout this period. I probably accounted for the majority of Bancinsurance’s trading volume from this point on.
On April 7th, 2010, I sent a letter to Bancinsurance’s board of directors.
Geoff Gannon
April 7, 2010
Board of Directors
Bancinsurance Corporation
Gentlemen:
I am writing to you about the $6.00 per share proposal Mr. Sokol made to you on March 22nd.
Offer
Mr. Sokol is offering $6.00 in cash for each share of Bancinsurance he does not already own. In exchange for this $6.00 in cash shareholders are being asked to give up $8.52 in tangible book value, $1.22 in pre-tax earnings, and $0.97 in after-tax earnings.
| Mr. Sokol’s Offer | |
| Tangible Book Value | 0.70x |
| Pre-Tax Earnings | 4.92x |
| After-Tax Earnings | 6.19x |
Bancinsurance has operated at a combined ratio below 100 in 25 of the last 28 years. The company failed to earn an underwriting profit in 1982, 1995, and 2004. In all other years – 89% of the time – Bancinsurance earned a profit for its shareholders before including any of its investment income.
Here is Bancinsurance’s underwriting history:
| Bancinsurance | Industry | |
| 1991 | 72.2 | 107.5 |
| 1992 | 67.7 | 114.7 |
| 1993 | 80.6 | 105.8 |
| 1994 | 95.7 | 107.1 |
| 1995 | 113.3 | 105.2 |
| 1996 | 83.7 | 104.7 |
| 1997 | 76.3 | 99.9 |
| 1998 | 80.5 | 103.5 |
| 1999 | 86.4 | 106.7 |
| 2000 | 88.8 | 108.9 |
| 2001 | 87.3 | 114.9 |
| 2002 | 93.9 | 106.6 |
| 2003 | 92.3 | 99.7 |
| 2004 | 128.5 | 97.6 |
| 2005 | 96.7 | 100.7 |
| 2006 | 96.5 | 91.5 |
| 2007 | 89.0 | 94.8 |
| 2008 | 97.5 | 104.1 |
| 2009 | 90.8 | 100.0 |
| Median | 89.0 | 104.7 |
| Mean | 90.4 | 103.9 |
Underwriting
From 2000-2009, Bancinsurance averaged a combined ratio of 96. This 10-year average includes (presumably non-recurring) losses from the discontinued bond program. Last year, Bancinsurance wrote net premiums of $7.96 per share. If the company maintains this same level of premiums and matches its underwriting performance of the last 10 years, it will earn an underwriting profit of $0.32 per share. If Bancinsurance matches its underwriting performance of the last 5 years, it will earn an underwriting profit of $0.47 per share.
Investments
At the end of last year, Bancinsurace had $17 per share in investments and $1.83 per share in cash. From 1995-2009, the company’s investments averaged 1.65 times its earned premiums. Net interest income divided by total investments averaged 0.67 times AAA corporate bond yields. Even if one assumes investments will fall from their current level of $17 a share to $13.14 a share – bringing investments in line with Bancinsurance’s historical ratio of investments to premiums – and one assumes yields on the company’s municipal bonds will fall to two-thirds of AAA corporate yields, Bancinsurance would still earn investment income of $0.47 per share.
Intrinsic Value
If the future unfolds along the tepid lines outlined above, Bancinsurance would earn between $0.79 a share and $0.94 a share in annual pre-tax profits. Even if one assumes this income is taxed at rates equal to other corporations (which is unlikely since 83% of the company’s investments are in tax-exempt municipal bonds), Bancinsurance is worth between $7.90 a share and $9.40 a share.
Book Value
Reasonable people can disagree about Bancinsurance’s intrinsic value. Reasonable people can not disagree about Bancinsurance’s book value. At the end of last year, it was $8.52 a share. I think Bancinsurance is worth more than tangible book value because the company has:
· A long history of above-average underwriting profits
· A long history of above-average book value per share growth
· Long-term customer relationships
· And a book of business focused on special products
But I could be wrong.
Therefore, it is reasonable to argue Bancinsurance’s minority owners are not entitled to a premium over the tangible book value of their investments. However, it is not reasonable to argue that Bancinsurance’s majority owner is entitled to buy out his fellow shareholders at a discount to the tangible book value of their investments.
Market Price
In his letter to the board, Mr. Sokol wrote that the $6.00 per share cash offer represented a 20% premium over Bancinsurance’s closing market price. That is true. However, as you know, the market price of Bancinsurance common stock has been unduly depressed since the company’s problem with its bail bond reinsurance program.
This is more than a case of irrational pessimism. The February 2005 letter from Ernst & Young set off a chain of events that decimated investor demand for Bancinsurance stock.
· Ernst & Young withdrew as the company’s independent auditor
· NASDAQ delisted the company’s stock
· The SEC began a formal investigation of Bancinsurance
· A.M. Best cut the company’s financial strength rating from A to B++ with a negative ratings watch
· Bancinsurance stopped sending regular reports to the SEC
· And the company’s stock dropped below $5 a share
Some of these problems have been fixed. Others have not. But these events did – and in some cases, continue to do – enormous harm to investor demand for Bancinsurance’s stock. Bad news always hurts a stock. This was more than that.
For example, many investors do not buy over-the-counter stocks. When NASDAQ delisted Bancinsurance’s stock, those potential investors were lost. Likewise, many investors do not invest in companies that are not current in their SEC filings. Bancinsurance has only fixed one of these problems. The stock still isn’t listed on a major exchange.
The combination of being traded over the counter and (until recently) having a market price under $5 puts a heavy cost burden on investors. Broker commissions are higher on OTC stocks. Commissions on low priced stocks are higher (in percentage terms) than commissions on high priced stocks. Some brokers do not accept stocks priced under $5 as collateral. And many firms have automated systems that make their brokers jump through more hoops to place a trade for any stock under $5.
For these reasons, the market price of Bancinsurance stock is not a good gauge of the company’s value. The stock is neither liquid nor listed. Therefore, the board’s own judgment of Bancinsurance’s value is needed.
Legal Risks
Selling the company to its majority owner at a price less than tangible book value will be seen by some – myself included – as unreasonable and egregious. There is not enough precedent within the industry for a transaction at multiples like those Mr. Sokol is proposing.
Because Bancinsurance stock is unlisted, illiquid, and has a majority owner, a court is unlikely to give the market price the weight it normally would. Other standards of value are more likely to be used.
An adverse judgment in a shareholder suit would result in millions of dollars of damages.
Alternatives
The Sokol family’s decades of stewardship made Bancinsurance what it is today. Mr. Sokol is the best manager Bancinsurance could have. He may also be the best owner. Going private will free Bancinsurance from the costs of being a public company. It will also free the company’s executives from the headaches that come from reporting to the SEC and dealing with outside shareholders.
There is nothing wrong with this transaction other than the price. If Mr. Sokol’s offer was increased to a cash payment equal to the tangible book value per share, it would be acceptable.
Because the investor group controls the vast majority (74.17%) of Bancinsurance’s common stock, raising the cash offer to tangible book value would be easy. The group is only seeking to buy around 1.345 million shares. I do not know how the company’s balance sheet has changed since December, but I believe raising the offer to tangible book value would require only $3 million to $4 million of additional cash.
I think a price equal to Bancinsurance’s per share tangible book value would be fair to both the buyers and sellers. There are at least 3 ways to structure such a transaction. I hope the board will consider them:
1. The investor group could raise additional cash themselves and increase their per share offer to $8.52 a share – or, more accurately, whatever the tangible book value per share is today
2. If the buyers do not have access to enough capital to close the deal at tangible book value, the board could agree to a two-step transaction in which a cash dividend – similar to the one the board declared last year – would be paid to all shareholders, thereby providing the buyers with cash while simultaneously lowering the tangible book value of the company’s shares. This would allow the deal to be closed at tangible book value albeit in a tax inefficient way.
3. Instead of getting cash, the minority shareholders could receive rights under terms like: “At time of transaction, each share of Bancinsurance common stock not held by the investor group will convert into right to receive cash equal to tangible book value per share plus interest. Interest will compound daily at Moody’s AAA corporate bond yield. Payment is due 3 years from time of transaction.”
There are other ways to structure a deal at tangible book value that would neither burden the investor group with raising the additional cash on its own nor risk Ohio Indemnity’s financial strength rating. I would be happy to discuss them with you.
I know receiving a letter like this is not an enjoyable experience. And I sympathize with the position this letter puts you in. I would not have written it if the problem was not as serious and clear cut as I present it to be.
Thank you for your time.
Sincerely,
Geoff Gannon
