Fremont Michigan Insuracorp: A Potential Takeover Target

Co-written by Sahil Gujral

We have recently taken a more activist stance in Fremont Michigan Insuracorp (FMMH.OB). As we have previously written, there is the potential for Fremont Michigan Insuracorp to be taken over by a shrewd acquirer. At the very least, judging by Form 4 filings, insiders believe Fremont is undervalued as well. With a strong investment portfolio, no debt, and profits to boot, 1.4X book is a likely valuation in a friendly, negotiated transaction.

With the stock selling at $19.00 against $22.31 per share in book value, for a price-to-book ratio of .85, 1.4X book would translate to a buyout price of around $31 a share, or an approximately 64% premium to the current stock price of $19.00. Selling at a 15% discount to book value, there is a significant margin of safety priced in to the shares, in addition to the headquarters property which may be worth more than it is carried for on Fremont's balance sheet.

In our opinion, the absolute lowest valuation a buyer would offer would be 1.2X book, and the highest valuation a buyer would offer would be 1.5X book value, implying an approximately 40% to 76% premium to the current market price. However, we see 1.5 book as a much more unlikely, "best case" scenario with the company's current strategy and cost structure, as we understand it.

However, if last quarter's expense ratio of 36.2 could be reduced 8.2 points to 28 over time, which would represent a "best in class" expense ratio for insurers who write through independent agents, the last five years average combined ratio of 91.27 would have been reduced to an average combined ratio of 84.16. We calculated the 84.16 number by averaging the last five years' Net Loss and LAE ratios (56.16) and adding 28. Such a reduced combined ratio might yield the ROE numbers necessary to sell the company for 1.5 book value or more. In addition, it could provide an excellent catalyst for stock price appreciation from current depressed levels.

Another catalyst might be the cryptic mention of "Processing & Product Fee Income" in the company's latest 8-K presentation filed on June 26th. If this is indeed a new line of business (We are not sure if it is or not), the company needs to fully explain this in a press release, as we trust it was explicated during the presentation.

In addition, one of us has tried to convince management and the Board of Directors of the myriad benefits of geographic diversification. Even after storms have ravaged parts of the Midwest, we have not yet received a reply in writing from the Board. Perhaps an already diversified insurer might be a logical acquirer in a friendly deal. If Fremont is acquired, a buyer might save $500,000 a year or more in direct and indirect public company costs, and its current culture of being a Michigan-centric business would remain intact.

Disclosures

Harry Long owns FMMH shares directly, through partnerships, and through trusts. To the best of his knowledge, certain of his family members own FMMH shares through partnerships and trusts. Such ownership may change at any time.

Sahil Gujral does not currently own FMMH shares nor, to the best of his knowledge, do any members of his family. Such ownership may change at any time.