Ticker: GLRE
Sector: Financials
Industry: Reinsurance
Recommendation:
HOLD/ADD
Pricing
Closing Price
52-wk High
52-wk Low
$23.30
(02/12/10)
$23.54
(02/12/10)
$12.22
(02/12/10)
Market Data
Market Cap
$838.35M
Total assets $1.46B
Trading vol
113,000 (3month
avg)
Valuation
EPS (ttm)
P/E (ttm)
Current
Dividend
$3.32
6.95
---
Profitability & Effectiveness
(ytd)
ROA
5.93%
ROE
20.88%
Profit Margin 39.89%
Oper Margin 40.36%
P/Book
1.33
Recommendation: HOLD/ADD
I am recommending a hold/add on Greenlight Reinsurance due to
its stellar recent performance and its positive long term outlook.
However, pricing in the reinsurance industry in the near term has
remained difficult due to the favorable hurricane season and the
recovery in the capital markets that took place in the latter half of
2009. Greenlight’s value should be relatively unaffected due to
the unique nature of how Greenlight RE is structured (it is very
similar to Warren Buffet’s Berkshire Hathaway). Its main
revenue source does not rely from its core insurance business but
from its investment portfolio which is managed by the well known
and respected hedge fund manager—David Einhorn (Greenlight
RE is essentially a publicly traded version of Einhorn’s hedge
fund--Greenlight Capital). The relative weak pricing power that is
projected to persist for the better half of 2010 in the reinsurance
industry should effect its’ value very little. Greenlight RE
primarily relies upon investment income to fuel earnings and
market value growth. Although the float from the reinsurance
premiums Greenlight RE has underwritten has shown strong
growth from ’08 to ’09 (an increase of 88% in net earned
premiums thru the first nine months of ’09 vs. ’08) premiums have
only accounted for about 4% of net income through 3 quarters of
2009.
Greenlight RE is basically a hedge fund on the back end of the
balance sheet utilizing sophisticated investment strategies to
generate superior returns relative to their more conservative
(mainly low yielding fixed income investing) peers within the
reinsurance industry. While the front-end reinsurance side of the
balance sheet is basically breaking even (currently generating little
extra net income) the back end (or investing portfolio) of
Greenlight posted superior returns in the latter half of 2009 fueling
stock price growth possibly foreshadowing good things to come in
Q4 ’09 and 2010. The near term earnings of Greenlight RE will
live and die with the returns produced by its approximate $700
Analyst: Tyler Peglow
million investment portfolio and its sophisticated hedge fund like approach to generating
Email: ktsqmb@mail.missouri.edu
those returns.
Aaron Foster
adfrhc@mail.missouri.edu
1
Company Overview
Greenlight Capital Re, LTD is a Cayman Islands-based specialty property and casualty
reinsurer. The company offers excess loss and quota share products in the property and
casualty market. Within the property and casualty reinsurance segment, underwriting
operations are analyzed using two categories: frequency business, and severity business.
Frequency business is characterized by contracts containing a large number of small
losses stemming from multiple events. Severity business is typically characterized by
contracts with the potential for losses originating from one event or multiple events (think
large infrequent events). The company’s investment portfolio is managed by DME
Advisors, LP. Their assets are managed according to a value-oriented equity-focused
strategy that complements the Company's business goal of long-term growth in book
value per share. (Greenlightre.ky)
Greenlight Capital RE was founded in 2004, and went public in May of 2007 at $19 per
share. David Einhorn (co-founder) manages the company’s investments as chairman of
DME Advisors, LP. Einhorn has had considerable experience and success in the
financial markets has founder of Greenlight Capital RE—a hedge fund based out of New
York. Greenlight Capital RE was founded by Einhorn in 1996 with an initial $1 million
dollar capital raise. Greenlight Capital RE has since grown to over $6 billion in assets
under management in just 14 years as Einhorn significantly outperformed broad market
indices over the time period attracting many large institutional investors to his fund.
While returns suffered in 2008, Greenlight has returned since inception, net of all fees
and expenses, more than 22% compared to the measly 6% return of the S&P 500 over
that same time period. Quite an impressive feat when you factor into the fact that
Einhorn has been investing through two recessions (the 2000 tech bubble and 2008 credit
crisis) which saw broad indices in each bear market fall more than 50%.
Reinsurance Business
Greenlight is focused on bringing a disciplined and differentiated underwriting strategy
that will allow it to mitigate losses and capture steady gains from its reinsurance business.
Greenlight Re offers excess of loss and quota share products in the property and casualty
market, focusing on customized solutions rather than participating in broadly available
opportunities—trying to create small niche opportunities. Their business is mostly
sourced through reinsurance brokers, providing the company with variable-cost global
distribution (commissions are based on gross premiums written).
The company seeks to maximize long-term results rather than manage for interim or
GAAP performance. Management is compensated based on multi-year underwriting
performance rather than premium volume or short-term results which should help smooth
operating earnings over time and help their underwriting strategy stay smart and
conservative (think AIG). Greenlight seeks to act as lead underwriter for most premiums
written as they look to find niche opportunities rather than commodity type deals.
Greenlight also enjoys an excellent credit rating of A- (4th highest of 15 ratings) through
2
A.M. Best--a full-service credit rating organization dedicated to serving the financial
services industries. Such a high credit rating will help to attract more reinsurance
contracts in the future has insurer’s will feel safer trading contracts with such a highly
rated credit worthy institution (again think AIG). The company is also under Cayman
Islands law and as such is not obligated to pay taxes on either income or capital gains.
Greenlight manages the business on the basis of one operating segment, property and
casualty reinsurance, in accordance with the qualitative and quantitative criteria
established by the US GAAP. Within the property and casualty reinsurance segment,
they analyze their underwriting operations using two categories:


Frequency business
o Characterized by large number of small losses
 Less volatile than severity
 Has greater predictability in margins, ROE
Severity business
o Characterized by potential large infrequent losses
 Clients buy protection to remove volatility from B/S
 Results can be volatile from period to period
Details of gross premiums written are provided below:
Frequency
Severity
Total
Three months ended September 30,
Nine months ended September 30,
2009
2008
2009
2008
($ in thousands)
($ in thousands)
$ 62,238
94.3% $ 27,787
73.7% $ 176,084
84.7% $105,432
78.8%
3,745
5.7
9,897
26.3
31,817
15.3
28,378
21.2
$ 65,983 100.0% $ 37,684 100.0% $ 207,901 100.0% $133,810 100.0%
Gross Premium Details:
 Represents a 75% increase year over year for 3Q 2009
 Represents a 55% increase year over year through 3 quarters of 2009
Greenlight is rapidly growing market share in the reinsurance industry.
3
Ratio Analysis:
Due to the opportunistic and customized nature of Greenlight RE’s underwriting
operations, expect different loss and expense ratios in both frequency and severity
businesses from quarter to quarter. The following table provides the ratios for the nine
months ended September 30, 2009 and 2008:
Loss Ratio
Acquisition Cost Ratio
Comp Composite Ratio
Internal Expense Ratio
Composite Ratio
Nine months ended
Nine months ended
September 30, 2009
September 30, 2008
Frequency Severity
Total
Frequency Severity
Total
60.8%
49.0%
58.1%
35.4%
64.3%
44.9%
37.4%
8.0%
30.6%
53.5%
8.8%
38.8%
98.2%
57.0%
88.7%
88.9%
73.1%
83.7%
9.1%
13.8%
97.8%
97.5%
The loss ratio is calculated by dividing loss and loss adjustment expenses
incurred by net premiums earned. We expect that our loss ratio will be volatile for our
severity business and may exceed that of our frequency business in certain periods.
The acquisition cost ratio is calculated by dividing acquisition costs by net
premiums earned. This ratio demonstrates the higher acquisition costs incurred for our
frequency business than for our severity business.
The composite ratio is the ratio of underwriting losses incurred, loss adjustment
expenses and acquisition costs, excluding general and administrative expenses, to net
premiums earned. Similar to the loss ratio, we expect that this ratio will be more volatile
for our severity business depending on loss activity in any particular period.
The internal expense ratio is the ratio of all general and administrative expenses
to net premiums earned. We expect our internal expense ratio to decrease as we continue
to expand our underwriting operations. During the nine months ended September 30,
2009, our net earned premiums increased 88.4% while our general and administrative
expenses increased 24.0% as compared to the corresponding 2008 period, resulting in a
lower internal expense ratio.
The combined ratio is the sum of the composite ratio and the internal expense
ratio. It measures the total profitability of our underwriting operations. This ratio does not
take net investment income or other income into account. The reported combined ratio
for the nine months ended September 30, 2009 was 97.8% compared to 97.5% for the
same period in 2008. Given the nature of our opportunistic underwriting strategy, we
expect that our combined ratio may be volatile from period to period.
4
Outlook and Trends in Reinsurance Business
The rebound of the financial markets in the latter half of 2009 has restored many
insurers’ balance sheets putting downward pressure on reinsurance pricing in the near
term. Underwriting capacity has become more available in the property and casualty
market which has resulted in a delay of expected price increases in various financial
insurance products. In addition, the lack of large catastrophes in 2009 to date has
preserved capital in the property and casualty industry alleviating a lot worries insurers
had in the middle of 2009—this could mean less business for reinsurers in the near term.
Greenlight appears to be well positioned to compete for attractive opportunities as they
continue to grow their market share and create more brand recognition within the
reinsurance industry. In addition there are still market participants who continue to suffer
from capacity issues even after the rebound of the financial markets in the latter half of
2009 creating greater niche opportunities. These opportunities could increase if financial
and credit markets report large losses and the industry keeps consolidating through
mergers and acquisitions decreasing the number of market participants. Greenlight (from
its 3Q ’09 10-Q) believes opportunities are likely to arise in a number of areas, including
the following:



lines of business that experience significant loss experience
lines of business where current market participants are experiencing
financial distress or uncertainty
business that is premium and capital intensive due to regulatory and other
requirements
Has Greenlight continues to grow their brand recognition expect large annual growth
increases in gross premiums underwritten. However, depending upon the accuracy of
Greenlight RE’s underwriting, large growth in premiums underwritten may not increase
net income. Unforeseeable catastrophic events or shoddy underwriting may hamper large
increases in gross premiums underwritten resulting in an unprofitable reinsurance
business making the company’s value that much more reliant on Einhorn and his
investment acumen.
5
Investments
As of September 31st, 2009 Greenlight RE had an investment portfolio with an
approximate market value of $700 million managed by an affiliate of Greenlight RE—
DME Advisors. DME Advisors is a related party and affiliate of David Einhorn,
Chairman of the board of directors and founder of the hedge fund Greenlight Capital.
DME Advisors implements a value-oriented investment strategy by taking long positions
in perceived undervalued securities and short positions in perceived overvalued
securities. DME Advisors aims to achieve high absolute rates of return while minimizing
the risk of capital loss.
Pursuant to the advisory agreement, DME Advisors is allowed performance
compensation equal to 20% of the net income of the Company’s share of the account
managed by DME Advisors, subject to a loss carry forward provision. The loss carry
forward position allows DME Advisors to earn reduced incentive compensation of 10%
on net investment income in any year subsequent to the year in which the investment
account incurs a loss, until all the losses are recouped and an additional amount equal to
150% of the aggregate investment loss is earned.
This is where most all of the value in Greenlight RE is derived. Where most reinsurers
invest a majority of their floats and investment portfolios into low yielding fixed income
safe assets Greenlight RE takes a much different approach. Under Chairman David
Einhorn (who is also head of DME Advisors) Greenlight RE employs a sophisticated
hedge fund type style of investing geared towards generating excess returns and creating
greater value.
In this regard Greenlight RE is very similar to Warren Buffet’s Berkshire Hathaway—
both insurance companies are mere “cover” companies that more or less give investors
access to professional money managers like Buffet and Einhorn without all the rules and
stipulations (minimum amount of capital and lock up of funds for a predetermined
amount of time) of a hedge or private equity fund. Both company’s values rely almost
solely upon the investments made in the financial markets by these two great money
managers and much less on their respective core insurance businesses. This fact makes
Greenlight RE’s operating earnings much more volatile than the industry as a whole.
More than 95% of the net income Greenlight has earned through 3 quarters of 2009 has
been derived from their investment portfolio while the core insurance business has
accounted for less than 5% spanning that same time period. The value of Greenlight RE
lives and dies quarter to quarter with the investment returns generated from Einhorn’s
positions. These positions include:
o
o
o
o
o
o
Long equities
Short equities
Credit default swaps – sells and buys
Interest Rate Options
Distressed debt
Investment grade corporate debt
6
o
o
o
o
Commodity’s
Warrants
Swaps
Futures
Clearly the portfolio of Greenlight RE is managed much more like a hedge fund and
much less like a conservative institution intent on preserving capital (as with most
reinsurers).
Investment Guidelines: (From Greenlight’s 2008 10-K Report)
The investment guidelines adopted by our Board of Directors, which may be amended or modified
from time to time take into account restrictions imposed on us by regulators, our liability mix, requirements
to maintain an appropriate claims paying rating by ratings agencies and requirements of lenders. As of the
date hereof, the investment guidelines currently state:
•
Quality Investments: At least 80% of the assets in the investment portfolio are to be held in
debt or equity securities (including swaps) of publicly-traded companies and governments of
the Organization of Economic Co-operation and Development, or the OECD, high income
countries and cash, cash equivalents or United States government obligations.
•
Concentration of Investments: Other than cash, cash equivalents and United States
government obligations, no single investment in the investment portfolio may constitute more
than 20% of the portfolio. No more than 10% of the assets in the investment portfolio will be
held in private equity securities.
•
Liquidity: Assets will be invested in such fashion that we have a reasonable expectation that
we can meet any of our liabilities as they become due. We periodically review with the
investment advisor the liquidity of the portfolio.
•
Monitoring: We require our 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 us as we 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% net margin leverage for
periods of less than 30 days.
7
DME Advisors Investment portfolio consists of the following: (Source: 2008 10-K)
As of
December 31,
2007
Long %
Short %
Long %
Short %
11.8%
0.0%
0.1%
0.0%
65.8
(39.3)
91.0
(51.7)
1.9
—
1.2
0.0
—
(0.2)
0.7
(7.6)
79.5%
(39.5)%
93.0%
(59.3)%
As of
December 31, 2008
Ot
Debt Securities
Equities & Related Derivatives
Equities - Unlisted
Other Investments
TOTAL
The following table represents the composition of our investment portfolio, by industry sector, based
on the percentage of assets in our investment account managed by DME Advisors as of December 31,
2008:
Sector
Basic Materials
C Consumer Cyclical
Consumer Non-Cyclical
Energy
Fi Financial
Healthcare
InInIndustrial
Technology
Utilities
Total
Capitalization
Large Cap Equity (≥$5 billion)
Mid-Cap Equity (≥$1 billion)
Small Cap Equity (<$1 billion)
Debt Instruments
Other Investments
Total
Long %
Short %
Net %
5.3%
(5.3)%
0.0%
5.5
(5.8)
(0.3)
2.5
(3.4)
(0.9)
6.3
(1.5)
4.8
20.6
(18.4)
2.4
1.9
(2.6)
(0.7)
20.9
(2.5)
18.4
12.6
(0.1)
12.5
3.9
0.0
3.9
79.5%
(39.5)%
40.1%
Long Short Net
%
%
%
16.9 % (22.1 )% (5.1 )%
32.7 (16.2 ) 16.6
16.2 (1.1 ) 15.1
11.8 (0.0 ) 11.6
1.9
(0.2 ) 1.9
79.5 % (39.5 )% 40.1 %
Notes on Financial Positions:



They are short (net) large cap equity
Long small cap equity
Long debt instruments
8
Net Investment Income:
InI
Inter
Gains (losses)
Interest, dividend & other income
Interest
Investment advisor compensation
Net investment income (loss)

Three months
ended
Nine months ended
September 30,
September 30,
($ in thousands)
($ in thousands)
2009
2008
2009
2008
$ 39,648 $(121,075) $ 170,846 $ (89,008)
2,997
4,368
12,725
17,308
(3,570)
(4,611) (11,006) (13,112)
(6,447)
3,509
(23,898) (7,734)
$ 32,628 $(117,809) $ 148,667 $ (92,546)
Nearly all the value Greenlight RE has created in book value this year ($152
million) is directly attributable to their net investment income (Einhorn’s financial
positions).
o This is why I refer to Greenlight RE has:
“A Hedge Fund with an Insurance Business”
Business Performance
Pre-2009
Revenues from net reinsurance premiums earned have increased each of the last 3 years
(2006 they were still private, also 1st year in reinsurance business), from $26.6M in 2006
to $114.9M in 2008. With this, expenses relating to the reinsurance business (namely
underwriting losses) have also increased substantially. Nonetheless, the reinsurance side
has done a very good job of covering their own expenses and earning net positive
incomes. For simplicity’s sake, I chose to expense out General & Administrative
expenses from the reinsurance net premiums earned, and came up with a net loss of
$2.5M for 2006, a net gain of $7.68M for 2007, and a net gain of $4.06M for 2008 (2008
10K). The company, however, does not consider General & Administrative expense as a
part of the reinsurance business, therefore their reported numbers for underwriting
income are much higher than what I just suggested. I included G&A expenses on my
reinsurance income calculation just to show that investment side truly is being operated
free of charge.
The other area of income, investments, is what will ultimately make or break this
company. While money can be made in the reinsurance side, its main purpose is to lay
the table for the investment side. As you will see in a chart below, Greenlight’s Net
Income is almost a direct reflection of their Net Investment Income. The track record
here is a little bit longer, as Einhorn has been investing people’s money since before the
Internet bubble. As has already been mentioned, Einhorn has proven himself to be an
expert at allocating capital. That success, so far, has translated to the reinsurance
company, with the exception of 2008.
9
In 2008, the investment portfolio reported a loss of 17.6% for the year (S&P 500 was
down 37.2%), compared to a gain of 5.9% in 2007. 2006 was a great year for the
portfolio, achieving returns of 24.4% (2008 10K).
The company states their primary financial goal is to increase long-term value in fully
diluted book value per share. In 2008, the fully diluted book value per share decreased
19.2%, following an increase of 16.1% per share in 2007 (2008 10K).
Net Investment Income & Net Income
2008
2007
2006
($ in thousands, except per share and share amounts)
Summary Statement of
Income Data
Gross premiums written
Net premiums earned
Net investment
income (loss)
Loss and loss
adjustment expenses
incurred, net
Acquisition costs, net
General and
administrative expenses
Net income (loss)
$
$
162,395
114,949
$
127,131
98,047
$
74,151
26,605
(126,126)
27,642
58,509
55,485
41,649
39,507
38,939
9,671
10,415
13,756
(120,904 )
11,918
35,325
9,063
56,999
$
$
Fiscal Year 2009
2009, so far, has been an excellent year for the company. The reinsurance business
continues to grow its revenues (although a small % of net income). Through three
quarters, net premiums earned are already nearly 30% above where they were for the
whole year of 2008. With that, underwriting losses have also grown, however net
premiums earned still cover all expenses (including G&A) by over $3.5M. The company
reported underwriting income at $17.2M thus far in 2009, compared to $13.2M at the
same time last year (3Q report).
The investment portfolio has also shown significant gains as the financial markets started
to gain footing in early to mid-year 2009. Greenlight’s investment portfolio has reported
a net gain of $148.7M, or a return of 24.2% (S&P up 18%), for the nine months ended
September 30, 2009. Over the same period last year, the company reported a net
investment loss of $92.5M, or 12.9% (3Q report).
10
During the first nine months of fiscal year 2009, fully diluted book value per share has
increased by $4.07 per share, or 30.0%, to $17.62 per share from the $13.55 per share at
year-end 2008 (3Q report).
Greenlight RE Highlights








David Einhorn is one of the most successful investors of the past decade
Focus on superior returns on both sides of the balance sheet (but we all know
value will mainly come from investments)
Favorable tax treatment due to Cayman Islands location
Disciplined, differentiated underwriting strategy
A- (excellent) financial strength rating from A.M. Best
Little leverage in investment operations
Has a rather large “short” exposure—profiting in down markets
$50 million personal investment by Chairman David Einhorn (owns over 17% of
company—interests aligned with investors
Investment Risks and Concerns





Limited loss experience
Exposure to natural disasters
Needs to maintain letters of credit
Competitive industry
Lack of operating history
11
Conclusion
I am recommending a hold/add on Greenlight Reinsurance. While pricing in the
reinsurance industry is forecasted to remain subdued through the first half of 2010 it
should affect the value of Greenlight RE very little. Greenlight (like Berkshire
Hathaway) relies heavily on their net investment income to drive book value (over 95%
of net income has come from their investment portfolio since Greenlight’s IPO in 2007)
and will continue to do so. Greenlight is structured like a liquid hedge fund utilizing the
skills of the respected and well known hedge fund manager--David Einhorn who has
significantly outperformed the S&P 500 over his investing career.
Secondly, being that the IFM Fund is long only equities, Einhorn could give the fund
some “short” exposure possibly creating greater diversification within the fund and earn
the fund higher risk-adjusted returns. If Einhorn’s history is a good predictor of future
success the IFM Fund can expect to achieve 15-20% annual returns with Greenlight
RE—assuming Einhorn can earn returns with Greenlight RE similar to his historical
returns with his hedge fund Greenlight Capital.
An investment in Greenlight RE is merely an investment in a liquid hedge fund backed
by a manager with an extraordinary historical performance. While Greenlight RE may be
somewhat riskier due to its more volatile revenue structure and lack of operating history
relative to other reinsurers, it has potential to be the next Berkshire Hathaway (albeit a
little bit riskier). Einhorn has beaten the S&P 500 by nearly 15% for the last 14 years—it
is hard to argue with performance.
Sources










10-k report
10-q report
Greenlightre.ky
Scribd.com
Yahoo! Finance
Google Finance
Reuters
S&P Net Advantage
Mergent Online
Bigcharts.com
12