The Westaim Corporation Update
Disclaimer: The content below is for educational and entertainment purposes only and should not be construed as investment advice or a recommendation to buy or sell any security. I own shares of The Westaim Corporation (TSXV:WED).
There have been several positive developments related to Westaim since my initial write-up roughly two months ago. The stock is up ~18% during this period but continues to trade below my estimate of intrinsic value. Here is a summary of the recent progress:
- Westaim issued a press release stating they “may consider opportunities to enhance the growth and value of HIIG” due to “several unsolicited enquiries.”
- Strong operating results at HIIG, demonstrated by the 94.7% combined ratio in Q1 2018.
- Arena announced the hiring of Parag Shah as Head of Marketing. Previously, he was Head of Marketing at Bridgewater Associates.
- Arena continues to deliver strong investing results as the Special Opportunities Fund reported net returns of 2.5% in Q1 2018. This equates to annualized gross returns in the mid-teens.
Houston International Insurance Group (HIIG)
Here is a link to the mid-April press release. Although the wording is a bit cryptic, I believe the disclosure served multiple purposes:
- Disclose to Westaim investors that several parties expressed interest in purchasing the asset
- Signal to potential bidders that a buyout would require a premium multiple since HIIG is executing well and primed for growth
- Signal to strategic sellers and advisors that Westaim may ultimately retain control of HIIG and accelerate growth through M&A
After digesting the press release, I believe a sale of HIIG is more likely as a transaction around ~1.6–2.0x book value seems to make sense for all parties. The multiple range is in line with recent specialty P&C deals (See Exhibit G from my initial write-up here) and would be accretive to strategic buyers due to cost synergies. Westaim would earn an attractive return and could redeploy the capital in higher yielding investments. Even in optimistic through-cycle scenarios (~96% combined ratio and ~5% blended investment returns), I estimate HIIG will earn ~13% on equity. In this scenario, the takeout multiple range would equate to a ~7–8% yield, which is presumably below Westaim’s hurdle rate and opportunity cost.
A transaction also seems more likely due to the strong Q1 operating results. The combined ratio of 94.7% is the best result posted since the acquisition closed in mid-2014. It suggests the restructuring is largely complete as the claims management process has been internalized and losses from legacy products are waning.
The Arena Group
Arena Investors confirmed the hiring of Parag Shah as Head of Marketing in early April. Shah previously worked at Bridgewater Associates from August 2002 through October 2017, most recently with the same Head of Marketing title. Bridgewater increased assets under management (AUM) from ~$35 billion to ~$160 billion during his tenure and Shah presumably has relationships with many institutional investors across the globe.
Additionally, the team continues to deliver impressive results. As shown in Exhibit A, Q1 2018 returns were 2.5% in the Special Opportunities Fund, net of a 2% management fee and a 20% incentive fee. The Q1 results imply annualized gross returns of ~14–15%. However, keep in mind that the majority of Arena’s AUM is held in separately managed accounts which may have slightly different portfolios.
I believe Arena is at an inflection point and AUM growth will start to accelerate. In addition to the Head of Marketing hire and strong results, assets are approaching the $1 billion threshold. This allows large institutional allocators to meet their minimum investment amounts while not making up an outsized percentage of total AUM. I would not be surprised to see commitments in the $50–100 million range over the next few quarters.
Illustrative Valuation — Updated
The below valuation analysis is updated to reflect the recent announcements and results.
The main changes in valuation assumptions include:
- HIIG: Increased assumed multiple from 1.3x to 1.5x book value given the strong results and increased likelihood of a sale.
- Arena Investors: Increased value to $120 million. As shown in Exhibit B, I estimate Westaim could earn ~$11 million in post-tax earnings if Arena scales fee-paying AUM to ~$2.5 billion over the next couple of years. Assuming a 15x earnings multiple, the ~$163 million valuation equates to a present value of ~$120 million discounted back two years at 15%.
As always, please let me know if you have any feedback or comments.