Summary

1347 Property Insurance Holdings (ticker: PIH) is a recent P&C insurance IPO that (for now) insures underserved homeowners in Louisiana.  It trades at 1.1x December's tangible book value, which seems too cheap compared to its closest peers (FNHC @ 2x TBV)⁽¹⁾ and given its growth runway.  The pace at which new policies are being underwritten and the absence of catastrophes suggest meaningful book value accretion between December 2013 and March 2014.  At $8, I think PIH probably trades below the book value it will show by 2Q and meaningful incentives are in place to drive the stock price higher over the next six months. 

IPO

Yesterday, PIH raised $13mn in net proceeds from issuing 1.89mn shares at $8.  The original IPO range of $10-$12 (1.2x TBV) was cut down to $8 last week, while the number of shares offered was cut from 2.27mn to 1.63mn, but then upp’ed to 1.89mn.  Prior to that, the Company was sitting on around $8mn in equity, against which it wrote $16mn in premiums.  The Company expects to use $5mn of the net proceeds to further capitalize its Louisiana entity (for offensive, not defensive, reasons), $2mn for GCP and the balance to pursue underwriting opportunities in other states, either organically or through acquisition.  Florida, Texas and Hawaii, in particular, are near-to-medium term priorities.  Seeding an offshore captive reinsurance vehicle is another possibility, though I believe this is much further down the priority list.

Immediately following the IPO, Kingsway will own 28% of PIH (activist investor Joseph Stilwell will indirectly own 6% through his 20% ownership of KFS).  Fund Management Group (FMG), run by Gordon Pratt, will own 17.5% of the shares.⁽²⁾  There is a 6-month lock-up.

Company history and management

1347 was incorporated under Kingsway Financial in October 2012 to underwrite coastal exposure in Louisiana that national carriers have been loath to assume given their loss experiences following severe cats this decade.  PIH underwrites on both a voluntary basis (5,500 policies; 48% of total policies in-force) and through Citizens' take-out program (6,000 policies; 52%).⁽³⁾  PIH's take-out policies insure solely wind and hail exposure.  Of the voluntary policies, 65% are home-owner multi-peril and another 33% are manufactured home.  I believe that the Citizen’s ponds in Florida and Louisiana have been largely fished and that PIH’s future focus will be on expanding its voluntary book.

While PIH was incorporated only recently, this company's formation was a long time coming.  Larry Swets, the Kingsway CEO that Joseph Stilwell installed in 2010, interviewed current PIH CEO Doug Raucy, who had spent 20 years at Allstate, for the CEO job at United Insurance Holdings (UIHC) in 2007.⁽⁴⁾  Doug ultimately didn't get the job, but he and Larry stayed in touch during the years that followed.  Doug went on to found Prepared Insurance in 2008 to focus on take-outs and voluntary business in Florida, but left several years later over disagreements with the Board (Doug wanted to expand the business, the Board did not).  Raucy then moved on to his second act, founding Access Home Insurance in 2011 to focus on take-outs in Louisiana, but was lured away by Larry Swets a year later.⁽⁵⁾  Larry had plans to start an insurer focused on assuming niche property risk in Louisiana and beyond, and 1347 Property Insurance Holdings was born in October 2012, just in time to participate in the state's December 2012 Citizens' depopulation.  Gordon Pratt and Larry Swets are both Board Members, with Gordon serving as Chairman.  

I think that we have a balanced team running the show.  Doug Raucy, age 57, sees PIH as his final hurrah.  While certainly "growth" oriented, he seems sensible about taking well-priced, opportunistic risk rather than growing for market share's sake.  Personally, he strikes me as a direct, matter-of-fact guy who isn't shy about admitting what he doesn't know.  John Hill, CFO, seems more mellow in comparison, more of an "in-the-weeds" guy (as you would expect from a CFO) and reasonably disciplined when it comes to capital allocation (to paraphrase, "I don't know why I would pay more than a 1-to-1 multiple on book value for an acquisition when I could just build organically in 6 to 9 months").  Larry Swets, despite his role as an operator at Kingsway, seems like an investor at heart.  Joseph Stilwell, with whom I have not spoken or met, appears to have a decent track record with financial company investments (Kingsway aside) and has meaningful indirect exposure to PIH.  Given the enthusiastic tone of my conversations and the attractive valuation, I wouldn’t be surprised see insider participation in the IPO.  I believe Doug and Larry are sincere in their long-term commitment to building this business.

Incentives

Concurrent with the new deal price of $8, the following language was added to the updated prospectus:

"On March 26, 2014, we entered into a Performance Share Grant Agreement with KAI, a wholly-owned subsidiary of KFSI, whereby we agreed that, beginning on the date that is six months following the completion of this Offering, KAI will be entitled to receive up to an aggregate of 375,000 shares of our common stock upon achievement of certain milestones for our stock price. Pursuant to the terms of the Performance Share Grant Agreement, if at any time the last sales price of our common stock equals or exceeds: (i) $12.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, KAI will receive 125,000 shares of our common stock; (ii) $15.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, KAI will receive 125,000 shares of our common stock (in addition to the 125,000 shares of our common stock earned pursuant to clause (i) herein); and (iii) $18.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, KAI will receive 125,000 shares of our common stock (in addition to the 250,000 shares of our common stock earned pursuant to clauses (i) and (ii) herein). The shares of common stock granted to KAI will have a valuation equal to the last sales price of our common stock on the day prior to such grant. For a complete description of the terms of this transaction, please refer to the Performance Share Grant Agreement between the company and KAI, which is filed as an exhibit to the Registration Statement of which this prospectus forms a part."

This is no small change for Kingsway….it would increase their ownership by 37.5% (they own 1mn shares already) and its aggregate ownership, if successful, could be worth close to $25mn (these incentive shares would be worth ~$6.8mn), which is significant as a % of Kingsway’s current market cap of $67mn.  

Valuation

Earnings/book value estimates are always imprecise, but the variance of outcomes for something like this (undiversified LA-coastal cat risk and no operating history) is so wide that only a fool would try.  So, here I go:

I believe the 2013 income statement meaningfully understates the Company’s run-rate earnings power, because a huge book of business didn’t appear on the balance sheet until December 2013.  The December 2013 take-outs represent ~31% of PIH’s total policies, yet only 1 month (at most) of these premiums have been “earned” in the trailing numbers.  This under-statement is reflected in the disparity between net premiums written in 2013 of $12.8mn and net premiums earned of just $5mn.  As these unearned premiums bleed into the income statement, we should get a truer reflection of the earnings power of policies booked through December.    

Assuming we’re good on cats through June (storm season really starts in August), me thinks we’re at low 8’s (~$8.10-$8.15) in BVPS by 2Q. 

On a more steady-state basis, it seems reasonable to me that by employing disciplined underwriting practices in niche markets that have been neglected by the majors, the Company should earn low to mid-teens on deployed capital.  Federated National Holding earns a 14.6% trailing ROE and trades at 2.0x TBV, which, at a similar valuation, gets us close to $15-$16 bucks a share for PIH.

Of the $11mn in net proceeds available for deployment ($13mn less $2mn inter-company payable to KFS), I think the $5mn that will be contributed to its LA sub can be leveraged rather quickly.  Absent an attractive acquisition, I would guess that the remaining $6mn will take a year or so to put to full use.

Risks

While somewhat mitigated through reinsurance, the obvious near-term risk is a major catastrophe hits Louisiana this storm season.  It will take some time for PIH to put this new capital to work in Florida and Texas, which means we have largely un-diversified cat risk in Louisiana and will be holding our collective breath this hurricane season.

The long-term risk is that Doug, et al turn out to be aggressive empire-builders who underwrite sloppily and blow a massive hole in the balance sheet several years out.

Footnotes

(1) 93% of Federated’s premiums come from insuring homeowners in FL and LA.  For what it’s worth, insurance executives I’ve spoken with think very highly of Michael Braun

(2) Assumes full warrant exercise.  In January 2014, FMG invested $2mn in PIH through Preferred shares that converted into common shares and warrants, concurrent with the IPO

(3) By "voluntary", I mean business sourced the traditional way, through agents and from national insurers.  Citizens is a state-created non-profit insurer of last resort that assumes certain catastrophe risk that large national insurance companies have been less willing to underwrite following a period of intense hurricane activity 10+ years ago.   About 6 years ago, Louisiana initiated a "de-population" (or "take-out") program to reduce the number of policies on its books.  Every year, state-approved insurers have the opportunity to assume policies written by Citizens.  Florida Citizens has a similar program

(4) United was formed through a merger with FMG Acquistion Corp., a blank check company with Gordon Pratt as Chairman, President and CEO and Larry Swets as CFO

(5) It is worth nothing that both Prepared Insurance and Access are still around.  Prepared has stayed true to its word of staying small and has shrunk its book over the last three years