True, at the time the shares were below the 140p listing price when the company came to the market in February 2006. However, I had put readers into the shares at 88p having initiated coverage the previous year ('Hyper value small-cap buy', 22 Jan 2012) and believed that my fair value estimate of 160p a share was a reasonable target price. The fund manager disagreed and feared "it will take a very long time to get there unless the board have a change of heart about returning cash to the minority shareholders”.
Well, the share price has not only got there, but it smashed through that level to a record high of 170p yesterday after BP Marsh reported a 12.5 per cent rise in net asset value per share to a record high of 243p. The company also raised the dividend by a quarter to 3.42p a share to take the aggregate declared payout to 11.17p a share since I commenced coverage. This means the investment is now showing a 100 per cent total return.
The 36 per cent increase in net asset value in the past three years also highlights the value created by recycling the cash from the disposal of the majority of the company’s shareholding in privately owned global insurance broker Hyperion Insurance into new investments. BP Marsh still retains a 1.6 per cent equity stake in Hyperion, worth £7.3m, subject to a call option from General Atlantic which is due to be exercised by its July 2016 expiry date. Proceeds from that holding, and recent disposals, should swell the company's net funds of £5.3m to £14m on a proforma basis, a sum worth 20 per cent of the January 2016 year-end net asset value and provide ample firepower for BP Marsh’s team to make more value accretive investments.
Equity portfolio surges in value
Furthermore, some of the investment gains have been eye-catching which is why the equity portfolio soared by 28 per cent last year, excluding the holding in Hyperion whose sale price is capped under the call option.
Revaluation uplifts include BP Marsh's 44.97 per cent holding in Besso Insurance Group, a top 20 independent Lloyd's broking group. Stripping out a 7.03 per cent stake held in the accounts at cost of £1.5m, and subject to a buy back by Besso, the value of BP Marsh’s remaining 37.96 per cent holding surged from £13.9m in July to £18.1m at the January 2016 year-end. This implies a value of around £48m for Besso’s equity, or eight times likely cash profits of £6m in 2016, up from £4.8m in 2015, and reflects a sharp rise in Besso’s profits.
But even after this hefty gain there is definitely further upside given that deals in the sector are being done at far higher valuations. Indeed, Robert Fleming Insurance Brokers, the international Lloyd's insurance and reinsurance broker, sold a majority share in its business to private investment firm Calera Capital, valuing its equity at £53m, or 10 times cash profits. Attributing a similar cash profit multiple to Besso's forecast earnings for fiscal 2016 would give rise to another hefty valuation gain to BP Marsh's stake.
The £19.7m stake in Besso is by far BP Marsh's largest equity shareholding and it accounts for 28 per cent of the company’s net asset value of £70.8m. BP Marsh also has a £2.3m loan outstanding to Besso. It’s therefore well worth noting that chairman Brian Marsh says that Besso is now likely “to do one or two acquisitions which will require north of £20m of funding.” This is more than a small company like BP Marsh would be able to finance and, just like the hugely profitable disposal of Hyperion three years ago, I wouldn’t rule out an exit here especially as the equity investment is now showing a 348 per cent gain on cost.
It’s not the only investment outperforming as BP Marsh also owns a 34.9 per cent stake in LEBC, an independent financial advisory firm that has been making hay in the post Retail Distribution Review (RDR) environment. The shareholding was valued at £8.4m in July 2015 and this has increased to £9.5m in BP Marsh’s latest accounts. That’s more than three times what BP Marsh invested. The revaluation is justified too because LEBC’s pre-tax profits for the last financial year to end September 2015 rocketed from £1.1m to £1.8m, driven by a 22 per cent rise in revenues to £15m. The stake now accounts for 13.4 per cent of the company’s book value and gives an implied value of £27.2m for the whole of LEBC. This is hardly an exacting valuation for a business growing rapidly and prospering in the post RDR world. Indeed, the momentum has continued into this year and I fully expect BP Marsh to recycle some of its cash pile into supporting the business further.
BP Marsh's investment in Nexus Underwriting, an independent specialty Managing General Agency (MGA), founded in 2008, is also doing well. Tim Coles, previously the boss of highly regarded Howden Broking Group, was appointed as chief executive last year with the mandate of developing Nexus into a business capable of writing $250m (£162m) of profitable speciality business within three years. He’s moving the business in the right direction as premium income is forecast to rise from $85m in 2014 to $110m in 2016. Having taken a 5 per cent stake in Nexus in August 2014, and raised its holding to 9.8 per cent in June 2015, BP Marsh raised its stake further to 13.7 per cent at a cost of £1.47m in December last year. The shareholding has been revalued at £6m, or 33 per cent above cost.
Of course, not all investments have performed so well and the company has a £1.8m total exposure to Walsingham Motor Insurance, a niche MGA. The company got into “a spot of bother” and is being resuscitated at the moment with the assistance of BP Marsh's senior directors, albeit Mr Marsh is positive about BP Marsh recovering its investment.
Sum-of-the parts valuation
But frankly when its three largest investments - Besso, LEBC and Nexus – are doing so well, then it can afford that odd poor performing investment. In total, these three equity holdings account for 50 per cent of BP Marsh’s net asset value, a sum worth 121p a share. Proforma cash post the sale of the £7.3m stake in Hyperion accounts for a further 20 per cent of book value, or 48p a share. In other words, the current share price is in effect fully backed by the equity investments in Besso, LEBC and Nexus and proforma cash.
This means that a £14.6m loan portfolio to investee companies worth 50p a share is in the price for free even though £6m of the £14.6m of loans outstanding is a loan made to Hyperion which earns annual interest of £450,000 and is due for repayment in October 2017, or sooner if Hyperion goes down the route of an IPO. A £2.3m loan to Besso and a £1m loan to LEBC account for about 22 per cent of BP Marsh’s loan book so offer further solid asset backing. In other words, two thirds of the loan book is invested in its top performing investments.
Furthermore, with BP Marsh’s share price trading on a 30 per cent discount to book value of 243p a share, we are also getting a free ride on the other 10 equity investments the company has made. It’s an anomalous valuation for a company that has delivered compound annual growth of 11.4 per cent in its net assets since 1990 and produced a total shareholder return of almost 22 per cent in the past two financial years. There is a decent payout to shareholders too as BP Marsh's shares offer a prospective dividend yield of 2 per cent.
I would also flag up that the company has been using its cash rich balance sheet to make net asset value accretive share buy backs to narrow the share price discount to book value. This acts as a floor to the share price as every time the discount widens too far, the company steps into the open market and repurchases shares.
New target price
Needless to say, I remain positive on the investment case, having last updated the investment case at 157p (‘Primed for investment gains’, 10 Feb 2016). In fact, I have nudged up my target price from 190p to 200p a share. Analyst Barrie Cornes at broking house Panmure Gordon is positive too, having raised his target from 180p to 194p post yesterday's full-year results, implying a 20 per cent share price discount to book value. With the shares in blue sky territory, and prospects of corporate activity for its investee companies, I feel both our targets could yet prove conservative.
On a bid-offer spread of 167p to 170p, valuing BP Marsh’s equity at £49.5m, or 30 per cent below book value of £70.8m, I continue to rate the shares a value buy.
