Helios Underwriting — Huge capacity increase follows capital restructure

Helios Underwriting reported FY24 expected underwriting capacity of £501.8m on 15 December 2023, a huge 61% increase on the 30 June 2023 capacity update and 69% on the update at the start of the year (see Exhibit 1 below). Of this gross capacity, £387m is expected to be retained, which represents a 62% increase over the year and 58% on the level disclosed as at H123 of £244.5m. This is a marked increase in capacity compared to its 8 November 2023 capacity update and was achieved in conjunction with a significant capital restructure and the introduction of ‘rental capacity’. Capacity of £114.9m is expected to be ceded to third parties for FY24.

While the ceded amount has historically almost fully represented QS reinsurance, Helios is expected to ‘rent’ up to £55m of its £501.8m FY24 capacity to other third parties under a new ‘rental capacity’ initiative with Argenta Private Capital Limited (Argenta). The ‘rental capacity’ initiative is aimed at third parties active at Lloyd’s via the member agent pooling arrangement (MAPA). £22m will be ‘rented out’ using Helios’s existing limited liability vehicles (LLVs) with a further 10 new LLVs created and already capitalised by Helios, offering up to a further £33m of capacity to the open market in H124. The ‘rented’ capacity will be in the form of tenancy capacity in the hands of the third parties, allowing for ownership over a 12-month period, which is likely to be extended on an annual basis. The third parties will pay a fee of 1.25% of the amount of capacity ‘rented’, which is almost twice as much as the fee paid by QS reinsurers, enhancing returns for Helios. If successful, the annual amount of rented out capacity is expected to grow, in conjunction with both Argenta and other members’ agents currently being pursued.

Over FY23 to 8 November 2023 (as per the company announcement on the date), Helios added capacity from the following sources, affecting its capacity value (WAV), which makes up the bulk of FY23 balance sheet intangible assets (see Exhibit 1 below):

In addition, due to strong pricing in the Lloyd’s auctions, resulting in a c 6.5bp higher weighted average price for the Helios syndicate portfolio, the company’s WAV was revalued upwards to the tune of £11.5m. This resulted in a 37% uplift in WAV for the year and an increase in NAV/share from 151p as at 31 December 2023 to 176p as at 30 September 2023. We have lifted our forecast for FY23 NAV from 170.5p/share to 187.1p/share on the back of this.

The 15 December 2023 announcement highlighted a further increase in capacity of £169.8m (all in the form of tenancy capacity), which was added as part of the company’s capital restructure. The level of capacity that can be carried by Helios’s balance sheet is dependent on the company’s ability to supply the Funds at Lloyd’s (FAL) to back the business to be written on said capacity. The £169.8m capacity addition was made possible by a significant capital restructure where Helios raised US$75m in seven-year unsecured debt at a coupon of 9.5%. The company obtained an A- / stable rating from Kroll Bond Rating Agency LLC (KBRA) for up to US$100m, which leaves a further US$25m undrawn. In conjunction with issuing the new debt, Helios repaid its Barclays facility of £15m, resulting in a c £40m increase in gearing as at 31 December 2023.

Helios management has indicated that the full increase in gearing would be reflected in its cash balance (free working capital) at 31 December 2023, with no additional transfer to FAL, despite the large increase in capacity. This is due to the deferral of required funding as well as a high level of syndicate solvency credits that will only unwind during the course of the year. Our FAL forecast for FY23 therefore remains largely unchanged at £64m and increases strongly to £90.5m in FY24. We expect to see a commensurate reduction in free working capital from £52m to £36.6m over the course of FY24.

As a result of the increased gearing being housed in cash for FY24, we expect a large increase in group investment income. This will, however, be more than offset by the finance charges on the unsecured debt, with a net finance cost impact of -5.5% on the c £60m of debt.

In a 10 October 2023 press release, Helios announced an increase in its annual base dividend from 3p to 6p to be paid in 2024. This doubling of the base dividend could be further supplemented by special dividends. Our model allows for such special dividends to be paid from 2025 onwards.

In addition, Helios bought 2.3m of its own shares at an average price of 143p/share during 2023, which is set to reduce average shares in issue by c 2.3% in FY24. This has a positive impact on EPS, NAV/share and valuation. The buyback programme was renewed in December 2023, with the company starting 2024 active in the market.

During the course of 2023, a forced partial sell-off by Odey Asset Management (a reduction in stake from 7.7m at 31 December 2022 to 6.6m shares currently) was concluded. This overhang allowed Helios to take advantage of share price weakness through its buyback programme. We note that share price weakness has continued despite the Odey overhang having been removed and this appears to be related to a drawdown in the stake of key investor Hudson Structured Capital Management (HSCM) (reduction in stake from 12.5m at 31 December 2022 to 11.6m shares). This sell-off is more likely related to the failure of Southern Fidelity Insurance Company (a Florida-based insurer in which HSCM Bermuda Fund had a 75% stake) than to concerns related to its much smaller investment in Helios.

While we warn that a continuing overhang from HSCM could put further pressure on the Helios share price, we see this as an opportunity for Helios and shareholders to add to or build positions at attractive levels.

The key changes to our FY23 forecasts for Helios are related to the capital restructure and the capacity revaluation (discussed above). As discussed, we expect the FAL impact for FY23 to be limited due to the deferral of required funding as well as a high level of syndicate solvency credits. In Exhibit 2 above we have increased our forecast capacity for FY23, but delayed £52m of this increase to FY24 to allow for some tenancy capacity only becoming active in H124 and not fully contributing to FY24 underwriting results and capital requirements. Our free working capital forecast has been increased meaningfully to £52.3m, allowing for the net proceeds of the new unsecured debt funding. Our NAV forecast has been increased on the back of the disclosed capacity value revaluation, resulting in an FY23 NAV/share forecast of 187.1p versus 170.5p in our previous research. As a result, our forecast for FY23 total comprehensive income has increased from £15.1m to £25.0m, despite an unchanged EPS forecast.

Our FY24 forecasts have been affected in a number of key areas, resulting in a reduction of EPS from 27.7p/share to 26.2p/share:

Our FY25 forecasts represent a clearer picture of the impact of the capital restructure, the ‘rental capacity’ initiative and the share buyback. The impact is strongly positive:

Our forecasts are conservative in their allowance for capacity growth through non-traditional avenues, the roll-out of the new ‘rental capacity’ initiative and the potential benefits from the portfolio evaluation and monitoring (PEM) initiative and allowance for growth in new and growing risk classes not typically available through traditional syndicates. It is also conservative insofar as the high forecast growth in stop loss costs, with alternative structures potentially being pursued to deliver cost efficiencies on this line item.

The risks to our forecasts are largely linked to Helios’s ability to maintain a healthy combined ratio beyond our FY25 forecast. The current strong underwriting environment is likely to face pressure over the medium term as the very healthy margins attract new competitors and pricing pressure. This is an industry-wide risk, which we have dealt with via conservative forecasts (as discussed above) and by applying an over-the-cycle RONAV in determining our valuation.

We forecast a RONAV of 13.6% for FY24 and 16.7% for FY25, with RONAV including revaluation (largely driven by the impact of pre-emptions on the capacity value) averaging just over 20%. For the purposes of our valuation, we have employed a return of 14.6%, which we use in our RONAV versus P/NAV valuation.

Our base case valuation of 280p/share uses a 14.6% over-the-cycle RONAV, which has been reduced from the 16.3% used in our previous research, Interim results deliver a long-awaited upswing, as a result of the higher-than-expected FY23 NAV base used in determining the valuation. As discussed above, due to the published capacity fund revaluations and uplift in 30 September 2023 NAV, we have lifted our year-end NAV forecast from 170.5p/share to 187p/share, also positively affected by the 2.3% reduction in shares in issue used for the calculation.

We have reduced our cost of equity from 11.1% to 10.3% based on a risk-free rate of 3.8% (down from 4.6%), a risk premium of 6.5% and a beta of 1x.

Our fair value for Helios is at a 1.48x multiple of its FY23 forecast NAV of 187p/share and at an 89% premium to the current share price. While the valuation is reasonably supported by expected FY23 EPS (P/E of 19x) and modestly so by dividends (2.1% dividend yield), it quickly moves into very attractive territory on a forward basis with the P/E multiple falling to 7.5x in FY25 and the dividend yield rising to 6.5%.