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Markel Insurance Strategic Review

Two months ago, Jana Partners, the activist investment firm, announced it had built a stake in Markel calling for the company to sell its Ventures division, a group of wholly-owned private companies, and focus on insurance. This led to one of the best responses to an activist position we’ve seen. Honest, humble, reflective, and keen to make amends:

While we don’t believe Markel should spin out Ventures, in fact, Ventures’ diversified cash flow is exactly what makes Markel such a robust and durable asset, Jana has a point. Markel has admittedly dropped the ball on insurance. Over the last five years, it has underperformed the S&P P&C index by ~400 bps annually. Markel’s expense ratio is ~500 bps above specialty peers and GWP growth is stagnating as peers continue to grow. 

At IP, we seek companies with decentralised organisations that assign accountability and pay for performance. At Markel, we’ve struggled to understand how the insurance business is organised. There are multiple layers of management within US Specialty. Such org structures can obfuscate accountability and cause misalignment. We've spent the last couple months studying Markel's insurance business and have published the following interviews with Former Markel executives:

  1. Markel Specialty Insurance Strategy & Expense Ratio: Markel’s horizontal vs vertical strategy, why expenses are high, how to reduce expenses, and how brokers treat Markel vs other specialty insurers. 
  2. Markel Specialty Insurance Culture & Org Structure: how Markel US insurance operation organised, who has P&L responsibility, and how to streamline decision making. 
  3.  Markel Specialty Insurance: Underwriting Culture and Philosophy: we walk through how Markel approaches underwriting US primary casualty lines, how underwriting policies are set, risk is approved, and how committees approve underwriting 
  4. Markel Reinsurance, Nephila, & Cat Risk: explores how and why insurers failed to price attritional risks and how the cat risk market is evolving 
  5. Markel: Evolution of Nephila and ILS Competition: explores Nephila's business model, synergies with State National, and the risk from cheaper alternative ILS offerings.

Insurance is the most critical engine for Markel. Unlike Berkshire, where Buffett parlayed investing genius into insurance, Markel parlayed an insurer into a holding company. It doesn’t have the capital surplus that Berkshire enjoys. Without a healthy insurance business, Markel’s access to capital for Ventures or public equities becomes limited. This dampens MKLs compounding. 

We’re excited to see the outcome of the insurance strategic review and have no doubt management is capable and committed to finding solutions. This may prove to be an important inflection point in Markel’s history. We will be following closely.

Precision Castparts vs Howmet: Airfoil Casting Competition & Pricing

In 2015, Berkshire acquired Precision Castparts (PCC) for $37bn. Over the last decade, PCCs revenue and operating income has declined from $10bn to ~$9.5bn and $2.5bn to $1.5bn, respectively. What was once an investment casting duopoly has now seen entrants such as Consolidated Precision Products (CPP) take share. 

This interview with a Former Precision Castparts Director, with over 20 years casting experience, explores how the investment casting business has evolved over the last decade. Engine airfoil investment castings for HPT blades and vanes are mission critical and complex products that only three companies globally can manufacture at scale:

These are essentially the most critical components from a specification and demand perspective on the engine. They are rotating components with high performance and metallurgical expectations. You need to get them right the first time from a manufacturing capability standpoint. There are probably very few manufacturers globally with that level of capability. - Former Senior Executive at Precision Castparts

OEMs have actively encourage entrants like CPP which has pressured contract pricing:

The biggest issue is pricing. The cost is increasing, not due to inefficiency or performance, but because of general inflation. The gap between unit price and cost isn't what it used to be. When you have three or four players instead of two, pricing takes a hit. There's been a lot of trading over the years. I know you're looking at casting in isolation. There's been a lot of what I call "horse trading" when examining PCC or Howmet. If you look at their businesses—casting, forging, fasteners, and machining—you can imagine the order of profitability. There's a need to give back a bit on the casting business to right-size volume on the fastener or airframe business. They don't actively trade margin or earnings quality for volume, but it happens occasionally. They might use one business to protect another from a market share or volume standpoint. For example, if GE tries to move fastener work away, they might say, "If you move this work away, I can't supply these castings to you. - Former Senior Executive at Precision Castparts

The interview further explores how airfoil and structural casting contracts are priced, the competition between Howmet and Precision, and potential future margin pressure. This is the first interview in a series on studying Howmet vs Precision and the underlying quality of the investment casting business.

AppFolio: a 5,000 Unit Enterprise Customer on Switching Costs

This interview with an enterprise AppFolio customer, who manages over 5,000 units across condos, rentals, and co-ops, explores last year’s ACH pricing changes and when and why they could switch to Yardi. 

Five years ago, this customer switched from a homegrown solution to AppFolio. One of the reasons they didn’t choose Yardi was because it has a poor mobile app. A reliable mobile app is important because a typical property manager’s sales staff is in the field ~25% of the day. If Yardi builds a good mobile app, this could cause the customer to switch.

If we were making the decision today, the app issue with Yardi is significant. Yardi has been aggressively trying to get us to switch by matching AppFolio's prices, removing the price issue. However, I've told them that until they have real app functionality, I won't consider it. They are working on it, but it may take another year or two. If they develop an app and their pricing becomes comparable to AppFolio, Yardi could potentially overtake AppFolio quickly. Yardi has a better product overall, but the interface is an issue. - Current AppFolio Enterprise Customer

Last year, AppFolio added $2.50 ACH fees for tenant rental payments or $1 if the property manager pays. Since July, this property manager has seen 25% of tenants switch to pay by check. This puts pressure on the PM to pay ACH fees and increases the overall TCO of using AppFolio. 

I'll tell you what we observed. We saw about a 25% decrease in percentage of people who were making electronic payments with it. So we have a lot more people that are sending in paper checks now. So really AppFolio claimed that it wouldn't make any difference and we were able to show them the data and they acknowledge now that it did make a big difference because about 25% of our residents switched from doing electronic payments because of this, to sending in paper checks. - Current AppFolio Enterprise Customer

The interview also goes on to explore how Bilt is impacting the industry.

Molson Coors, Fever-Tree, & US Grocery & C-Store Distribution

This interview with a Former Molson Coors Sales Executive, who is now running a large Molson regional distributor, explores how beer and non-alcs are distributed to Walmart and national grocery and leading c-stores. 

Under Molson, Fever-Tree's largest opportunity for net distribution gains seem to be in the c-store channel:

With this deal, Molson Coors, their chain executives on the Molson Coors side will be reaching out to every single one of their chains, saying, "Hey, we're bringing this brand on. I believe this is an opportunity for you to grow." From a net distribution standpoint, you'll likely see more gains on the C-store side. - Former Molson Coors Sales Executive and Current Molson Distributor

But the customer use case is different in c-stores compared to grocery. Over 60% of consumption is single unit cold items. The coolers are critical real estate. How Molson positions Fever-Tree within fridges or shelving and in what pack size will determine c-store adoption. 

The interview further explores the difficulties in distributing non-alc products within a beer network and the intricacies of persuading distributors to focus on such a small % of their overall volume. It will take time for Fever-Tree to gain enough attention and adoption by distributors within Molson’s network. 

John Deere: Agricultural Automation

One hypothesis is that agricultural production could be the first major industrial use case of automation. In the last 50 years, US farming land per capita has halved due to productivity improvements. This may further improve over the next decade.

John Deere, the market leader in agri equipment, has a scale advantage in collecting and optimising farm acreage data to drive productivity for customers.  

For a long time, Deere could drive a tractor straight, automatically turn it around at the end of a row, and plot a path. These are nearly all the components needed for an automated tillage solution, which Deere announced at CES in early January. However, they weren't fully integrated yet. Deere is now knitting these automations into true autonomy. Regarding AI, machine learning, and Blue River-type technologies, Deere is commercializing them. Deere has studied millions of photos of weeds versus healthy agricultural products and can distinguish between them. This capability is essential for automatically spraying to kill weeds without harming plants, as seen in See & Spray. Deere is turning the corner by offering truly autonomous solutions and profitably using AI. - Former Strategy Director at John Deere

IP Fieldwork Podcast: How to source executives

In this episode on primary research methods, we explore how we source executives compared to other expert networks, our internal team structure, and challenges finding and building trust with great operators. 

Listen on Apple / Spotify and other pod players.