upgrading cix to strong buy

All...

Hunter Hall's lifting of their stake in Calliden to 19.99% - the pre Australian Unity General Insurance level - signals one of two things: either HHL think the current value represents excellent value (read their investment mandate regarding "deep value" stocks), OR HHL have a longer-term play at hand on CIX.

HHL entered this stock many years ago and were one of the few investors to take a decent punt on Reinsurance Australia Group ('ReAC'). From memory, these guys were buying at around 3 cents - so they are sitting on a tidy profit. That said, HHL also backed the AUGIL takeover at a time when CIX was 42 cents, only to see CIX climb about 15% and then shed 50% over the coming three years.

Operating errors aside (note here that I think Kirk has lost sight of the mission: the conservative reinsurance and quota share programmes are awful, and the general strategy seems to have gone amiss somewhere), the book itself (being capital plus insurance value) far exceeds the current market cap. For example, at 26 cents per share the market cap of CIX is only just above $60mm - and even the capital (retained) exceeds this; valuing, in effect, the insurance book at zero.

The problem Calliden has is its COR, which at 100-plus means they are relying on investment income to break even or make a small profit. Investment income in an insurer should be cream, not the entire constituents of the pie: and in Calliden's case their failure over the past two years to get their credit and duration right means that even their investment "cream" has turned a bit sour (apols for the bad analogy - but I think you get what I mean).

However... Sell the entire book (GWP circa 300mm) and strip out the capital, and then we have a game on our hands. Suppose, for example, the insurance margin is more reasonable, CIX SHOULD be making something along the lines of $9mm this year (which they won't). Using a conservative PE of 10:1 (remember: Wesfarmers paid 16 for OAMPS!), and CIX should actually be worth somewhere in the order of $150mm (taking into account capital plus the multiple of insurance earnings - I won't go into the exact calcs here, but my valuations come in between $135mm and $155mm). For arguments sake, lets use the low point of $135mm - in other words we will say the insurance book is only worth about $45mm on a PV basis.. Based on that, CIX's break-up value is in the order of 58 cents per share - around double the market price at this point in time. Deduct acquisition costs, "non-acretive" value, and all the other "bits" (system and conversion / consolidation costs) and you end up with a break-up of around 52 cents per share.

IF Hunter Hall, for example, offered to acquire the remainder of the shares at a 50% premium to the current share price (something the Director's could NOT recommend against) and paid 39 cents, the could stand to bag around $30mm by selling off CIX....

If I were HHL I would launch a takeover offer for CIX with this in mind. Yes, they could just be "adjusting" their holding based on current "value" in the share price, but I am sure that Peter Hall would not knock back $30mm if you offered it to him - particularly since option B here is to sit back for another 5 years and wait for Kirk to finally realise that "business as usual" for Calliden simply will not cut the mustard.

Either way, I am upgrading CIX to a STRONG BUY at these levels based on the off-chance that HHL may move (or, at the very least, some people may interpret it that way and start buying CIX themselves).

Best regards
Kit