Greenlight Capital Re, Ltd.

Buy Price: $12.90

Overview:

At current prices, Greenlight Capital Re ("Greenlight") provides an excellent opportunity to piggy-back off of the future investment performance of one of the superior value-oriented money managers of our time, David Einhorn, founder of the hedge fund Greenlight Capital.

Greenlight, founded in 2004 by Einhorn (who owns 10% of the company) operates as follows: Einhorn has hand-picked a few reinsurance veterans to head up a Cayman's based underwriter which writes casualty and property reinsurance contracts through a network of brokers. Unlike many (re)insurers, Greenlight focuses its underwriting on, and management is compensated upon, multi-year underwriting performance rather than sheer volume. The goal is long term underwriting profit (premiums collected less claims paid out). Thus far, management has been clear that it will not write policies if not profitable, it will instead sit on its hands and rely on investment performance. It should be noted that there have been and will be times when writing reinsurance policies by themselves (absent investment performance) is a losing business. The price of insuring risk fluctuates. Insurance premiums collected are then managed by Einhorn through DME Advisors (the management company of Greenlight Capital, the hedge fund). Note that Greenlight will pay fees and expenses to DME Advisors (the classic 2 and 20) just like other hedge fund investors.

The Company then profits in two ways: (1) the net difference between premiums paid for reinsurance contracts written, (2) returns on the investment of these premiums. This model may sound familiar to stock market followers - Warren Buffet has invested insurance premiums, or "float" for years. In addition to owning primary insurers (e.g., GEICO), Berkshire Hathaway also owns General Re, the world's third largest reinsurer. Insurance premiums allow an investor to essentially borrow money via an interest-free loan and invest this money. Sometimes, the (re)insurer must return all of the money, sometimes more of the money, and if contracts are written by keen actuaries with an eye towards underwriting profit, slightly less of the money.

David Einhorn:

Few investors have as stellar a performance record as David Einhorn. Starting with $1M under management in 1996 after a stint as an investment banker, Einhorn's fund has delivered anual returns of over 24%, after fees and expenses. Even more astonishing is that these returns have come without the use of leverage. Einhorn is a classic long/short stock picker, relying on relentless due diligence. As he puts it, he invests long in 9s or 10s, and shorts 1s and 2s. The stability of his investment performance (inherently hedged to overall market risk through the use of a long/short strategy) has allowed Greenlight to maintain an A- (excellent) rating from A.M. Best. We believe that Einhorn will continue to produce market beating performances (not constantly year-in and year-out but over a longer time horizon), not just because of his past performance record but because he and his team devote themselves to uncovering misunderstood situations and show an analytical ability few can match. These investment returns combined with underwriting profit will allow for compound growth that will likely substantially outperform the market for years to come.

Taxes:

In addition to the compound investment returns that result from underwriting premiums, Greenlight also comes with a built in tax advantage. As a Cayman Island's corporation, Greenlight doesn't pay corporate income tax, further allowing for compound growth in investment income. This treatment comes with some risk (see below).

Valuation:

Traditional valuation ratios (PE, PEG, EV/EBITDA) are largely irrelevant when discussing a reinsurer such as Greenlight. Profit will fluctuate wildly from year to year based on investment returns.

Greenlight's goal is to instead increase tangible book over time at a market beating rate. Assets will consist of investments managed by Einhorn and cash available to pay claims. In most years, we anticipate that Greenlight will trade at a modest premium to book value (reflecting Einhorn's superior investment performance). Greenlight currently trades at a slight discount to book value, which we believe presents a compelling investment opportunity. If Greenlight begins to trade at a premium to book value that we believe is unsustainable we will consider selling our position.

At a given moment, Greenlight will have cash roughly equal to its outstanding liabilities (which consist of an actuarial estimate of claims), and thus its book value will roughly equal the amount of money invested with Einhorn.

Risks:

Greenlight comes with several risks, including (1) underwriting risks, (2) investment risks, and (3) organizational/tax risks. Underwriting, particularly in the property and casualty space comes with inherent risks beyond the control of management, including the occurrence of natural disasters. While we believe Einhorn's investment performance will beat the market over a long period of time, Greenlight's investments are subject at any time to market dislocations or even mistakes of Einhorn. Greenlight could also lose its current tax status if deemed to be a passive foreign investment under US law. If so, stockholders would be taxed based upon on corporate level earnings at their ordinary income rate. Greenlight will need to be conscientious about being a reinsurer first, and a hedge fund investor second.

The Bottom Line:

Long 10%

We are allocating 10% of our portfolio to purchasing Greenlight. We will continue to monitor price to book value going forward.