Greenlight Capital

Document Sample
Greenlight Capital Powered By Docstoc
					Ticker: GLRE
Sector: Financials
Industry: Reinsurance


Pricing                                               Recommendation: HOLD/ADD
Closing Price   $23.30
                (02/12/10)           I am recommending a hold/add on Greenlight Reinsurance due to
52-wk High      $23.54               its stellar recent performance and its positive long term outlook.
                (02/12/10)           However, pricing in the reinsurance industry in the near term has
52-wk Low       $12.22
                                     remained difficult due to the favorable hurricane season and the
                                     recovery in the capital markets that took place in the latter half of
                                     2009. Greenlight’s value should be relatively unaffected due to
Market Data                          the unique nature of how Greenlight RE is structured (it is very
Market Cap   $838.35M                similar to Warren Buffet’s Berkshire Hathaway). Its main
Total assets $1.46B                  revenue source does not rely from its core insurance business but
Trading vol  113,000 (3month         from its investment portfolio which is managed by the well known
avg)                                 and respected hedge fund manager—David Einhorn (Greenlight
                                     RE is essentially a publicly traded version of Einhorn’s hedge
                                     fund--Greenlight Capital). The relative weak pricing power that is
Valuation                            projected to persist for the better half of 2010 in the reinsurance
EPS (ttm)       $3.32                industry should effect its’ value very little. Greenlight RE
P/E (ttm)       6.95                 primarily relies upon investment income to fuel earnings and
Current          --                  market value growth. Although the float from the reinsurance
Dividend         --
                                     premiums Greenlight RE has underwritten has shown strong
                                     growth from ’08 to ’09 (an increase of 88% in net earned
Profitability & Effectiveness        premiums thru the first nine months of ’09 vs. ’08) premiums have
(ytd)                                only accounted for about 4% of net income through 3 quarters of
ROA            5.93%                 2009.
ROE            20.88%
Profit Margin 39.89%                 Greenlight RE is basically a hedge fund on the back end of the
Oper Margin 40.36%                   balance sheet utilizing sophisticated investment strategies to
P/Book          1.33                 generate superior returns relative to their more conservative
                                     (mainly low yielding fixed income investing) peers within the
                                     reinsurance industry. While the front-end reinsurance side of the
                                     balance sheet is basically breaking even (currently generating little
                                     extra net income) the back end (or investing portfolio) of
                                     Greenlight posted superior returns in the latter half of 2009 fueling
                                     stock price growth possibly foreshadowing good things to come in
                                     Q4 ’09 and 2010. The near term earnings of Greenlight RE will
Analyst: Tyler Peglow                live and die with the returns produced by its approximate $700
              million investment portfolio and its sophisticated hedge fund like approach to generating
              those returns.
Aaron Foster

                                   Company Overview

Greenlight Capital Re, LTD is a Cayman Islands-based specialty property and casualty
reinsurer. The company offers excess loss and quota share products in the property and
casualty market. Within the property and casualty reinsurance segment, underwriting
operations are analyzed using two categories: frequency business, and severity business.
Frequency business is characterized by contracts containing a large number of small
losses stemming from multiple events. Severity business is typically characterized by
contracts with the potential for losses originating from one event or multiple events (think
large infrequent events). The company’s investment portfolio is managed by DME
Advisors, LP. Their assets are managed according to a value-oriented equity-focused
strategy that complements the Company's business goal of long-term growth in book
value per share. (

Greenlight Capital RE was founded in 2004, and went public in May of 2007 at $19 per
share. David Einhorn (co-founder) manages the company’s investments as chairman of
DME Advisors, LP. Einhorn has had considerable experience and success in the
financial markets has founder of Greenlight Capital RE—a hedge fund based out of New
York. Greenlight Capital RE was founded by Einhorn in 1996 with an initial $1 million
dollar capital raise. Greenlight Capital RE has since grown to over $6 billion in assets
under management in just 14 years as Einhorn significantly outperformed broad market
indices over the time period attracting many large institutional investors to his fund.
While returns suffered in 2008, Greenlight has returned since inception, net of all fees
and expenses, more than 22% compared to the measly 6% return of the S&P 500 over
that same time period. Quite an impressive feat when you factor into the fact that
Einhorn has been investing through two recessions (the 2000 tech bubble and 2008 credit
crisis) which saw broad indices in each bear market fall more than 50%.

                                  Reinsurance Business

Greenlight is focused on bringing a disciplined and differentiated underwriting strategy
that will allow it to mitigate losses and capture steady gains from its reinsurance business.
Greenlight Re offers excess of loss and quota share products in the property and casualty
market, focusing on customized solutions rather than participating in broadly available
opportunities—trying to create small niche opportunities. Their business is mostly
sourced through reinsurance brokers, providing the company with variable-cost global
distribution (commissions are based on gross premiums written).

The company seeks to maximize long-term results rather than manage for interim or
GAAP performance. Management is compensated based on multi-year underwriting
performance rather than premium volume or short-term results which should help smooth
operating earnings over time and help their underwriting strategy stay smart and
conservative (think AIG). Greenlight seeks to act as lead underwriter for most premiums
written as they look to find niche opportunities rather than commodity type deals.
Greenlight also enjoys an excellent credit rating of A- (4th highest of 15 ratings) through

        A.M. Best--a full-service credit rating organization dedicated to serving the financial
        services industries. Such a high credit rating will help to attract more reinsurance
        contracts in the future has insurer’s will feel safer trading contracts with such a highly
        rated credit worthy institution (again think AIG). The company is also under Cayman
        Islands law and as such is not obligated to pay taxes on either income or capital gains.

        Greenlight manages the business on the basis of one operating segment, property and
        casualty reinsurance, in accordance with the qualitative and quantitative criteria
        established by the US GAAP. Within the property and casualty reinsurance segment,
        they analyze their underwriting operations using two categories:

                       Frequency business
                           o Characterized by large number of small losses
                                    Less volatile than severity
                                    Has greater predictability in margins, ROE
                       Severity business
                           o Characterized by potential large infrequent losses
                                    Clients buy protection to remove volatility from B/S
                                    Results can be volatile from period to period

               Details of gross premiums written are provided below:
                            Three months ended September 30,        Nine months ended September 30,
                                 2009                 2008              2009                 2008
                                      ($ in thousands)                       ($ in thousands)
        Frequency         $ 62,238     94.3% $ 27,787      73.7% $ 176,084     84.7% $105,432     78.8%
        Severity             3,745      5.7       9,897    26.3     31,817     15.3     28,378    21.2
Total                     $ 65,983 100.0% $ 37,684 100.0% $ 207,901 100.0% $133,810 100.0%

             Gross Premium Details:
                 Represents a 75% increase year over year for 3Q 2009
                 Represents a 55% increase year over year through 3 quarters of 2009

               Greenlight is rapidly growing market share in the reinsurance industry.

           Ratio Analysis:

            Due to the opportunistic and customized nature of Greenlight RE’s underwriting
     operations, expect different loss and expense ratios in both frequency and severity
     businesses from quarter to quarter. The following table provides the ratios for the nine
     months ended September 30, 2009 and 2008:
                                     Nine months ended                Nine months ended
                                     September 30, 2009               September 30, 2008
                               Frequency Severity      Total    Frequency Severity       Total
    Loss Ratio                      60.8%     49.0%       58.1%      35.4%     64.3%        44.9%
    Acquisition Cost Ratio          37.4%       8.0%      30.6%      53.5%       8.8%       38.8%
Comp Composite Ratio                98.2%     57.0%       88.7%      88.9%     73.1%        83.7%
    Internal Expense Ratio                                 9.1%                             13.8%
    Composite Ratio                                       97.8%                             97.5%

             The loss ratio is calculated by dividing loss and loss adjustment expenses
     incurred by net premiums earned. We expect that our loss ratio will be volatile for our
     severity business and may exceed that of our frequency business in certain periods.

            The acquisition cost ratio is calculated by dividing acquisition costs by net
     premiums earned. This ratio demonstrates the higher acquisition costs incurred for our
     frequency business than for our severity business.

             The composite ratio is the ratio of underwriting losses incurred, loss adjustment
     expenses and acquisition costs, excluding general and administrative expenses, to net
     premiums earned. Similar to the loss ratio, we expect that this ratio will be more volatile
     for our severity business depending on loss activity in any particular period.

             The internal expense ratio is the ratio of all general and administrative expenses
     to net premiums earned. We expect our internal expense ratio to decrease as we continue
     to expand our underwriting operations. During the nine months ended September 30,
     2009, our net earned premiums increased 88.4% while our general and administrative
     expenses increased 24.0% as compared to the corresponding 2008 period, resulting in a
     lower internal expense ratio.

              The combined ratio is the sum of the composite ratio and the internal expense
     ratio. It measures the total profitability of our underwriting operations. This ratio does not
     take net investment income or other income into account. The reported combined ratio
     for the nine months ended September 30, 2009 was 97.8% compared to 97.5% for the
     same period in 2008. Given the nature of our opportunistic underwriting strategy, we
     expect that our combined ratio may be volatile from period to period.

                     Outlook and Trends in Reinsurance Business

The rebound of the financial markets in the latter half of 2009 has restored many
insurers’ balance sheets putting downward pressure on reinsurance pricing in the near
term. Underwriting capacity has become more available in the property and casualty
market which has resulted in a delay of expected price increases in various financial
insurance products. In addition, the lack of large catastrophes in 2009 to date has
preserved capital in the property and casualty industry alleviating a lot worries insurers
had in the middle of 2009—this could mean less business for reinsurers in the near term.

Greenlight appears to be well positioned to compete for attractive opportunities as they
continue to grow their market share and create more brand recognition within the
reinsurance industry. In addition there are still market participants who continue to suffer
from capacity issues even after the rebound of the financial markets in the latter half of
2009 creating greater niche opportunities. These opportunities could increase if financial
and credit markets report large losses and the industry keeps consolidating through
mergers and acquisitions decreasing the number of market participants. Greenlight (from
its 3Q ’09 10-Q) believes opportunities are likely to arise in a number of areas, including
the following:

              lines of business that experience significant loss experience
              lines of business where current market participants are experiencing
               financial distress or uncertainty
              business that is premium and capital intensive due to regulatory and other

Has Greenlight continues to grow their brand recognition expect large annual growth
increases in gross premiums underwritten. However, depending upon the accuracy of
Greenlight RE’s underwriting, large growth in premiums underwritten may not increase
net income. Unforeseeable catastrophic events or shoddy underwriting may hamper large
increases in gross premiums underwritten resulting in an unprofitable reinsurance
business making the company’s value that much more reliant on Einhorn and his
investment acumen.


      As of September 31st, 2009 Greenlight RE had an investment portfolio with an
approximate market value of $700 million managed by an affiliate of Greenlight RE—
DME Advisors. DME Advisors is a related party and affiliate of David Einhorn,
Chairman of the board of directors and founder of the hedge fund Greenlight Capital.
DME Advisors implements a value-oriented investment strategy by taking long positions
in perceived undervalued securities and short positions in perceived overvalued
securities. DME Advisors aims to achieve high absolute rates of return while minimizing
the risk of capital loss.

Pursuant to the advisory agreement, DME Advisors is allowed performance
compensation equal to 20% of the net income of the Company’s share of the account
managed by DME Advisors, subject to a loss carry forward provision. The loss carry
forward position allows DME Advisors to earn reduced incentive compensation of 10%
on net investment income in any year subsequent to the year in which the investment
account incurs a loss, until all the losses are recouped and an additional amount equal to
150% of the aggregate investment loss is earned.

This is where most all of the value in Greenlight RE is derived. Where most reinsurers
invest a majority of their floats and investment portfolios into low yielding fixed income
safe assets Greenlight RE takes a much different approach. Under Chairman David
Einhorn (who is also head of DME Advisors) Greenlight RE employs a sophisticated
hedge fund type style of investing geared towards generating excess returns and creating
greater value.

In this regard Greenlight RE is very similar to Warren Buffet’s Berkshire Hathaway—
both insurance companies are mere ―cover‖ companies that more or less give investors
access to professional money managers like Buffet and Einhorn without all the rules and
stipulations (minimum amount of capital and lock up of funds for a predetermined
amount of time) of a hedge or private equity fund. Both company’s values rely almost
solely upon the investments made in the financial markets by these two great money
managers and much less on their respective core insurance businesses. This fact makes
Greenlight RE’s operating earnings much more volatile than the industry as a whole.
More than 95% of the net income Greenlight has earned through 3 quarters of 2009 has
been derived from their investment portfolio while the core insurance business has
accounted for less than 5% spanning that same time period. The value of Greenlight RE
lives and dies quarter to quarter with the investment returns generated from Einhorn’s
positions. These positions include:

           o   Long equities
           o   Short equities
           o   Credit default swaps – sells and buys
           o   Interest Rate Options
           o   Distressed debt
           o   Investment grade corporate debt

              o   Commodity’s
              o   Warrants
              o   Swaps
              o   Futures

Clearly the portfolio of Greenlight RE is managed much more like a hedge fund and
much less like a conservative institution intent on preserving capital (as with most

         Investment Guidelines: (From Greenlight’s 2008 10-K Report)

       The investment guidelines adopted by our Board of Directors, which may be amended or modified
from time to time take into account restrictions imposed on us by regulators, our liability mix, requirements
to maintain an appropriate claims paying rating by ratings agencies and requirements of lenders. As of the
date hereof, the investment guidelines currently state:

     •      Quality Investments: At least 80% of the assets in the investment portfolio are to be held in
            debt or equity securities (including swaps) of publicly-traded companies and governments of
            the Organization of Economic Co-operation and Development, or the OECD, high income
            countries and cash, cash equivalents or United States government obligations.

     •      Concentration of Investments: Other than cash, cash equivalents and United States
            government obligations, no single investment in the investment portfolio may constitute more
            than 20% of the portfolio. No more than 10% of the assets in the investment portfolio will be
            held in private equity securities.

     •      Liquidity: Assets will be invested in such fashion that we have a reasonable expectation that
            we can meet any of our liabilities as they become due. We periodically review with the
            investment advisor the liquidity of the portfolio.

     •      Monitoring: We require our investment advisor to re-evaluate each position in the investment
            portfolio and to monitor changes in intrinsic value and trading value and provide monthly
            reports on the investment portfolio to us as we may reasonably determine.

     •      Leverage: The investment portfolio may not employ greater than 5% indebtedness for
            borrowed money, including net margin balances, for extended time periods. The investment
            advisor may use, in the normal course of business, an aggregate of 20% net margin leverage for
            periods of less than 30 days.

     DME Advisors Investment portfolio consists of the following: (Source: 2008 10-K)
                                                                                      As of
                                  As of                                            December 31,
                             December 31, 2008                                        2007
                                                              Long %    Short %      Long %     Short %
     Debt Securities                                              11.8%       0.0%        0.1%        0.0%
     Equities & Related Derivatives                               65.8     (39.3)        91.0      (51.7)
     Equities - Unlisted                                           1.9         —          1.2         0.0
Ot   Other Investments                                              —        (0.2)        0.7       (7.6)
     TOTAL                                                        79.5%    (39.5)%       93.0%     (59.3)%

            The following table represents the composition of our investment portfolio, by industry sector, based
     on the percentage of assets in our investment account managed by DME Advisors as of December 31,

    Sector                                                                 Long %    Short %     Net %
     Basic Materials                                                            5.3%      (5.3)%      0.0%
C Consumer Cyclical                                                             5.5       (5.8)      (0.3)
     Consumer Non-Cyclical                                                      2.5       (3.4)      (0.9)
     Energy                                                                     6.3       (1.5)       4.8
Fi Financial                                                                   20.6     (18.4)        2.4
    Healthcare                                                                  1.9       (2.6)      (0.7)
InInIndustrial                                                                 20.9       (2.5)      18.4
    Technology                                                                 12.6       (0.1)      12.5
    Utilities                                                                   3.9        0.0        3.9
    Total                                                                      79.5%    (39.5)%      40.1%

                                                Long Short Net
     Capitalization                             %     %        %
     Large Cap Equity (≥$5 billion)             16.9 % (22.1 )% (5.1 )%
     Mid-Cap Equity (≥$1 billion)               32.7 (16.2 ) 16.6
     Small Cap Equity (<$1 billion)             16.2 (1.1 ) 15.1
     Debt Instruments                           11.8 (0.0 ) 11.6
     Other Investments                          1.9    (0.2 ) 1.9
     Total                                      79.5 % (39.5 )% 40.1 %

     Notes on Financial Positions:
                 They are short (net) large cap equity
                 Long small cap equity
                 Long debt instruments

        Net Investment Income:
                                                    Three months
                                                         ended        Nine months ended
                                                    September 30,        September 30,
                                                   ($ in thousands)     ($ in thousands)
                                                    2009      2008       2009      2008
         Gains (losses)                           $ 39,648 $(121,075) $ 170,846 $ (89,008)
InI      Interest, dividend & other income            2,997     4,368     12,725    17,308
Inter    Interest                                    (3,570)   (4,611) (11,006) (13,112)
        Investment advisor compensation              (6,447)    3,509    (23,898) (7,734)
        Net investment income (loss)              $ 32,628 $(117,809) $ 148,667 $ (92,546)

               Nearly all the value Greenlight RE has created in book value this year ($152
                million) is directly attributable to their net investment income (Einhorn’s financial
                    o This is why I refer to Greenlight RE has:
                                 ―A Hedge Fund with an Insurance Business‖

                                             Business Performance


        Revenues from net reinsurance premiums earned have increased each of the last 3 years
        (2006 they were still private, also 1st year in reinsurance business), from $26.6M in 2006
        to $114.9M in 2008. With this, expenses relating to the reinsurance business (namely
        underwriting losses) have also increased substantially. Nonetheless, the reinsurance side
        has done a very good job of covering their own expenses and earning net positive
        incomes. For simplicity’s sake, I chose to expense out General & Administrative
        expenses from the reinsurance net premiums earned, and came up with a net loss of
        $2.5M for 2006, a net gain of $7.68M for 2007, and a net gain of $4.06M for 2008 (2008
        10K). The company, however, does not consider General & Administrative expense as a
        part of the reinsurance business, therefore their reported numbers for underwriting
        income are much higher than what I just suggested. I included G&A expenses on my
        reinsurance income calculation just to show that investment side truly is being operated
        free of charge.

        The other area of income, investments, is what will ultimately make or break this
        company. While money can be made in the reinsurance side, its main purpose is to lay
        the table for the investment side. As you will see in a chart below, Greenlight’s Net
        Income is almost a direct reflection of their Net Investment Income. The track record
        here is a little bit longer, as Einhorn has been investing people’s money since before the
        Internet bubble. As has already been mentioned, Einhorn has proven himself to be an
        expert at allocating capital. That success, so far, has translated to the reinsurance
        company, with the exception of 2008.

In 2008, the investment portfolio reported a loss of 17.6% for the year (S&P 500 was
down 37.2%), compared to a gain of 5.9% in 2007. 2006 was a great year for the
portfolio, achieving returns of 24.4% (2008 10K).

The company states their primary financial goal is to increase long-term value in fully
diluted book value per share. In 2008, the fully diluted book value per share decreased
19.2%, following an increase of 16.1% per share in 2007 (2008 10K).

                         Net Investment Income & Net Income

                                      2008              2007             2006
                                ($ in thousands, except per share and share amounts)
Summary Statement of
Income Data
Gross premiums written          $     162,395          $    127,131           $     74,151
Net premiums earned                   114,949                98,047                 26,605
Net investment
income (loss)                       (126,126)                 27,642                58,509
Loss and loss
adjustment expenses
incurred, net                          55,485                 39,507                 9,671
Acquisition costs, net                 41,649                 38,939                10,415
General and
administrative expenses                13,756                 11,918                 9,063
Net income (loss)               $    (120,904 )        $      35,325          $     56,999

                                    Fiscal Year 2009

2009, so far, has been an excellent year for the company. The reinsurance business
continues to grow its revenues (although a small % of net income). Through three
quarters, net premiums earned are already nearly 30% above where they were for the
whole year of 2008. With that, underwriting losses have also grown, however net
premiums earned still cover all expenses (including G&A) by over $3.5M. The company
reported underwriting income at $17.2M thus far in 2009, compared to $13.2M at the
same time last year (3Q report).

The investment portfolio has also shown significant gains as the financial markets started
to gain footing in early to mid-year 2009. Greenlight’s investment portfolio has reported
a net gain of $148.7M, or a return of 24.2% (S&P up 18%), for the nine months ended
September 30, 2009. Over the same period last year, the company reported a net
investment loss of $92.5M, or 12.9% (3Q report).

During the first nine months of fiscal year 2009, fully diluted book value per share has
increased by $4.07 per share, or 30.0%, to $17.62 per share from the $13.55 per share at
year-end 2008 (3Q report).

                               Greenlight RE Highlights

      David Einhorn is one of the most successful investors of the past decade
      Focus on superior returns on both sides of the balance sheet (but we all know
       value will mainly come from investments)
      Favorable tax treatment due to Cayman Islands location
      Disciplined, differentiated underwriting strategy
      A- (excellent) financial strength rating from A.M. Best
      Little leverage in investment operations
      Has a rather large ―short‖ exposure—profiting in down markets
      $50 million personal investment by Chairman David Einhorn (owns over 17% of
       company—interests aligned with investors

                            Investment Risks and Concerns

      Limited loss experience
      Exposure to natural disasters
      Needs to maintain letters of credit
      Competitive industry
      Lack of operating history


I am recommending a hold/add on Greenlight Reinsurance. While pricing in the
reinsurance industry is forecasted to remain subdued through the first half of 2010 it
should affect the value of Greenlight RE very little. Greenlight (like Berkshire
Hathaway) relies heavily on their net investment income to drive book value (over 95%
of net income has come from their investment portfolio since Greenlight’s IPO in 2007)
and will continue to do so. Greenlight is structured like a liquid hedge fund utilizing the
skills of the respected and well known hedge fund manager--David Einhorn who has
significantly outperformed the S&P 500 over his investing career.

Secondly, being that the IFM Fund is long only equities, Einhorn could give the fund
some ―short‖ exposure possibly creating greater diversification within the fund and earn
the fund higher risk-adjusted returns. If Einhorn’s history is a good predictor of future
success the IFM Fund can expect to achieve 15-20% annual returns with Greenlight
RE—assuming Einhorn can earn returns with Greenlight RE similar to his historical
returns with his hedge fund Greenlight Capital.

An investment in Greenlight RE is merely an investment in a liquid hedge fund backed
by a manager with an extraordinary historical performance. While Greenlight RE may be
somewhat riskier due to its more volatile revenue structure and lack of operating history
relative to other reinsurers, it has potential to be the next Berkshire Hathaway (albeit a
little bit riskier). Einhorn has beaten the S&P 500 by nearly 15% for the last 14 years—it
is hard to argue with performance.


      10-k report
      10-q report
      Yahoo! Finance
      Google Finance
      Reuters
      S&P Net Advantage
      Mergent Online


Shared By: