WHITE MOUNTAINS INSURANCE GROUP LTD quarterly report, Q2 FY2018

Business context and reporting period

White Mountains Insurance Group, Ltd. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2018. Its businesses include municipal bond insurance and reinsurance (HG Global/BAM), specialty insurance distribution (NSM), marketing technology (MediaAlpha), and investment and other operations. Unless indicated otherwise, financial amounts are in millions of dollars.

Key financial results and position

Metric	Three months ended June 30, 2018	Six months ended June 30, 2018
Total revenue	$122.3; prior year $83.5	$164.4; prior year $172.3
Pre-tax continuing-operations loss	$(12.4); prior year $(2.2)	$(78.4); prior year $(5.8)
Net income (loss) attributable to White Mountains common shareholders	$3.5; prior year $13.6	$(44.5); prior year $42.6
Basic and diluted EPS, consolidated operations	$1.02; prior year $2.97	$(12.41); prior year $9.31

• For the six-month period, investment returns were a major earnings swing: pre-tax realized and unrealized investment losses were $43.2, versus gains of $70.0 in the prior-year period. Net investment income increased to $31.5 from $27.5.
• MediaAlpha reported $71.8 revenue and $4.5 pre-tax income in Q2; six-month revenue was $143.5 and pre-tax income $4.3. Its Q2 gross profit was $11.9 (about 16.6% of revenue); first-half gross profit was $24.6 (about 17.1%).
• Operating cash flow from continuing operations was $(25.5) for the first six months, versus $(66.2) a year earlier. Net cash provided by investing activities was $526.5; net cash used in financing was $467.1. Cash at period-end was $131.1.
• At June 30, total assets were $3,368.1, total liabilities $570.6, White Mountains common shareholders’ equity $2,940.1, and total equity $2,797.5. GAAP book value per share was $924.46 and adjusted book value per share was $912.08; both increased 1% in Q2, while year-to-date GAAP book value per share declined 1% including dividends.
• Debt was $169.6 carrying value, compared with $23.8 at year-end 2017; total debt to adjusted capital was 5.5%, versus 0.7%. Management reported compliance with all debt covenants.
• Management reported $728 of net unrestricted cash, short-term investments and fixed maturity investments at the Company and intermediate holding-company level. This is distinct from consolidated cash and investments held within operating subsidiaries.

Material changes versus the prior comparable period

• White Mountains acquired 95% of NSM on May 11 for $274.2 cash consideration; NSM’s results are included from that date. NSM acquired U.K. broker Fresh Insurance on May 18 for about $49.6 upfront, with contingent earnout consideration also recorded. NSM contributed $23.5 of revenue and $3.2 of pre-tax income in the reported period.
• MediaAlpha revenue more than doubled year over year in Q2, with management citing growth in property and casualty and Health, Medicare and Life verticals, including the contribution from the 2017 Healthplans.com asset acquisition.
• During Q2, the Company repurchased and retired 575,068 common shares for approximately $505 at an average price of about $878 per share. Total first-half repurchases were $513.1. Shares outstanding declined to 3,180,358 from 3,750,171 at December 31, 2017.
• First-half revenue declined despite the newly consolidated NSM and MediaAlpha growth, reflecting the sharp reversal in investment gains and the absence of prior-year discontinued-operation revenue. OneBeacon was sold in September 2017; its prior-period results are presented as discontinued operations.
• BAM’s claims-paying resources rose to $827.2 from $708.4 at year-end, primarily due to a new $100 collateralized reinsurance arrangement with Fidus Re.

Outlook, risks, contingencies and unusual items

• The filing provides no specific earnings or revenue guidance. Management said cash balances, operating cash flows, and routine investment sales and maturities were adequate for expected requirements for the foreseeable future, while noting access to external financing is not assured on satisfactory terms.
• BAM insured $3.1 billion of municipal bonds in Q2 and $4.4 billion in the first half. First-half gross written premiums and member surplus contributions were $40, versus $48 a year earlier; management attributed the decline chiefly to lower first-quarter issuance after issuers pulled forward activity amid tax-reform uncertainty. Pricing was 100 basis points for the first half, compared with 98 basis points.
• NSM’s $151 term loan bears floating interest; its effective blended rate was 6.84%, or 7.47% after the interest-rate swap at June 30. The debt is secured and subject to financial covenants. The filing identifies risks from interest rates, investment markets, competition, regulation, ratings actions and availability of capital.
• MediaAlpha generated approximately 32% of its Q2 and first-half 2018 advertising revenue from one customer, a material customer-concentration risk.
• NSM and White Mountains guaranteed an arrangement under which AIG may require NSM to purchase U.S. collector-car renewal rights for $82.5 if a sale is not facilitated by December 31, 2019. Management believed fair value exceeded the purchase price and recorded no liability.
• A Swedish tax dispute involving a former subsidiary could require White Mountains to indemnify Sirius Group for approximately $17.3 if the tax authority prevails; the Company believed the subsidiary would prevail.
• BAM’s Fidus Re agreement is accounted for as a deposit, not reinsurance, and entails financing expense. BAM retains the first $165 of aggregate covered losses before the loss-sharing applies; the agreement’s aggregate loss limit is $276.1. Payments on BAM surplus notes require regulatory approval.
• Management disclosed no current litigation expected to have a material adverse effect, no material changes to previously reported risk factors, and no significant internal-control changes. Disclosure controls were assessed as effective.

Important facts for investors to verify

1. How much of first-half losses reflects market-driven investment marks versus recurring operating performance, and how the portfolio repositioning affects future returns.
2. NSM and Fresh Insurance acquisition accounting, purchase-price adjustments and earnout assumptions; also monitor NSM’s leverage, floating-rate exposure and covenant headroom.
3. Whether MediaAlpha’s rapid growth can be sustained, given its customer concentration and revenue-share-linked cost of sales.
4. The potential economics and eventual outcome of the AIG renewal-rights obligation and the Sirius-related Swedish tax contingency.
5. BAM’s underwriting and pricing trends, Fidus Re protection terms, claims-paying resources, and regulatory constraints on surplus-note payments.
6. The deployment of the reported $1.3 billion of undeployed capital after the substantial share repurchase and acquisitions, and the effect on book value per share.