April SA – part 2: Digging deeper
After part 1 of the analysis, I wanted to dig a little bit deeper into April SA.
Insurance brokerage business:
I mentioned that the insurance brokerage business is a highly attractive businesss model. In the April 2010 annual report, April basically confirms this with the following statement on page 31:
Through its activity and financial model, where cashflow generates a negative working capital requirement, the brokerage business enables the Group to achieve a very low level of debt (total financial liabilities of only 6,374 thousand euros on the consolidated balance sheet) and a very high level of liquidity (186,939 thousand euros in net cash and cash equivalents on the consolidated balance sheet).
In many cases, the broker collects the premium from the clients and passes it on with a certain delay to the insurer. This generates a “float” for the broker which doesn’t even carry interest.
The same principle applies in principle to the insurance industry as well which was the basis for Warren Buffet’s model at Berkshire. However, under new rules (especially Solvency II), insurance will become less and less attractive as “funding” model, whereas brokerage business wil remain rather lightly regulated in this regard.
Another important aspect of the brokerage model is the fact that an insurance broker basically “owns” the client. Insurance Brokers are very succesful on taking over a lot of activities (collection, drafting policies) and degrading insurers into pure capacity providers. If someone looks at moats, than in this case the moat of the long term contract remains with the broker, not the insurance company. In my opnion, brokers are also much better positioned to really profit from the online trend in the insurance industry, however this is a wildcard anyway for the whole industry.
On page 60 of the report, it is quite interersting to see that CEO and 66% owner Bruno Rousset only took 100 k in compensation both in 2009 and 2010. His succesor, Patrick Petitjean however earned ~430 k in 2010 plus an additional 1 mn in option grants. The Options have a strike price of ~20-22 EUR per share, so there should be at least some motovation to increase the shareprice by the new CEO.
What I also found quite interesting is the fact that Rousset’s shareholding vehicle Evolem seems to “evolve” into a real private equity investor, howver with the main asset April SA. Nevertheless I think there is a strong incentive to pay relatively large dividends in order to fund addional investments.
By the way, the CEO is running a blog, unfortunately in French. It seems to concentrate on “entrepreneurship”, somehting Rousset tries to promote strongly.
In September 2011, Rousset (through Evolem) purchased significant amounts of additional stock at around 13 EUR per share.
Capital management / Free Cashflow
Unfortunately, consolidated Cashflows are pretty meaningless for financial companies, especially insurance companies. Much more important is the ability to extract dividends out of those regulated entities.
April provides the relevant information from page 178 in the 2010 annual report under “statuatory” accounts. Relevant are the dividends received which are shown on page 190. Together with the 2007 report, we can generate a 6 year history:
If we assume that other holding income and expenses net out on a cash basis, than the 1.44 EUR are a good proxy for “real” cash flow generation for the last 6 years. On a (meaningless) consolidated basis, Bloomberg shows free cashflows of ~3 per year on average from 2005 to 2010, but this should be ignored.
For the time being, there doesn’t seem to be any direct catalyst event (buyout etc) on the horizon. although the business would be highly attractive for many other Insurance group. Munich re for example is trying to build up a similar organization called DKV Globality. I also think that it is no coincidence that Talanx (through Hannre) is a shareholder. However,his would be rather something for the long term, I don’t think Rousset would sell his “baby” at current prices.
April used to buy back stock in the past, but nothing in the previous months.
However, I have some hope that the current change in business strategy (reducing insurance premium retention, increasing brokerage fees) could lead to a gradual shift into better profitablity, more stableprofits and eventually higher multiples. It remains to be seen how this process will work out.
Before getting too excited, let’s look at some issues which are not so positive:
Acquisitions & goodwill
April is using a significant part of the cash generated on holding level (~75%) for acquisitions. Especially for brokerage companies, this results in increased goodwill on the balance sheet. Anyone who has some experience with acquisitions knows that the integration of newly purchased companies always requires management time and money.
In the 2010 report from page 16, one can see how many companies April creeated and bought in the last years which is quite mind boggling for such a small company
I am not a chart expert, but the chart looks quite ugly:
The absolute low was around 10,30 last September, but it still looks very much like a falling knife. Personally I would very much prefer a longer consolidation before buying into such a stock.
Balance sheet risks
Within its insurance subsidiaries, April of course carries the “usual” balance sheet risks like any insurance company, both on the investment side as well as the reserve side. Despite the use of Reinsurance, a signifcant portion remains on Apri’s balance sheet. Fortunately they do not have any Life & Savings business which in my opnion is currently the worst part of the insurance sector.
April SA was a real growth stock some years ago. As with many growth stocks, when growth finally stalls, the stock goes into a transition phase when former groth investors ditch the stock. If growth doesn’t resume quickly, it will take a long time until real value territory is reached. Based on the current numebrs (P/B 1.1, P/S 0.6 P/E 7) one could argue that compared to insurance companies, the stock is still expensive as a “deep value” stock.
Summary: After this deep dive, I am still not really sure about the stock. On the one side, we have the very attractive business model, on the other side there are some reasons why the stock could trade still lower than that. So this would be one of my first stocks which I woudl buy based on the business model rather than the valuation alone. However, I will come up with some refined valuation approach in another post. No decision yet.