Bearing this in mind, this week's intriguing announcement from Aim-traded insurance sector investment company BP Marsh & Partners (BPM:179p) is well worth noting. That's because the company owns a 44.97 per cent stake in Besso Insurance Group, a top 20 independent Lloyd's broking group, and one that has appointed investment bank Cannacord Genuity to carry out a strategic review. Discussions with potential investors are ongoing with a view to a sale, or investment in Besso, and as a major shareholder the board of BP Marsh have been active in these discussions.
It's a valuable investment too because after stripping out a 7.03 per cent stake held in BP Marsh's 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 2015 to £18.1m at the company's January 2016 financial 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. The investment accounted for 67.6p a share, or 27.8 per cent of BP Marsh's net asset value of 243p a share at the end of January so is a chunky holding. It's proved a shrewd investment too, currently showing a 348 per cent gain on cost.
Moreover, even after these valuation gains there is ample potential for further upside in a M&A scenario given that deals in the sector are being done at far higher valuations. For instance, 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 2016 would increase the value of BP Marsh's 37.96 per cent stake from £18.1m to £22.8m and give a valuation of £24.3m for its 44.97 per cent holding, or the equivalent of 83p per BP Marsh share. If a bid emerges for Besso it could be even higher because there is a case to be made that the Lloyd's broking group could command a valuation premium to the exit multiple of the Fleming Insurance Brokers deal.
Net funds soar as cash floods in
The news gets even better because BP Marsh has just sold its remaining 1.6 per cent equity stake in privately-owned global insurance broker Hyperion Insurance and one that was subject to a call option from General Atlantic. The equity investment in Hyperion increased over six-fold in value, so has proved a shrewd purchase.
The £7.3m cash proceeds from that sale, combined with other recent disposals, have by my calculations increased the company's net funds from £5.3m to £12m, a sum worth 17 per cent of the January 2016 year-end net asset value of £70.8m. If Besso is taken out on a multiple of 10 times cash profits then this would bolster net funds by a further £24.3m to £36.3m, a sum worth 124p a share. BP Marsh also loaned £2.3m to Besso which you would expect to be repaid on change of ownership. This would add another 8p a share to its net funds. In effect, based on my calculations above, then 75 per cent of the current share price will be in cash if Besso is sold. It would also give a further lift to BP Marsh's net asset value in the order of 16p a share based on a cash profit multiple of 10 times.
The rock solid asset backing doesn't end there either because £6m (equivalent to 20p a share of BP Marsh's net asset value) of the £14.6m (worth 50p a share) of loans BP Marsh has made to investee companies is a loan outstanding to Hyperion earning annual interest of £450,000 and due for repayment in October 2017, or sooner if Hyperion goes down the route of an IPO.
Investment risk to the upside
Hyperion is not the only holding that has been outperforming as BP Marsh also owns a stake in LEBC, an independent financial advisory firm that has been growing strongly in the post Retail Distribution Review (RDR) environment. The shareholding was valued at £8.4m in July 2015 and was marked up to £9.5m in BP Marsh's latest accounts to end January 2016. That's more than three times what BP Marsh invested. Since then BP Marsh has raised its stake to 42.68 per cent by investing a further £1.9m, so by my reckoning the holding is currently worth £11.6m, accounting for 16.4 per cent of BP Marsh's net asset value, implying a value of £27.2m for the whole of LEBC.
That valuation looks justified too as 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, and I understand that the momentum has continued into this year. The investment risk here looks firmly to the upside. The same can be said of Nexus Underwriting, an independent specialty Managing General Agency (MGA), founded in 2008. 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 last December. The shareholding has been revalued at £6m, or 33 per cent above cost, a valuation justified by the ongoing growth in the business.
Sum-of-the parts valuation
If a bidder emerges for Besso on the above terms, then there is a decent chance that BP Marsh's net cash could shortly account for 73 per cent of the share price. Add to that a loan portfolio worth 20 per cent of the share price alone, and in effect we are almost getting a free ride on all the other investee companies, including LEBC and Nexus. I estimate these holdings are worth 87p a share.
We are also likely to see BP Marsh's net asset value per share hit another record high when it reports its half year results to end July 2016, so underpinning the positive sentiment. I would also flag up that the board have just confirmed they will lift the dividend per share by 10 per cent to 3.76p in the current financial year to end January 2017, having increased the payout by almost a quarter to 3.42p a share last year. Latest guidance is to expect at least this level of dividend for the next two financial years too.
It goes without saying that with BP Marsh's share price trading on a 26 per cent discount to historic book value of 243p a share, the valuation risk firmly skewed to the upside, and the share price in blue sky territory, then this looks a relatively low risk investment to me. In fact, having first advised buying the shares at 88p ('Hyper value small-cap buy', 22 Jan 2012), banked 11.17p a share of dividends since then, and upgraded my target price range to 190p to 200p a share when I updated the investment case at the time of the final results ('BP Marsh records hefty gains', 8 Jun 2016), I now feel that a disposal of the stake in Besso could make my target price look too conservative given the likely hefty valuation uplift on that holding.
In the circumstances, I am raising my target price again to 215p and rate BP Marsh's shares a strong buy on a bid offer spread of 175p to 179p ahead of likely corporate activity.
Please note that I have written two columns today, and three this week, all of which are available on my home page
