Thursday, November 29, 2007

Enstar Group’s inflated premium - ESGR

Enstar Group (ESGR) was created in 2001 and is in the business of acquiring and managing insurance and reinsurance companies in run-off. This has been very profitable for Enstar as Enstar has been successful in re-negotiating insurance claims at a point below their reserve level. This has increased Enstar’s book value or net worth at a decent clip.

Since 2001 Enstar has grown its book value per share/ net asset value (generally the best way of valuing an insurance company) from around $17 per share in 2001 to $34 as of September 2007.

Sometimes even good businesses get too expensive and Enstar is too expensive. Its shares trade for $114 which is over 3.3x its book value. Interestingly its price to book value has expanded from 0.9 in 2000 to 3.3 today. During this time its book value has doubled.

Whilst famous investors like Warren Buffett made their fortunes investing in insurance holding companies , no-one has ever made their fortune buying insurance companies for over 3x book (more likely smart investors would only be interested in paying around book value or modest premium to book value depending on the quality of the business).

In fact Enstar trades at a significant premium to all of its peers. Even if you take the view, well Enstar is a far superior company, you could respond by saying the same was said about AIG back in 2000 before reality set in and the rule of numbers took their toll.

By my calculation it will take Enstar over 8 years of consistently growing its net book value (currently $416 billion) at 15% (its historical average) to reach its current market valuation of over $1.3 billion and this means also making consistently profitable acquisitions. That’s a high threshold for any company to meet without a hiccup. Its also a long time to wait for the price you pay to match the underlying net asset value of the insurance business.

Furthermore Enstar has only been tested over a 6 year time frame, that’s not very long. Other insurance companies with excellent track records and stronger paper trails over 20 years such as Markel Corp trade for a more modest price to book ratio of 1.8.

It could be argued Enstar is more of a private equity vehicle than an insurer and part of the premium on Enstar’s stock is no doubt attached to Christopher Flowers involvement.

Flowers is a billionaire and has proven himself as a successful investor. I’m not disputing that fact. I am simply making a point that when you risk your capital you expect to be compensated for that risk and at its current price , even with the potential for private equity deals, Enstar is priced for perfection!

In conclusion, if investing is like playing cards you bet heavily when you have a strong hand not when you have a weak or ordinary hand. Buying Enstar at the current price is the same as betting heavily when you have a weak hand. The probability or odds of being very successful are low and odds of a poor outcome are high.

Disclosure: No position in Enstar ESGR, shares held in Markel MKL

No comments: