In my last article I said that financial insurers could very well be the subject for another piece, always about financial conundrums. In fact, the conundrum here is very well explained by the unfair behaviour of some folks who were shorting those securities, helped by the usual behaviour of mainstream media (a megaphone for the strongest screaming at any given time).
Since then however there have been some very good pieces, which have done a very good job restoring the truth and exposing the bad faith of some market actors and the lunacy of the rest. As I could not do better and as I hate to waste words (there are already tons of vain words in every field of our life), I refer to them.
I’ll limit myself to add a different perspective to point the compelling opportunity to pick these businesses at their current price, resorting again to plain, cool, cold numbers. These companies (MBI, ABK, RDN) have been producing free cash in past years as they were the US Federal Reserve. In the past ten years to 2007 RDN has delivered 4.575 $ of average annual FCF to shareholders, MBI has minted cash at 5.39 $ rate average every year and ABK has done even better: 7.154 $ every year on average, a figure equaling almost two times its current stock price. In 2007 fiscal year RDN has cashed 3.71 $ per share, MBI 8.09 $ and ABK 9.3 $. Impressing, isn’t it?
Sure, I know your objection: those were just the good old times, the party’s over now, you can forget about that free cash. Well, in fact ABK and MBI have delivered free cash even in the first half of this year, 0.4 $ and 1.84 $ respectively; just RDN has burned 2.3 $ of cash in that period. Not the end of the world, admittedly. Of course, in the years coming it could be very well possible that they will lose cash, but I don’t think these (eventual) cash loss will be of the magnitude necessary to justify their current stock price; in fact, a strong case could be made that actual defaults on the securities they insure will be much less than everybody seems to assume now; moreover, the actual defaults will be paid over a long period.
You see, it’s not only a free cash case here. Apart from book value (6.76 $ for ABK, 16.67 $ for MBI and 30.54 $ for RDN, but you should adjust here and the numbers will be much better), and even considering a mere run-off scenery, for every share you buy of ABK you get 59.76 $ of investments pool, 81.26 $ per share if you buy RDN and a whopping 159.64 $ per share if you choose MBI. A very conservative 4% annual return on those investments would mean 2.39 $ per share for ABK, 3.25 $ for RDN and 6.38 $ for MBI, every year. Again, I invite you to check their current stock price one more time.
In short, my friends, here you have the opportunity to make a bet risking 1 to get 4-5 times what you risk, and with very good probabilities on your side, better than 75% in my humble opinion. No bookmaker would give you such a deal but Mr. Market, with its schizophrenic problems. In fact, it’s possible to build a scheme to limit your loss to a 25-30% of that 1 if things will develop for the worst. I’m working over this, there are other stocks in different sectors which present the same opportunity, and I hope to present a concrete action to subscribers in a few weeks.
You can play it even more safely, with Old Republic (ORI). This insurance company is not a pure player, just a part of its business is about financial insurance, so it offers a cushion and a good discount at the same time. It’s a cash machine as almost every insurance company: 2.73 $ average annual free cash flow in the last ten years to 2007, 3.68 $ in 2007 and 1.43 $ in the first half of 2008. You can buy a share for a little more than 10 $ today and get 17.59 $ of (not adjusted) book value and 37.67 $ of investments pool. It yields just shy of 7% and it’s been around since a century; my guess is it will still be around a long time from now.
P.S. – To address current and future financials crisis a very good start would be to dismantle rating agencies and their hateful, nefarious legal monopoly. They are really a joke!
Disclosure – no personal position (yet), RDN and ORI are picks of my model portfolios.