Marsh McLennan (MMC) has endured two long ordeals and appears to be surviving both of them. First, an after-hours trading scandal and inferior investment performance combined to cause MMC's investment arm, Putnam Investments, to decline more than $200 billion in assets, starting 2000 with more than $390 billion under management and finishing 2005 with less than $190 billion. Second, Eliot Spitzer accused MMC of unethical practices, forcing new commission structures in its insurance brokerage division. As a result, MMC saw its brokerage margins move from 30% to less than 10%.
With these ordeals basically behind MMC, what lies ahead? Putnam Investments is still sizeable with $190 billion under management, arguably valued at nearly $6 billion by applying the multiples accorded other public traded mutual funds. This translates to about $11 per share, assuming the bleeding continues to be stanched.
The brokerage division is still powerful, sharing the title of largest in the world with AON. With the loss of contingent commissions, MMC's brokerage appears to be at reduced 14% operating margins, still giving an operating income of about $800 million. By applying a multiple of 10 times operating income, the brokerage area is arguably worth about $8 billion or $15 per share.
The two remaining divisions have been unhampered by controversy. The Mercer consulting division has been growing and should contribute about $500 million of operating income. Again, by applying a multiple of 10 times operating income, Mercer may be worth about $9 per share. The Kroll risk management division has done well and is probably worth another $4 per share, bring the entire value of MMC to about $39 per share, significantly higher than the current $31 per share. However, the long term debt level has risen and when subtracted, the intrinsic value seems close to current market levels.
Thursday, November 9, 2006
Friday, October 6, 2006
Wells Fargo: Wild At Heart
In reviewing the 2005 annual report of Wells Fargo (WFC), some surprising facts emerge. While WFC is the only bank in the U.S. rated Triple A by Moody's, risk-taking behaviors do lurk under the surface. The first surprise was that WFC made more money as a venture capitalist last year ($500 million) than it did through its 1200+ stores in consumer finance ($400 million). The second surprise was that junior lien mortgages stood at nearly $60 billion or 20% of the loan book. This seems a departure from Triple A behavior. It will be interesting to see how these perform over this tightening cycle.
Tuesday, September 26, 2006
Coastal Insurance
An article in the NYT today describes the rising cost of insurance for homeowners on the coast. Insurance premiums are rising between 100 and 1000% for homeowners, depending on the materials used in construction and whether the home is single-family or condominium.
Such high premiums are required. Despite the appearance of gouging, insurance companies are aware that historical loss models have not protected them. Coastal insurance premiums have been dramatically underpriced, given recent experience. This may finally bring people back to the reason that coasts were not populated in the first place - no one wanted the high risk of loss. Thus, the coasts were populated with disposable structures by people who could afford to lose them. Mortgages were rare on the coast.
Of course there is a wild card. The Federal Government may just tax the rest of the country to cover the risks taken by coastal dwellers. Already, flood insurance is subsidized by those who don't use it. FEMA has flood policies that are much cheaper than what private insurance would charge. A fair approach is for the government to move these risks and their management to the private sector so that coastal dwellers bear the true costs of ownership. However, the article suggests that perhaps costs may move the other way - all coastal insurance may be transferred to the government.
Such high premiums are required. Despite the appearance of gouging, insurance companies are aware that historical loss models have not protected them. Coastal insurance premiums have been dramatically underpriced, given recent experience. This may finally bring people back to the reason that coasts were not populated in the first place - no one wanted the high risk of loss. Thus, the coasts were populated with disposable structures by people who could afford to lose them. Mortgages were rare on the coast.
Of course there is a wild card. The Federal Government may just tax the rest of the country to cover the risks taken by coastal dwellers. Already, flood insurance is subsidized by those who don't use it. FEMA has flood policies that are much cheaper than what private insurance would charge. A fair approach is for the government to move these risks and their management to the private sector so that coastal dwellers bear the true costs of ownership. However, the article suggests that perhaps costs may move the other way - all coastal insurance may be transferred to the government.
Small Cap "Sure" Seems High
Signs of factors driving up the valuation of smaller companies continue to appear. The WSJ announced that a private equity company named Innovative Brands LLC is expected to purchase the deodorant Sure from Proctor and Gamble (PG) for $100 million.
As stated in an earlier post, I am seeing large companies and private equity concerns bid up the prices of smaller companies. The result has been a dramatic premium for lower quality companies over their larger and more powerful competitors.
The sales of Sure last year, ex-Wal-Mart, were $35 million. Assuming about a 12% number for Wal-Mart, I estimate the total sales were $40 million, putting the total sales price at 2.5 times sales. This is roughly the same multiple that PG is selling at. Given the dramatically superior characteristics of PG as a company to the single product line of Sure, it would seem that either PG is cheap or Sure is too high. Or both.
As stated in an earlier post, I am seeing large companies and private equity concerns bid up the prices of smaller companies. The result has been a dramatic premium for lower quality companies over their larger and more powerful competitors.
The sales of Sure last year, ex-Wal-Mart, were $35 million. Assuming about a 12% number for Wal-Mart, I estimate the total sales were $40 million, putting the total sales price at 2.5 times sales. This is roughly the same multiple that PG is selling at. Given the dramatically superior characteristics of PG as a company to the single product line of Sure, it would seem that either PG is cheap or Sure is too high. Or both.
Monday, September 25, 2006
Impact of Tobacco
Tobacco presents an investing dilemma. On the one hand, the profits are enormous. On the other hand, the impact on lives is certainly destructive. A recent discussion with Pfizer's former CEO "Hank" McKinnell reveals a couple of significant facts.
First, he states, "the newly released Cancer Atlas says that upwards of one billion people will die this century due to smoking-related illnesses." The number speaks for itself. Is it really that bad? Can't these deaths be averted?
Apparently not. McKinnell states, "People are addicted to nicotine. In fact, it's as powerful an addiction as heroin. Therefore, telling people to just stop smoking obviously doesn't work. Over 90% of smokers try to quit, but only 5% who try actually succeed."
What makes nicotine so powerful? Apparently, it moderates personal reactivity. When someone is depressed, it lifts one up and when someone is too anxious or manic, it sedates them. The combination is miraculous, but the damage to lungs is overwhelmingly bad. The key is probably some alternate nicotine delivery system.
I remember making a loan to a classmate in high school who might have been up to no good with the money. How else could I explain his payment of 50% interest rate per week? Ultimately, I bought into that mixed line of reasoning - "the devil's had that money long enough."
First, he states, "the newly released Cancer Atlas says that upwards of one billion people will die this century due to smoking-related illnesses." The number speaks for itself. Is it really that bad? Can't these deaths be averted?
Apparently not. McKinnell states, "People are addicted to nicotine. In fact, it's as powerful an addiction as heroin. Therefore, telling people to just stop smoking obviously doesn't work. Over 90% of smokers try to quit, but only 5% who try actually succeed."
What makes nicotine so powerful? Apparently, it moderates personal reactivity. When someone is depressed, it lifts one up and when someone is too anxious or manic, it sedates them. The combination is miraculous, but the damage to lungs is overwhelmingly bad. The key is probably some alternate nicotine delivery system.
I remember making a loan to a classmate in high school who might have been up to no good with the money. How else could I explain his payment of 50% interest rate per week? Ultimately, I bought into that mixed line of reasoning - "the devil's had that money long enough."
Thursday, September 14, 2006
Small Cap Valuations
The recent purchase of Reynolds and Reynolds (REY) by Universal Computer Systems explains some of the unusual valuations of smaller companies. Small companies have historically been valued at 20-25% less than their larger rivals. However, over the past few years this valuation has dramatically reversed so that now smaller companies trade at roughly 50% higher valuations. What's going on?
REY was just purchased by Universal Computer Systems. REY was founded in 1866 as a business forms company, refocused in 1927 to help car dealerships and has been recently a major computing systems supplier to the car dealership business. We have studied them for years. However, with no growth in earnings, REY's tremendous free cash flows have only justified a purchase valuation of $20 (10X cash flow) with roughly $40 as a sell price. That $40 is exactly what UCS paid. How do they pay top dollar?
Private equity. UCS is keeping the Reynolds and Reynolds name, trying to get some "synergistic" growth, removing a competitor all with private equity money. In a world of slow growth and low interest rates, these easily leveraged small companies are miracles of finance, justifying extraordinary multiples (63 here) in a low P/E market.
REY was just purchased by Universal Computer Systems. REY was founded in 1866 as a business forms company, refocused in 1927 to help car dealerships and has been recently a major computing systems supplier to the car dealership business. We have studied them for years. However, with no growth in earnings, REY's tremendous free cash flows have only justified a purchase valuation of $20 (10X cash flow) with roughly $40 as a sell price. That $40 is exactly what UCS paid. How do they pay top dollar?
Private equity. UCS is keeping the Reynolds and Reynolds name, trying to get some "synergistic" growth, removing a competitor all with private equity money. In a world of slow growth and low interest rates, these easily leveraged small companies are miracles of finance, justifying extraordinary multiples (63 here) in a low P/E market.
More About Wal-Mart
Wal-Mart is controversial. Here is a company which I believe is doing more for the quality of life for lower-income citizens than any company in the world and yet it is despised by the Democrats and loved by the Republicans. How can that be? Doesn't the Democratic party pride itself on helping the common man (which, IMO, is a goal worthy of pride)?
A recent Wall Street Journal article describes just one more fact supporting my nomination for Wal-Mart as the first corporate winner of the Nobel Peace Prize. It reports: "Wal-Mart's prices for the financial services are lower than many competitors. Wal-Mart charges 46 cents for a money order, compared with as much as $1.30 at the post office. The company also charges a maximum of $3 to cash a payroll check; check-cashing firms usually charge 2% to 3% of the check's face value." Generally, Wal-Mart increases the purchasing power of our lower-income citizens by 25%, but here it's 50%. No wonder the banks are screaming about Wal-Mart getting a banking permit. Better watch out; pretty soon the Republicans will hate them as much as the Democrats already do.
A recent Wall Street Journal article describes just one more fact supporting my nomination for Wal-Mart as the first corporate winner of the Nobel Peace Prize. It reports: "Wal-Mart's prices for the financial services are lower than many competitors. Wal-Mart charges 46 cents for a money order, compared with as much as $1.30 at the post office. The company also charges a maximum of $3 to cash a payroll check; check-cashing firms usually charge 2% to 3% of the check's face value." Generally, Wal-Mart increases the purchasing power of our lower-income citizens by 25%, but here it's 50%. No wonder the banks are screaming about Wal-Mart getting a banking permit. Better watch out; pretty soon the Republicans will hate them as much as the Democrats already do.
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