When Wall Street doesn’t have a clear picture about what’s going on with a company’s finances, it can assume the worst. So when Markel (NYSE: MKL) made public last week that U.S. and Bermuda regulators were looking into some loss reserves at one of its units, it caused share prices to take a dive. It also led a Market Foolery listener to ask for the Fools’ views on the situation.
In this segment of the Market Foolery podcast, host Chris Hill and senior analyst Jason Moser — who, full disclosure, added to his Markel position on the drop — explain why the concerns, which strictly relate to the small Markel CATCo business, can largely be discounted.
A full transcript follows the video.
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Chris Hill: Speaking of Markel, question from Jason McClara, who writes, “What are your thoughts on the recent announcement of a regulatory inquiry into Markel?” That may have driven some of those sales.
Jason Moser: Yes.
Hill: Jason writes, “The stock has traded down a little less than 10% since the announcement. Just wondering where things go from here. Thanks.” Thank you for the question, Jason. Yeah, it was a week ago, Markel announced that it is hiring an outside counsel for an internal review after it was notified by unnamed regulators. And I think right off the bat, it’s the “unnamed” part of that sentence that makes some investors go, “Wait a minute, is this a paperwork thing? Is this just a rounding error? Or is the SEC kicking in your door?”
Moser: Yeah, and it’s fair to be a little bit knee-jerk whenever you see “investigation.” I mean, that doesn’t exactly instill a lot of confidence. But it’s one where you have to dig in a little bit and try to understand exactly what’s going on here. And so we look at the 8-K that Markel actually released. They were saying that after having been contacted on Nov. 30, they’re cooperating with inquiries by U.S. and Bermuda authorities into loss reserves that were recorded in late 2017 and early 2018 in the Markel CATCo Investment Management business.
Hill: God, that’s in the weeds!
Moser: Just rolls right off the tongue, doesn’t it? But my point in reading that, and the CATCo part there, is that it’s limited just to that catastrophe part of the business, the reinsurance CATCo business that they have, and they acquired not all that long ago. It does not have anything to do with any other part of Markel whatsoever. Not Markel Ventures; not the Markel Insurance. This is limited to just one little wing of the business that they acquired for about $210 million a little while back.
Hill: In terms of Markel’s overall revenue streams, roughly what percentage is CATCo contributing?
Moser: I’m very glad that you asked that. It’s not a lot. To be very clear as to what this CATCo business is, they’re involved in what’s called retrocession. Again, rolls right off the tongue, doesn’t it?
Hill: [groans] God!
Moser: Isn’t insurance exciting?
Hill: Is anything duller than insurance?
Moser: [laughs] Retrocession is essentially like reinsurance for the reinsurers. It’s a way that reinsurers spread that risk to other reinsurers. It’s just part and parcel of the insurance business. So when we talk about the actual exposure to Markel’s overall business, it’s not a whole heck of a lot. If you look at the total revenues that were attributed to this Markel CATCo side of the business in 2017, for the full year, it was only $28.7 million. Markel’s trailing 12-month revenue is about $7.5 billion. This is just a drop in the bucket.
I think it was a little bit of a knee-jerk reaction. The stock wasn’t necessarily cheap before the sell-off. I wouldn’t argue that it’s cheap now, either. It’s still trading at about 1.5 times book value. But my litmus test there is ultimately, what if you just completely eliminated this CAT business from Markel’s business model? What ultimately happens? They lose a little bit on the assets under management side, but it doesn’t really impair the business at all.
Another encouraging thing is that the original management team with this CATCo business is still on. These are the guys that knew the business from the very start. It’s very difficult to come up with the reserves for these reinsurance businesses. It’s not just this set-in-stone process. It’s a bit nebulous, you have to make some assumptions, and we’ve had some pretty severe natural disasters over the past couple of years. These California wildfires are going to be contributing to that, as well.
So it’s understandable in the near term to be a little bit worried, perhaps, of what this might mean. But once you dig in, you recognize very quickly — I don’t want to say it’s meaningless, but it’s pretty close to meaningless when you’re talking about a company that I intend to own for the next 20 years-plus, hopefully. These guys know what they’re doing. I think this is one where you can see, it’s a little bit of noise in the short-term. That’s why I bought shares on that dip. I’m still confident in what they’re doing.
Hill: To this point, has Markel given any guidance or made any public statements regarding the timing of this investigation and how long it’s expected to last?
Moser: No. There’s nothing that we know, other than, they’re going to continue to cooperate and do whatever they need to do. It’s probably going to result in having to bring those reserves back up to speed. Perhaps that plays out on the book value of the stock in the near term. But again, they make their money a number of different ways. The Markel ventures side of the business alone, which is wholly owned and partially owned, these businesses that they invest in all over the country, that brought in $1.4 billion in revenue last year.
Again, the point is, this CATCo business, it’s a neat little aspect of the business, but it is not extremely meaningful. Once you can see that, I think it makes a little bit more sense to own the stock and feel at least decent about buying on a dip like that.
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