Montpelier Re (MRH), my only core investment right now, has been a dissapointment lately. I don't follow it closely but do keep an eye on it once in a while. It suffered huge losses on their investment portfolio last year, which is never a pretty sight when the insurer is mostly investing in supposedly "safe" assets. As I indicated in my outlook for 2009, I am bearish on insurers. If interest rates stay low, we may see a period like the 40's or 50's, when insurance companies, who mostly own bonds, don't earn much off their investment portfolio. For this reason, I am not too optimistic with these companies in aggregate. However, specific companies can be good investments.
In any case, in the latest quarterly conference call, I noticed something that I wish more businesses were doing. Namely, buying back bonds:
The second was a repurchase of 21 million of our outstanding 2013 Senior Notes or 15 million resulting in an immediate $6 million gain and a 1 million annual interest savings going forward.
Some would argue that buying back shares is the best thing to do right now. Shares seem cheap to many. I'm probably in the minority camp who feels that shares may not be cheap. Clearly we have many, including Warren Buffett (at least if we use his opinion piece from October of last year), saying that shares are undervalued. I'm just a newbie with little experience but I am not certain that shares are cheap here—even though we have seen two major stock market crashes in the last decade. Since, in my opinion, the risk to earnings is to the downside for most companies (i.e. corporate profit margin for the next 10 years likely to be worse than the last 10 years), buying back shares can be risky. Leverage cuts both ways and when earnings collapse, it will amplify the pain. If it works out, it will look great but if it doesn't, it would look like some idiot who bought back his shares at $50 only to see it trading at $30 two years later.
Others would argue paying out dividends is the best thing to do now. Dividends are becoming scarce and the hence it will be valued more by the market than it was possibly at any point in the last 20 years. By increasing the dividend by, say, 5%, you can attract the passive investors who blindly buy on screens (such as companies that are increasing dividends.) In Montpelier Re's case, dividends probably don't matter much since it is a very risky company and very few would consider it a 'divdend stock.' In general, though, I am not a fan of dividends and hence I don't like companies raising dividends.
On the other hand, I think it is probably better to buy back bonds, assuming you are certain you have excess cash. Bonds look even cheaper than stocks to me. Many bonds are trading 20% to 40% below par value. In this case, it seems Montpelier Re bought back the bonds around 29% below par value. Buying back bonds will also reduce leverage going forward. Some investors seem to like leverage but I don't view it as positively as many others, especially if one is not confident with future profitability.
So, companies that are sitting on large piles of cash, and are certain they won't be needing that cash, should start buying back their bonds. Tags: Montpelier Re (MRH)