DOI: 10.5281/zenodo.10367508
title: KINGSWAY FINANCIAL SVCS INC

description: KFS was written up by fiverocks in May 2020 and has been a home run - up over 5x since his write up at $1.75 per share and exceeding the price target on his initial thesis, which has largely played out.
 
The company has:
Re-started investor outreach (IR page now revamped, investor days/earnings calls being held) after years of zero outbound IR. (The company was also dark on its financial statements at the time of previous write up).
Sold down several non-strategic real estate assets and re-allocated the funds to purchasing operating companies (both extended warranty and as part of search accelerator program). 
Simplified its balance sheet, with debt coming down massively as large amounts were associated with the non-core real estate assets, while the company also bought back the majority of its Trups preferred debt at discount to face value.
Unfortunately, I haven't partaken in most of the investment gains to date, only buying shares late last year. However thanks to the author's yeoman's work in the comments section, I noticed he was continually raising his price target, as the initial thesis was playing out and a new one was emerging. 

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One of my favourite signals for further investigating an idea on VIC, is when the author of an idea continues to pound the table on an idea that has already multi-bagged, given they have every incentive to hit that author exit recommendation button and take the W. It worked out well for me on XPEL, HMHC and HQI, where I either didn't take a position on initial recommendation (or took a very small position), but still managed to make some money, thanks to the respective author's subsequent cheerleading, as the thesis played out and evolved. 
Thanks to fiverock's cheerleading on KFS, its clear after looking into the company that there is still plenty of meat left on the bone, as the thesis evolves from the complex to the simple thesis outlined by management, towards a potential compounding machine at a very reasonable starting valuation, as the company continues to build out its search accelerator business. 
 
Summary of current business
KFS's much simplified business now consists of two operating segments - 1) the Extended Warranty Business (68% ebitda) and 2) Search Accelerator (32% ebitda). I'll cover the extended warranty briefly, but its search accelerator business that really has the potential to make the stock a multi-bagger from here.
Extended Warranty business:
Kingsway's Extended warranty business operates under four different companies - three targeting the automotive sector (87% ebitda - IWS, PWI and Penn) and one targeting mechanical (13% of ebitda - Trinity). 
KFS likes the extended warranty business, due to its lack of capital intensity + the sticky nature of relationships with customers (for example, the automotive extended warranties are mostly sold by credit union/dealer partners with credit union in particular exhibiting little churn). Furthermore, the nature of claims are fairly predictable, typically relating to mechanical failure (eg, transmission issues), with high quality data and little tail risk, resulting in predictable and recurring revenues.
Whilst KFS has in the recent past been able to acquire extended warranty businesses at attractive valuations, they see current valuations as probably too high to contemplate acquisitions here in near future and will be focusing on organic growth.
Search Accelerator:
KFS's search accelerator business 'officially' commenced as a separate operating segment with the purchase of the Ravix business (accounting/HR outsourcing) in 2021, under Timi Okah, their first operator-in-residence. KFS CEO JT Fitzgerald is quite experienced with the search fund model, having been a post-MBA search fund CEO himself, while also being an active investor in the space . Since the acquisition of Ravix, KFS has also purchased CSuite (financial executive search) and SNS (nurse staffing). There are also 4.5 operators-in-residence (OIRs) that are currently searching for businesses to acquire (the 0.5 being Charles Joyce, who is working on initiatives to improve search efficiency and OIR recruitment at holdco level, but is also interested in acquiring a business at some point).
Before describing the current state of affairs for KFS's search accelerator business, I think its worthwhile to give a brief history of the search fund model, its history of lucrative returns and why I believe KFS's search accelerator is well-positioned to perform well.
Search Funds (also knows as 'Entrepreneurs through acquisition' or ETA) are typically set up by freshly minted, high potential MBAs who have the ambition of running their own company, but are lacking in both financial resources and experience. Typically at least some of the search fund principals will have experience in both search funds and/or running a business and in addition to investing are also there to provide mentorship and guidance to the searcher. Whilst the asset class has grown rapidly since the early 80s, professional search investors are still a relatively small group and mostly know each other. 
In terms of size, KFS is looking to purchase businesses with ebitda between $1.5mn-$3mn- at the sweet spot of being too small for a mid-market PE fund, whilst also being out of reach for majority of ex-HNWI individuals. In terms of types of business they are looking to acquire, KFS (and search funds in general) look to acquire businesses with predictable, recurring revenues and low operational complexity (given they will be managed by rookie CEOs). 
Searchers are typically looking to purchase businesses from owners approaching retirement age, who are looking for both exit liquidity and succession planning (JT has used the phrase 'succession capital' to describe the solution that searchers like KFS are providing to retiring entrepreneurs.) Deals can be sourced in multiple ways including business brokers, cold approaching and purchase of databases. Its typically a very time consuming process, with several rocks needing to be turned over, and can take take anywhere up to two years.  
In terms of deal economics, at KFS the OIRs are given a very modest salary and resources to initiate their search (at more traditional search funds, the searchers have to raise a fund to cover search costs, typically upto two years). On consummation of a deal, the searcher is given some equity in the business, with this amount increasing over time, and the amount typically linked to certain return goals. It's also typically structured in such a way that KFS's equity is preferred and they need to be made whole on their investment (+ modest single digit return), before the searcher participates in any upside. While the searcher CEO is paid a salary, it is usually fairly modest and given the typical talent level, well below their opportunity cost if they had entered the corporate world post-MBA, so the carried interest is really their main way of making bank and aligning the incentives between searcher and KFS. It makes more financial + reputational sense for a searcher/OIR to either end or extend their search than consummate a mediocre/bad deal.
Searchers typically look to create value in the business once acquired, either by pursuing additional revenue channels, cutting costs and/or investing in the business. Given that the previous owner is typically approaching retirement age, in several instances the company is a lifestyle business and not necessarily cost or revenue-optimised, so there is usually some low hanging fruit to improve profitability. Early signs at Ravix look promising (although its probably too soon to judge). 
Stanford Business School releases a study every couple of years on the financial performance of search funds. The most recent study was 2022, which looked at the performance of 546 search funds in US and Canada between 1984 to 2021. In total, the aggregate pre-tax IRR and MOIC of all funds in the study was 35% and 5.2x, respectively, with this number including 1) search funds that failed to consummate an acquisition (34% of total funds) and 2) search funds that produced a loss (27% of funds that consummated an acquisition), so potential returns could be higher if these left tail outcomes can be mitigated (in the most recent investor day, JT discusses how he believes the KFS model can avoid some of the pitfalls associated with traditional search funds).

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In 2022, KFS set up a strategic advisory board to the search accelerator business comprising Will Thorndike (investor and author of 'Outsiders') and Tom Joyce (ex CEO of Danaher). In the words of the press release, "the goal of the Advisory Board will be to assist the KSX CEOs and Operators-in-residence with their strategic thinking, acquisition opportunity analysis, operational execution, and capital allocation decisions, as well as to provide advice, experience, and expanded networks."
I'm sure Thorndike is known to many on VIC for writing the bible on capital allocation. What is less well known is that Thorndike is an important player in the search fund community. His firm Housatonic Partners pioneered institutional investment in the space and according to one Thorndike speaker bio, he had invested in the majority of search funds that had a top twenty outcome (typical 10x-ers+). He's also already helped KFS add an OIR to their bench (Davide Zanchi). Furthermore, subsequent to his appointment on the advisory board, an investment firm he co-manages (Sun Mountain Partners LLC) made an investment in 800k KFS shares (worth ~$7mn), providing an additional endorsement to KFS's search accelerator business model.
Tom Joyce was the CEO of Danaher between 2014 and 2020. During that period, Danaher crushed the S&P 500, whilst its considered one of American businesses' greatest success stories. Danaher's history involves being one of the early pioneers in the US of importing kaizen/lean manufacturing techniques from Japan. What's unique to Danaher compared to its Japanese peers, is that it specifically built out a toolkit of techniques (referred to as Danaher Business Systems or DBS), that it would use in its M&A strategy, to massively improve operating performance of acquired companies that it would believe would greatly benefit from DBS. Kingsway is also building out its toolkit called Kingsway Business Systems (no points for originality), likely aimed at the more business service oriented companies that are favoured by search funds. As JT mentioned on KFS most recent earnings call, "we've been using Danaher Business system tools for a long time, but to have the guy that actually helped build those teaching us how to use them the right way is really powerful." 
JT mentioned on the most recent earnings call that the search accelerator is expected to do 2-3 acquisitions per year and they are looking to have 4-5 OIRs searching at any point in time.
When taking account the favourable historical returns of the search fund asset class, the pedigree the advisory board and the small sample size of success to date at KFS, this bodes well for a favourable outcome and possibility that the search accelerator business could be a compounding machine for years to come.   
Other Investment Strengths:
Insider ownership/insider buying: Insiders own over 60% of KFS shares and the insider buying over the past couple of years has been constant, even after a massive amount of share appreciation.
NOL: KFS still has over $600mn in NOLs, meaning it won't have to pay federal taxes for the rest of the decade. If KFS sees some traction in building out the search accelerator, the ability to save on federal tax and re-invest pre-tax profits at attractive IRRs could further supercharge KFS operating income over the next few years.  
 
Valuation
 
Management note that run-rate ebitda of the operating businesses is in $18-19mn range. If we assume that over the next five years that management is able to compound earnings at between 15-25% (we think its possible for this rate to be higher in the next few years), and the market re-rates the multiple in recognising the growth from newly acquired search accelerator businesses (to, say between 15-20x exit multiple), we derive a value of between $550mn-1.1bn in five years (or 17-35% 5 year IRR).
 
Reason for opportunity
Small market cap / no sell-side coverage
Company only recently started investor outreach (Earnings call in November 2022 call, was the first since 2009)
The initial 'complex to simple' thesis has largely played out, so possibility the shares are in holding pattern until there is more investors on board the revised thesis. Furthermore, with shares up 5x since fiverock's 2020 write up, its a tough chart to bu