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Just bought some Emergent Capital at $2.90 a share (yet another truly awful fill) -7.4% portfolio weight EDIT 8/11/2016 *Cut to 3.7%*.  This, in essence is a portfolio of life insurance policies.  It is trading at a market cap of about $76m.  The NAV is $220m so there is the potential for a near tripling in value.

This has been written up on Seeking Alpha and in the Value Investor’s club.  I havent read the Seeking Alpha one (no subscription).

The key facts are:

  • The company has a $30m lawsuit (+ punitive damages) vs SunLife Assurance Company of Canada.  Best information I have is that the court date was set at 31st October 2016.  I have no idea how much the punitive damages are likely to be, or how long it is likely to take but it is significant. *EDIT 3/11/2016 I have been informed that they lost this on 2nd September – no announcement was made.*
  • The company has announced it received “a number of unsolicited inquiries from several interested parties” on August 1st 2016.  The share price has fallen since then to c$2.78 from a high of c$4.20 in early August.
  • The company’s policies are valued at a 16.5% discount rate and the substantial level of debt the company holds also have very high rates of interest.  If an acquirer has a lower cost of capital than this there is the potential for them to add value.  If we get into a bidding war there is the possibility for the shares to go much higher – although I dont think the odds of this are good.
  • A similar (but smaller) company TLI – recently sold at NAV – again being valued at a similarily high discount rate.  For more on TLI check out Wexboy’s blog here.
  • Emergent Capital hey have sold a number of policies at about 10-15% less than what they were in the books for – albeit a couple of years ago.  This still gives substantial upside…
  • Management have been buying shares at  over $4 and they bought their own shares back in 2015 at $4.17.  They have options at $8.50 – which I don’t think they will ever be able to exercise…
  • No excessively large/ dominant shareholders.

Going back a step.  These are US life insurance policies bought by wealthy US individuals they pay a premium – and if they die their estate gets the value of the policy money.  These can be sold, and if the premium is still paid and whoever pays it get’s the value.

There is scope for fraud as with a lot of insurance.  These policies are often financed with loans secured by charges over the individual’s assets which can be misstated – known as premium financing.  Further when selling policies individuals can misstate life expectancy and related details.   This is in addition to the usual misselling of financial services.  There was an investigation of the company and a payment in association with a premium financing business $6.5m was paid but $56.6m of costs!  On the plus side following such a through investigation by the US attorney office we can be pretty sure the portfolio is reasonably clean.  On the other hand perhaps there wouldn’t have been such an investigation without some reasonable suspicion….  Only half the assets were ever premium financed – and they are discounted at a higher rate so there is still potentially value here…

 

EDIT 3/11/2016 There may be a credit crunch coming – premiums that were anticipated to be paid exceed those anticipated to be received over the next few years.  I am unsure as to the exact impact of this – and it is very material.  What I do know is that the quarterly statement says:

At June 30, 2016, $54.0 million was undrawn and $307,000 was available to borrow under the Red Falcon Revolving
Credit Facility. The amount available to borrow is calculated based on and limited to the premium payments and expenses if any, that are due as of the
calculation date. In essence, what is available, is what is required to pay expenses and keep the policies in force as of the calculation date.

If that $54m can be drawn we are fine to keep the company financed, if not we may be in trouble here.*EDIT 8/11/2016* Looks from comments made on conference call they cant draw the $54m only the $300k  – they have about 10m cash burn remaining.

There is risk here – lots of debt at very high rates of interest, the policies need to be maintained by payment of annual premiums and they can be raised by the issuing insurance company.  There is also longevity risk – shareholders only get paid once the holders die, they may not.  There are good tables showing expected mortality on page 62 of their 10k.  The expected life expectancy is 9.9 years.

Even if people die early (known as settlement) there are waterfall payments – so debt gets paid before distributions can be made to shareholders…

None of this really matters.  What is important is that there is an undiscounted $2.9bn to be received and $1.4bn to be paid in premiums – in addition to debt and  interest on the debt, it might take 20 years but it will come.  Key questions driving the valuation are:

  • How long do they live?  The longer the less the portfolio is worth.
  • What rate do we use to discount the future cashflows?  The company uses an average rate of 16.5% (Q2 results).  If this falls 0.5% the value of the portfolio goes up 2.5%.  If any acquirer has a lower discount rate the value of the portfolio goes up.
  • Will premiums go up – they could destroy value?  Lots depend on the wording of insurance and contract norms.  This is the area I have the weakest understanding of.  I believe the insurance company can’t just jack up rates whenever it wants, but it can raise them and my understanding of this is limited…

This is an utter pain to deal in.  It’s the first small cap US stock I have ever invested in.  There is very little on offer.  I managed (with the help of another guy, or some malignant bot) to drive the price up 5% when I dealt.  I wasn’t dealing much… After I finished straight back down again… I would suggest you put limit orders on and wait…

What I hope will happen here is an announcement and a sale, or a law-suit win.  I expect a doubling to tripling – hopefully within 6 months to a year.

I would love to know what you think.

This of course is not investment advice and, like any stock this could go to 0.

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