Beautifully put, Tiger2three.One look at the 2007 Annual Report...

Beautifully put, Tiger2three.

One look at the 2007 Annual Report (Note 33, page 71, AR2007) shows that CIX had a very good structure to their investments heading into the start of 2008. Credit, for example, was simple structured debt securities all with investment grade (refer table at top of page 71). Previous holdings of structured securities (refer early 2007 statements by the company) were unwound prior to the credit markets unravelling in mid 2007, with debt investments being "simplifield" well prior to any credit market damage being felt. On its own, pure brilliance.

Calliden's Full Year Results Briefing (21/2/08) also highlighed the shortening of equity exposures during 2007 from 11.1% to 5.3% [of total investments], which was "underweight" when compared to other listed insurers. They probably took some flak for this move, yet persisted in de-riskinig their investment portfolio in Q1 2008, ridding themselves of all equity risks when the ASX200 was 20% higher than where it is now. At the time I am sure a few people screamed "time in the market, not timing of the market" (an old insurance investment credo) however in this case, yet again, Kirk and the lads appear to have nailed it. Find another insurer out there who did: is that silence I hear?!

If you look back at the AUGIL acquisition annoucements it appears as though CIX payed $62.5 million for the deal, made up of debt, equity (scrip), and liquidation of existing [debt] investments. Back then Kirk stated that the deal was worth "between $7.5 and $8.5 million in our hands" (simple maths makes this a 8.6% to 13.6% ROE). Remember, however, that this purchase has allowed CIX to consolidate its APRA licences and free up regulatory capital which can now be deployed into additional insurance assets: in other words, the deal allowed CIX to leverage their capital better. Annoucements early this year already showed an APRA MCR well above market norms, and with this additional leveraging (through consolidation of APRA capital bases) I would imagine the new "combined" MCR is now even higher.

Two things spring from all this.

1. The business was already approaching break-even just prior to the AUGIL purchase. With AUGIL on board, combined with other purchased assets, it is conceivable that CIX's "normalised" profit for 2008 will be something near that $7.5 million mark (take off a bit for the equities realisation in Q1, but add a bit back on reinsurance savings and actuarial releases). Any dividend paid (from current profits) will be fully franked (refer their previous statements / comments re franking credits) and they will therefore be under a large amount of pressure from shareholders to commence dividend payments (hence your reference to Ben Graham Tiger2three, I presume?); and

2. The freeing up of APRA [regulatory] capital from the licence colsolidation allows CIX to either (a) pay down debt used to purchase AUGIL, (b) acquire further insurance assets at a time when they are now in an under-priced phase, or (c) return capital to shareholders. Any of these would be beneficial to shareholders, as (a) reduction of debt increases S&P's medium-term ratings view of CIX (presuming they have ambitions in that arena[?]), (b) we are now in a period when the PE ratios of insurance books are at an extreme low, versus, for instance, the time when PE's were at 16-to-1 [such was the ratio used when OAMPS was purchased by Wesfarmers], and (c) capital returned to shareholders would improve the longer-term ROE of the company. Not matter which way you look at it, a good quandry for Kirk to have.

I, for one, remain perplexed as to why CIX is trading at 35 cents. Aside from the above comments, a market cap of around $81 million against an equity base of $95 million (ish) doesn't make sense, and just tells us that the market is actually cropping the value of intangibles. In reality, however, the value of these intangibles have probably increased (since they were purchased) due to the nature of the insurance purchased and the synergies that have been obtained on a group-consolidated basis. Perhaps a realistic view of the equity base is that it should actually be well north of $100 million.

This discount also fails to recognise the value of the insurance business itself. The sectorial nature of CIX's business (i.e. the ability to cherry pick) has protected CIX from the broader softening of rates, whilst at the same time allowed CIX to build market share in smaller niches where it can actually compete - if not on price, then certainly on responsiveness and product (something small companies should do well at - ref Porter et al). If you took a slide rule to the insurance business (say, calling value equalling one-times GWP) the actually value of the business is several multiples away from where it is now.

I personally have marked CIX down for a significant re-rating over the next 12 months. Recognition of a quality book, quality management, and good quality, selected niche markets will soon pop-up on the radar of "professional" analysts and CIX's PE will start to creep up from its current level of around 9.8-to-1 (expected 2008 - thumbnail dipped in tar calculation) towards the current market norms of around 15-to-1. Such a move would see the share price increase to around 52 cents, all other things being equal. And as the broader market recovers (in, say, 12 to 18 months time) the value of that insurance business will actually increase (with a flow-on into share price).

For my money, at 35 cents, its certainly got very limited downside, yet excellent upside.

Hope some of you agree.

Best regards
Kit