Stock Mart: Scottish Annuity

Someone tells you that you can buy a pool of money by spending 72 cents for every dollar you receive. Is it a scam?

No, say fans of Scottish Annuity & Life Holdings (SCOT). It's a bargain, they say.

As of March 31, the fledgling reinsurance company was sitting on a $256 million fixed-income investment portfolio and shopping around for reinsurance business to transact. That hoard translated into a book value of $13.52 a share -- well above Scottish Annuity's Friday closing price of 9 3/4 a share, up 3/16.

"There aren't that many opportunities to buy anything for 9 1/2, 10, when book value is $13.50 or thereabouts," says Paul Newsome, senior analyst at CIBC World Markets, which was a co-manager of the company's IPO last year. "It's a pretty hefty discount. It doesn't happen very often." Newsome has a strong buy rating on the stock, the firm's highest rating.

The company's price-to-book ratio of 0.7 compares favorably to that of Annuity and Life Re (ALRE), another reinsurance company that went public last year. Annuity is trading at 1.7 times its book value. A more established reinsurance company, Reinsurance Group of America (RGA), is trading at 2.3 times book value.

So what exactly does Scottish Annuity plan to do with its money? The Cayman Islands-based company is in two major lines of business. The first is life reinsurance, or insuring the risk of life insurance products that have already been written. More specifically, the company, according to CEO Mike French, is insuring annuity products -- those products that promise people annual payments, as opposed to insurance that focuses on death benefits.

The company also is in the life insurance business itself, writing variable-life policies for high-income customers (and using reinsurance itself to spread this risk around).

But Scottish Annuity expects that the biggest part of its business will be reinsurance, a field in which the company is targeting a 15% return on equity.

The company's chairman is Sam Wyly, the Texas investor atop the Maverick Capital investment firm, which had $2.5 billion under management as of October. French, an attorney by training, was a Maverick managing director. CFO Peter Presperin is a CPA with 20 years of experience in the insurance business. Chief insurance officer Henryk Sulikowski, who comes from Swiss Reinsurance, has "an excellent, excellent reputation," says Newsome at CIBC. And in recent months, the company has added insurance industry veterans to its actuarial staff.

"I think they understand the reinsurance business," Newsome says.

That hasn't prevented the company from stumbling in the past year. The company reported earnings about 12% lower than expected for the first quarter because its portfolio yield was smaller than expected.

"The company has made some steps to fix that," Newsome says. "We're really not that concerned about it because what we think is key to the story is the signing of reinsurance contracts and, to a lesser extent, the selling of life insurance policies."

Even after analysts lowered their estimates, the company is still a bargain using a price-to-earnings yardstick. As of Friday, it was trading at about 14 times the First Call consensus of estimated 1999 earnings; Annuity and Life Re, by comparison, was trading at about 19 times.

The company's boosters aren't limited to the Wall Street firms that brought it public. Keefe Bruyette & Woods, which hasn't done underwriting for the company, rates the firm attractive, its second-highest rating.

So why is Scottish Annuity's stock so low? Problems started with the IPO last November. After going out at 15 a share, it peaked at 16 1/8 on the first day of trading, closed at 13 15/16 and hasn't made it back to its offering price. "With so many hot IPOs, when an IPO doesn't pop sharply, right away, investors tend to view it as a broken IPO," says Newsome.

The other is investor impatience. For all the money and personnel at its disposal, Scottish Annuity just hasn't done much reinsurance business. It decided not to go through with a deal it was contemplating at the time of its IPO; it took until early May to announce its first reinsurance deal, which ties up $11 million in capital. On Friday morning, the company said it had signed a definitive agreement to acquire Delaware-based Harbourton Reassurance, an deal that Scottish Annuity said would open up new reinsurance opportunities in the U.S.

"These guys have not ramped up their deals as quickly as expected, so people are saying, 'I don't want to be around anymore,'" says a fund manager holding the stock, speaking on condition of anonymity.

French, the CEO, says the criticism is unfair. "We were careful to try to tell people you don't write this business overnight," he says. "We're on target in that we're very comfortable with the business flow we're seeing."

He adds, "We probably stumbled a little more in public relations than in operations."

Newsome agrees. "With any new company, there's a transition point where you learn how to manage investor expectations and learn how to communicate with investors," he says. "They haven't necessarily gotten those skills down."

Adds the investor, "Once they start cutting reinsurance ... the stock should do very nicely."

All the company needs to attract attention, perhaps, is a little bit more action.

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