There is no magic in the formula KFS is utilizing to turn what was once a wart infested pariah of a company in the insurance industry into a gleaming, ornate demonstration of success through proper management paired with smart activism on behalf of a majority shareholder.
If you haven't already done so, please review the research report I wrote on KFS in April of 2014. You will notice a couple of trends that were taking place at the company a year ago. Namely, debt was in the process of being reduced in dramatic fashion (pg. 6 of research report). Meanwhile, the insurance underwriting sector which nearly torpedoed the company several years ago was near profitability (pg. 5 of research report).
Fast forward to the 10K the company released on Friday. Insurance underwriting is now profitable for the first time since pre-2008/2009 crisis. Insurance services remains profitable with a more than 100% increase in operating income year over year.
Underwriting segment was the reason for the calamity this company faced years ago. The company has emerged from the calamity with the following:
- Underwriting now profitable
- Lean, with significantly reduced debt
- New operating units with the services segment experiencing steady growth
- Management completely revamped and proven to be highly capable, creative financial artists. See former units AFH and PIH that are now public, as examples of their artistry.
- Significant tax benefits in the amount of $14.68 per share that haven't even started to be explored yet
The cream on the puff cake here is that debt is planned to be reduced entirely over the next 18 months or so. The company has LROC preferred securities principal due at the end of June for the amount of $13.6 millon. Also, there is the issue of Trups that are in deferred interest status with the 20 month limitation expiring in early 2016. There is $22.7 million in interest due there.
The interest on the Trups is accounted for as an accrued expense on balance sheet, which is why it doesn't show in the table below. As you can see, the level of income that will be generated past 2016 will rise dramatically as debt burden will be all but gone at that point. This should coincide with a sweet spot in the growth for both their services and underwriting segment. The sum total of all these events is (1) nearly no observable risk in KFS shares at this point. It is at worst a sideways performer going forward (2) a near guaranteed future date of significant share price appreciation as Wall Street plays catch up with earnings growth that nobody saw coming. The classic asymmetric opportunity, in other words:
This is a lock, stock and barrel opportunity involving little risk, brilliant management, an activist investor in Joseph Stilwell that has thrown a substantial portion of his weight into KFS, tax efficiency and the high potential for a highly accretive acquisition taking place in the next 18 months that better utilizes the $14.68 per share in NOLs that company is sitting on.
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