Markel Ventures: As Berkshire Hathaway Inc. (NYSE:BRK.B) in its infancy, Markel has established a sidecar venture called Markel Ventures. It’s something like a private equity firm, but with permanent capital. Like Berkshire Hathaway Inc. (NYSE:BRK.B), Markel’s modus operandi in Markel Ventures is to find solid businesses whose owners are seeking a source of liquidity and a stable and well-capitalized partner, while retaining the ability to manage his/her enterprise on a laissez-faire basis. Right now, its investments span such far-flung enterprises as specialized baking equipment, barges, and concierge medical services.
These are ultra-long-term investments. As its stock investments, Markel’s management is seeking that quadfecta. They want businesses with unique moats, fortified market positions, and long growth ramps. And they want to invest behind them, for the long term. As it stands, Markel Ventures is a relatively small part of the Markel Corporation (NYSE:MKL) enterprise, generating $60 million EBITDA last year. But given a long view, the potential is positively enormous. Remember how Berkshire Hathaway Inc. (NYSE:BRK.B), at its inception, was just a wee textile mill?
Why Markel, today?
For its very attractive long-term characteristics, a few catalytic elements in conjunction with a historically cheap valuation conspire to make Markel shares an eye-catching investment today: the transformative potential of the Alterra acquisition, strengthening insurance markets, and the compounding potential of a mini-Berkshire.
Alterra firma: I have a decidedly dour opinion of the reinsurance biz, which comprised roughly half of Alterra’s premium volume and will represent about 20% of the combined entity. It’s competitive, losses can be staggering, and save players of scale — a la Berkshire Hathaway Inc. (NYSE:BRK.B)’s GenRe — it’s hard to write business on good terms.
But the Alterra acquisition accomplishes several very important ends: a larger market presence, increased investments per share, and the potential to juice Alterra’s investment portfolio returns. And for the scrappy, competitive corners of the market it’s inhabited, Alterra’s historical results are quite impressive: It’s consistently generated underwriting profits despite record catastrophe losses. Acquired at book value, that’s not such a bad deal.
For an insurer, particularly of Markel’s ilk, opening market opportunities is doubly important: Premium growth expands its pool of investable funds, and multiplicatively increases the potential for book value growth. To wit: Markel Corporation (NYSE:MKL)’s investment leverage (investments divided by book value) increased from 2.4 to 2.6 with the deal’s completion. Not to be ignored, the bulk of Alterra’s investment portfolio was deployed to bonds. As Gayner shifts it to stocks, and returns increase, shareholders should reap the benefits.
Snowball gaining mass: Among the more beautiful, elegant, and oft-repeated elements of a well-functioning insurance company is its ability to compound value via the combination of underwriting profits and savvy equity investments. As noted above, for Markel, the Alterra deal secures its ability to grow book value. Simple math paints a pretty picture: At 2.6 times investment leverage, a mere 4% after-tax return on its investments can grow book value at a 10% clip.
With that, Markel’s ability to compound book value at a mid-teens rate of growth for two decades running suddenly becomes much less mysterious. Should its underwriting profitability begin to approximate the past decade’s results, Markel Corporation (NYSE:MKL) can easily compound book value at a double-digit clip for years to come. That would be very good.
Hardening markets: The past eight years have been a hard slog for P&C insurers. Plagued by excess capacity, the industry’s wily-nily approach to risk, and American International Group Inc (NYSE:AIG)‘s seeming willingness to write any business at any price (until recently), prices languished, increasing at below-market rates for seven years running. In things obvious: That’s a categorically unsustainable condition. In other things seemingly apparent: Insurers are in a tough spot, because in the long run, they need to earn a profit on their book. Low interest rates, which have compressed returns on bond portfolios, only exacerbated the pain for insurers.
That’s come with a silver lining: Insurers are finally starting to come around. Prices are firming, and according to insurance analytics firm Verisk Analytics, Inc. (NASDAQ:VRSK), the P&C lot collectively earned an underwriting profit for the first time in years in Q1 of 2013. If we’re to give effect to the pricing lag of years past, rates could still increase as much as 20%-30% in the next few years.
