VALUE INVESTING
A Kick Up The RSA

By Stephen Bland (TMFPyad)
September 11, 2003

Following the recent half-year results from the company, I have sold my holding in Royal & SunAlliance (LSE: RSA)(NYSE: RSA) at around 131p. I had been holding an oversized portfolio of three shares and Royal & Sun, at the time of investment in October last year, represented about half of my then total funds. This leaves me holding a still rather obese portfolio of two shares. However, one of them, Anglo Pacific (LSE: APF), is just a very small side bet meaning that nearly all my holdings remain in one share plus a nice dollop of cash, although a fair chunk of that has already been reinvested.

With a buying price for Royal & Sun of about 108p, this means I have realised a profit over the ten-month holding period of about 21%, or 23% if I include the dividend received of 2p. By no means my greatest play ever, but better than a kick up the RSA I guess.

I always love the feeling of going cash but, at the same time, I have a somewhat dichotomous relationship with it and start to get itchy again soon after. With interest rates so excruciatingly low, almost nothing if you are a 40% taxpayer, there is little incentive to hold cash apart from the fact that it is safe. But that does not mean that as a value player I am prepared to buy just anything purely to get out of cash.

Interestingly, Royal & Sun's shares had run up ahead of the results announcement, going over 150p despite the widespread press speculation of a rights issue. Normally, rights issues depress share prices but in this case, although that happened initially when the press rumours first broke, the shares subsequently rose quite well. Unfortunately though, in the event the market did not like the facts. I don't care what the market thinks, in fact value plays lead me to do the opposite, but I did not like the figures too much either.

The problem was not the rights issue itself, I could have lived with that, especially as current profitability has increased pretty well, but the substantial further provisions of some £800m required for old claims. I had thought until then that all the bad news was out of the way, bearing in mind that Royal & Sun has suffered in recent years from a quite staggering amount of bad news, both on claims and from the bear market effect upon its investments. This suggested to me that a further serious rise in the shares was likely. But the results changed my mind. I will always sell when a share fails to demonstrate sufficient value for me to continue holding. This can happen simply because the price rises or because of adverse figures and news.

Furthermore, and an important point for me, the interim dividend was cut from 4p to 2p. One thing, in most cases, I require from my value shares is a decent yield. This provides a nice income while waiting, plus yield in itself is a value indicator, but this was now lost with Royal & Sun.

The rights are 1 for 1 at 70p. This is way below the existing tangible book value per share of around 200p. The effect is that the new tangible book value, once the new shares relating to the rights issue have been issued, must be a lot lower. It will be something like 130p.

With the shares at 131p when I sold, the theoretical ex-rights price would therefore be about 100p, meaning that they would still be well below new book value of 130p, but at a rather lower discount than they were previously. To maintain the same discount to book value, a price of around 85p ex-rights would be required. In turn this means that the pre-rights share price would need to fall to about 100p in order to equate to the previous discount to book value.

It could though be argued that a smaller discount to book was justifiable post rights, because the cash raised reduces the overall risks of the company. That's not an argument that interests me.

Anyway, with the low yield and the continued risks involved as demonstrated by the latest additional provisions, the discount to book value alone was not enough to keep me in. As a short-term value play, for me, this was time to dump.

None of this means that the shares might not again become attractive at some point if the price goes low enough, but that is something I would re-assess at the time according to my perception of them then. Although this is the third time I have traded these shares, the first being with the old Royal, before the merger with Sun, nostalgia plays no part in my decisions. What has happened is that they have often traded so far below book value, plus exhibited other attractions like a good yield, that I have become interested.

Generally, I have always found big insurance companies to merit a look when they go well below book value. I would not buy on that criterion alone -- yield and several other factors will also be important -- but the asset point is often very attractive.

Clearly though, book value is a moving target with insurers because this will comprise large holdings of equity investments. In a bear market therefore, this will decline and the emotional gearing involved, even if the actual equity holdings are not that critical, will usually cause the insurer's shares to decline more rapidly than the market. The reverse happens in a rising market and as we have seen, Royal & Sun had been until recently one of the best performing shares since the market turned up.