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OPINION

Cash rich small cap buy

Cash rich small cap buy
August 19, 2014
Cash rich small cap buy
IC TIP: Buy at 132p

In light of this, I have noted a drift in the shares of Aim-traded insurance sector investment company B.P. Marsh & Partners (BPM:132p), a company I have been favourable on for the past few years. I have had good reason too as the share price discount to book value was anomalous when I recommended buying the shares at 90p ('Hyper value buy', 26 Oct 2012). To a degree that anomalous pricing had corrected itself when I last updated the investment case when the price had risne to 152p (‘B.P. Marsh cashed up for acquisitions’, 4 June 2014). However, having re-assessed the investment case, I concluded at the time that a fair price for the equity was nearer 170p, so offering decent medium-term upside. Trading on a bid offer spread of 128p to 132p now, and with 29 per cent share price upside to that 170p target, I have little reason to change my positive stance.

As the title of that last article indicates, B.P. Marsh has a very robust balance sheet. By my reckoning, the company was sitting on net cash and treasury investments of £14.8m, equivalent to 50.5p a share, at the start of this year. In addition, B.P. Marsh still retains a 2.79 per cent equity stake in global insurance broker Hyperion, which is in the books for £7.3m, or 25p a share. General Atlantic has a call option to purchase this stake by July 2016 or when Hyperion undertakes an initial public offering (IPO), whichever is the earlier. I fully expect General Atlantic to exercise its option because at the exercise price Hyperion's equity is being valued at £260m, a very fair valuation for a fast-growing company that generated cash profits of £35.9m last fiscal year on revenues of £166m.

In addition, B.P. Marsh has a loan of £6m outstanding to Hyperion earning annual interest of £450,000 and due for repayment in October 2017, or earlier if there is an IPO. In total the carrying value of the loan to Hyperion and the 2.79 per cent equity stake accounts for £13.3m of B.P. Marsh's net asset value of £58.9m. That's the equivalent of 45.5p a share.

In other words, cash and the Hyperion stake account for 96p of B.P. Marsh’s net asset value of 202p which means that all the company’s other investments are in effect being valued at 33p in the pound in B.P. Marsh’s current share price. In my view, that’s not just anomalous, but plainly ridiculous given that that B.P. Marsh's ongoing equity portfolio increased by 14 per cent in value in the financial year to the end of January 2014, and that followed on from a 13.3 per cent uplift the prior year.

The company's investments include a £1.8m holding in Aim-traded Randall & Quilter (RQIH: 158p), a specialist in managing the run-off of insurance companies and Lloyd's of London syndicates that have stopped underwriting new contracts, but have already settled liabilities arising from policies written. The shares are modestly priced on a little over book value and offer a solid dividend yield of 5.3 per cent.

Other notable investments in B.P. Marsh's investment portfolio include a 37.9 per cent stake worth £7.2m in Besso Insurance, a profitable insurance broker in the North American wholesale market. The carrying value of that holding increased by £1.2m in the last fiscal year, largely reflecting a much improved financial performance, according to B.P. Marsh's chairman and major shareholder, Brian Marsh.

Cashed up for acquisitions

And it’s not as if the company is hoarding its cash pile either: in the past week, it announced a £1.5m investment in Nexus Underwriting, the independent specialty Managing General Agency (MGA), for a 5 per cent stake in the preferred ordinary shares.

Founded in 2008, Nexus has grown rapidly in the six years since inception. In fact, from a standing start Nexus is now one of the largest independent specialty MGAs in the London market and one that is expected to generate a premium income in excess of £60m in 2014 (£55m in 2013). Commission income is forecast to have risen from £873,000 in 2008 to £13m in 2014 which in turn has driven profits up from £560,000 to a forecast of £3m over the same six-year period.

Reassuringly, Nexus is backed by two insurance sector stalwarts: chief executive Colin Thompson, who previously had senior roles at Axis Specialty Europe and Chubb Insurance Company; and chairman Ian Whistondale, who has over 30 years' experience in the London insurance market and has successfully founded and managed a number of profitable insurance underwriting and brokerage businesses.

Nexus primarily generates its income through two operating subsidiaries: Nexus Underwriting, which underwrites Speciality Insurance Products (Directors & Officers, Professional Indemnity, Financial Institutions and Accident & Health); and Nexus CIFS, which covers Trade Credit Insurance.

It looks a sensibly priced deal valuing the equity of Nexus at £30m, or 10 times operating profit estimates. It's not a one-off either as in the past year B.P. Marsh has made several interesting investments including the acquisition of a 40 per cent stake for around £444,000 in Sydney-based MB Group, a managing general agent and a market leader in prestige motor insurance in Australia, and a £1.95m investment for a 19.7 per cent equity stake in Sterling Insurance, an Australian specialist underwriting agency specialising in niche markets within the liability sector, including mining, construction and demolition. Both these investments have produced significant valuation uplifts since being made.

Buy backs enhance net asset value per share

Interestingly, the company’s board is now taking advantage of the share price drift to buy back shares. At the end of last week, B.P. March bought back almost 8,000 shares in the company for cancellation at prices between 126p and 127p. This makes a lot of sense as it removes excess stock off the market, while giving a boost to book value per share. Remember for every share repurchased at these prices, the company is in effect buying net assets of 202p, so is getting 75p a share of assets for free. I would expect further share buy backs to follow as long as the shares are trading on such a deep (35 per cent) discount to book value.

So with the cash rich company making some interesting acquisitions to divest the capital raised from selling down its stake in Hyperion, and the board initiating share buy backs and committed to paying out a final dividend of at least 2.75p a share for the financial years ending 31 January 2015 and 2016, then I can see no reason at all why B.P. Marsh’s share price should be trading on a 35 per cent discount to book value.

So ahead of a pre-close trading update at the end of this month before the release of interim results in October, I believe that the share price drift represents yet another buying opportunity. It is also one supported by an oversold technical set up as the 14-day relative strength indicator has a reading around 40.

■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'