Description

Assurant, Inc. ("Assurant", “AIZ” or "the Company") is a New York-based holding company which owns and operates a group of warranty and specialty insurance companies.  Assurant primarily sells consumer warranties, which is lightly regulated, less capital intensive and valued on earnings relative to its smaller lender-placed homeowners and pre-need funeral insurance books.  The latter two businesses are regulated, capitalized and valued like any traditional book of insurance.

Situation overview

On October 28, 2020, Assurant formally announced they were exploring options to sell its pre-need business, which may set in motion a strategic repositioning to unlock the trapped value of Assurant’s core consumer warranty business. 

The market reacted favorably, and Assurant’s stock was up as high as 4% following the announcement. The sell-side community continued to maintain their positive outlook on the stock (all 4 equity research coverage analysts rate AIZ as outperform).

Assurant’s have been strong through the pandemic, as claims have been down and their products tied to “stay-at-home” consumers have stayed relevant, with future leverage as consumer spending slowly continues to recover to pre-pandemic levels.  2Q 2020 earnings grew by 27% and were expected to grow by roughly 10% in 2H 2020 and another 20% in 2021.

Thesis and potential outcomes

AIZ at approximately $127 per share represents an opportunity to cheaply buy a leading consumer warranty franchise, growing earnings by mid-teens each year at roughly 12x 2021E earnings, plus a free option on the potential large upside from divesting its pre-need and lender-placed insurance businesses and repositioning the company as an earnings-based consumer lifestyle / warranty company.

In a status-quo growth scenario, potential upside is likely around $162 per share with expected earnings growth in a conservative 10% range, which sets a solid floor of a 28% return in a baseline case in the next 12-18 months.

If both non-core businesses are divested in the next 24-36 months, further upside exists, likely to as high as $194 or an 53% return.  If the management team can merge with or acquire FrontDoor, a key competitor, additional upside would exist here to somewhere as high as $255 or roughly a double, but not for 36+ months.

In mid-March, at the bottom of the market, the stock traded at $76, or approximately 8.5x LTM earnings.  If a similar downside here would be protected by incremental earnings plus the market’s likely appreciation of the Company’s actual, strong 2Q 2020 performance, which is probably in the $95 range, or 25% downside, assuming the LTM multiple contracts a turn less than earlier in the pandemic, given the historical performance and better understanding of potential issues.

Business overview

Assurant is a leading global provider of lifestyle and housing solutions that support, protect and connect major consumer purchases.  They partner with leading brands to develop innovative products, services and customer experience.  They operate in North America, Latin America, Europe and Asia Pacific through three operating segments: Global Lifestyle (76% of revenue), Global Housing (22%) and Global Pre-need (2%).  

Global Lifestyle is focused on providing mobile device solutions and extended service products and related services for consumer electronics and appliances (“Connected Living”); vehicle protection and related services ( “Global Automotive”); and credit and other insurance products (“Global Financial Services and Other”).

In this segment, Assurant has relationships with 9 of the top 10 global auto manufacturers, and 6 of the top 10 global connected living brands.

Global Housing provides lender-placed homeowners insurance, lender-placed manufactured housing insurance and lender-placed flood insurance ( “Lender-placed Insurance”); renters insurance and related products (“Multifamily Housing”); and voluntary manufactured housing insurance, voluntary homeowners insurance and other specialty products ( “Specialty and Other”).

Assurant has relationships with 9 of the top 10 largest U.S. multifamily housing property management companies and 8 of the top 10 largest U.S. mortgage service providers in the global housing segment.

Global Preneed provides pre-funded funeral insurance, final-expense insurance and related services, driven by an exclusive relationship with the largest funeral home and cemetery service provider in the U.S. and Canada.

Strategy shift and historical performance

Beginning in 2015 with the appointment of new CEO Alan Colberg, Assurant realigned its corporate strategy to focus on housing and lifestyle protection products and services.  By early 2016, Assurant had shut down its health insurance business, and sold its employee benefits business to Sun Life for $940 million.

In 2016, the Company was able to focus on deploying its new organizational model.  The groundwork was laid for a profitable turnaround focused on improving expense discipline, investments in technology, AI and data analytics to improve its customer experience and deployed improved talent across the enterprise to support cross-selling and innovation.  In 2017, the Company returned to profitable growth as a result of these initiatives.

In 2018, in line with the Company’s stated strategy to allocate capital to consumer lifestyle protection businesses, Assurant bought the Warranty Group (“TWG”) from TPG Capital for $2.5 billion.  TWG, a market leader in vehicle protection, extended service contracts, financial services as well as other consumer warranty solutions, immediately gave Assurant a proven asset in the space, successfully owned by many private equity firms since its founding.

Since integrating TWG, Assurant has focused on executing its strategy as well as evaluating other parts of its business that are not core to its operations.  In late 2020, they announced the acquisition of HYLA Mobile, a provider of smartphone software, trade-in and upgrade services, at the same time they announced the pre-need business strategic options.

Since 2015, Assurant has grown EPS at a 11% CAGR and post health discontinuation and employee benefits sale, revenue by 57% in three years.  Since 2015, the operating margin of the enterprise has remained steady in the 8-10% range, albeit weighed down by the more capital-intensive segments.

Global Lifestyle

The Global Lifestyle segment has been the key driver of the results in this time period.  Connected Living has grown covered devices from 32 million to 53 million (a 14% CAGR) and operating income from $64 million to $233 million (a 38% CAGR).  These gains were primarily driven by new product offerings covering emerging risks.  For instance, in 2010, most buyers of mobile device protection paid approximately $7-8 per month per plan and did not buy any other services.  By 2019, consumers paid approximately $12-15 per month per plan, and included services like data protection, phone upgrades, and other tech services (including AppleCare-related products and “TechPro” and “PocketGeek” services).  Consumer dependency, increasing smartphone prices and more complex devices contributed to this trend.  Assurant took gains in this category as a result of its alignment with market leaders and evolving entrants which has created streams of recurring revenue with future earnings value.

Global Automotive which primarily sells vehicle service contracts (“VSCs”), has grown protected vehicles from 1 million to 48 million, and operating income from $39 million to $153 million since 2015.  The Warranty Group acquisition was the primary driver.  TWG brought leading brands, market share, key distribution relationships, deep capabilities and differentiated product offerings as the market leader in U.S. warranty.  Demand for VSCs is driving higher as loan terms and vehicle ownership tenure lengthen, automotive technology becomes more complex and Finance and Insurance (“F&I”) represents a greater portion of dealer economics (25%+ in 2018). VSC sales have been resilient in slower economic environments (including COVID), has growing penetration rates across new and used cars, and has an element of countercyclicality in used car products, which tend to trail new car trends by multiple years.  Global Automotive also has significant embedded value in its unearned premium reserves (approximately 4x 2019 revenues), which will flow through earnings through the life of the VSC, and revenues continue to grow: in 2019 earned premium in this segment was 83% of written premium, indicating a healthy, growing segment.

Global Financial Services is a small part of Global Lifestyle, offering a suite of credit and travel-related protection products for varying customer needs in the segment.  It represented ~6% of total segment revenue in 2019 and is more of an accommodative product for existing clients and has been roughly flat in terms of growth since 2015.

Global Lifestyle represents 76% of Assurant’s revenue, and virtually all the Company’s net operating income (Global Housing and Global Pre-need cover corporate expenses / losses at the parent company).

Global Housing

Global Housing has produced mixed results in this time period as its two largest components act countercyclically relative to the housing market.  The Multifamily Housing segment has been the key growth driver, growing revenue by 18% CAGR since 2011.  The growth is primarily driven by the expansion of rental households in the last decade during the time period after the GFC.  AIZ wins in this segment given its alignment with long-tenured property managers (9 of the top 10 in the U.S.), vertically integrated capabilities and integrated solutions within property management technology across the renter cycle.  A national account management team controls and manages the distribution / relationship management process across all 50 states to ensure growth and compliance with local regulations.  Assurant has made digital investments in this platform to ensure its continued growth.

The other contributor in the Global Housing segment is the lender-placed insurance (“LPI”) business.  LPI is a countercyclical business that relies on placement from mortgage-holders (i.e. banks, credit unions, or other lenders) when a borrower drops coverage on the property they have lent to, usually in the case of an eviction or foreclosure.  Assurant has relationships with 8 of the top 10 mortgage servicers in the U.S. As delinquency rates on properties have normalized following the GFC, the business has shrunk accordingly.  For instance, from net operating income from 2015 to present fell from ~$225 million to ~$150 million on a comparable expense base, while the AIZ placement rate of policies fell from about 225 bps to below 150 bps.  Serious delinquent policies fell to less than 20% of the overall portfolio by year-end 2019.  As reinsurance rates harden, this issue will continue to be exacerbated.  During COVID-19, government stimulus and other relief measures have not caused any broad shift in the housing market that the Company would expect to take advantage of in this line of business.

Global Pre-need

Pre-need provides mortality-linked products to pre-pay for final expenses and other funeral-related costs.  Assurant is affiliated with the largest funeral home and cemetery provider in the U.S. and Canada, providing a leading distribution channel for this business. Earnings have been under pressure in this segment, as they have remained flat to down since 2015.  A combination of low interest rates plus recent spikes in mortality related to COVID-19 have led to earnings pressure.  Assurant announced in late October that it was exploring strategic alternatives for this business.

Investment strengths 

Market leadership in businesses with attractive growth prospects and recurring revenue

The Global Lifestyle businesses and Multifamily Housing business are poised to continue to grow along with the rebound of the U.S. consumer following COVID-19. These businesses have all grown by double-digits historically and are expected to continue to do so.  The segments within Global Lifestyle, as well as multi-family, all have market-leading franchises and distribution partners that are poised to continue to gain share as tailwinds for both mobile devices and housing is likely to continue with fiscal stimulus and low interest rates ahead.

With respect to mobile devices, as more devices come online, need to be refurbished, collect more valuable data and have higher retail prices, AIZ will likely be able to continue to raise prices on its more valuable tech warranty and support offerings.  Mobile devices are expected to grow significantly by 2025, as the mobile workforce takes shape following COVID-19.  The number of global mobile connections is predicted grow by roughly 20% to reach 6 billion by 2025, which is an increase of nearly 1 billion devices from year-end 2019.  Assurant is the #1 provider in the U.S. by revenue, with estimates of their market share ranging as high as the low 70%s and continues to take market share from competitors each year.

Car sales in the U.S. have been stable over the long-term and are expected to continue to remain on course post COVID-19.  The counter or extended cyclicality of the used car buying cycle also smooths out any blips in new car sales (i.e. as have been experienced during COVID-19) and incentivizes used car buying which are also likely to need warranties.  Assurant / TWG is the #1 auto extended warranty provider by revenue in the U.S. w/ 8-9% market share and growing.

As household formation continues and demographic trends favor renting for large parts of the U.S. population, continued growth can be expected from the multifamily housing segment.  Assurant is not a leading provider by market share (larger brand names like State Farm, Travelers and Allstate lead the category), but the Company’s strategic relationships with property managers position them for further, targeted growth.

The businesses mentioned above all have very high customer retention and little churn as a result of the “installed” customer base using Assurant protection plans.  Also, the contracts are earned over periods of time, so significant embedded revenue exists as discussed above about Global Automotive.

Assurant is well-positioned in lead in these markets, and simply needs to continue executing on its playbook since 2015, which has re-positioned the Company to capitalize on areas with significant tailwinds to aid their execution.

Management’s experience with strategic repositioning

With the expected contribution of the higher growth areas of the business (Global Lifestyle and Multifamily Housing), an opportunity exists to spin-off or sell the no (or negative) growth LPI and Pre-need businesses to owners who value them more than Assurant.  Executing on this opportunity would likely create a significant re-rating in the stock price, as Assurant would trade closer to specialty / personal lines P&C or warranty-only peers like FrontDoor, based on earnings, rather than on the significant capital invested in the regulated insurance businesses.  The benefits of this type of re-positioning are fully discussed a little later in the scenario / valuation section below.

Alan Colberg and his team have proven their ability to pivot Assurant since 2015 as it positioned the business for profitable growth with the discontinuing of the health business and sale of its employee benefits business.  An obvious transaction to complete the overhaul of Assurant to be a capital-light consumer protection business gives AIZ stock significant upside and is an extension of what the management team has already been able to accomplish.  The team has already announced their intent to explore options for the Pre-need business and, thinking logically, others should follow.

High cash-flow conversion creating financial flexibility for capital return and M&A

Since 2010, Assurant has returned $5.7 billion in dividends to its parent company, and on average, has distributed over 100% of segment earnings upstream.  Assurant is focused on deploying capital into its capital-light growth businesses to drive innovation and growth, as well as on selected tuck-in M&A transactions.  HYLA is a representative acquisition that brings a capital-light, high growth, complimentary business to Assurant for $325 million which is very digestible, at a reasonable price (reportedly a low teens multiple of EBITDA), has limited execution risk given the Company’s cash flow profile and will produce roughly $25-30 million of incremental operating earnings.  Assurant in the future will continue to guide away from capital-intensive businesses with their capital allocation philosophy which they have proven in their playbook over time.

Key Risks

COVID-19 recurrence

COVID-19 recurrence with 1Q 2020 style lockdowns is a risk to Assurant’s business on the consumer side if appropriate stimulus is not deployed by the government.  Additionally, changes to the housing market as a result of an elongated experience with COVID-19, that have not yet come to pass, may also impact the Company’s business.  It is important to note, however, that mobile devices, cars and renters’ insurance are critical products for people as they go about their lives from home.  Assurant’s business performed very well during the 1H 2020 time period, as claim activity related to personal lines insurance and protection products across the board was depressed as people were in motion significantly less.  Changes to the housing market could affect renters, especially if governments change their stance on renter eviction protections during the pandemic.  Assurant’s LPI business provides a natural hedge to the multifamily business in this case as more policies will be bound with mortgage defaults and dropped coverage.

While Assurant’s business performed well through the last spike in COVID-19 hospitalizations, there is no way to guarantee the next wave’s impact on the consumer, which could have drastic implications for AIZ’s business.

Distribution relationship interruption

Assurant’s business model is differentiated by its scope of relationships with distributors of their product.  Across each of their business lines, they have touchpoints with a significant percentage of the top sellers, providers or manufacturers of the products they are protecting. 

Typical contracts across Global Lifestyle and Global Housing last from three to five years and are generally on an exclusive basis.  Pre-need’s single contact with Service Corporation International, the largest funeral operator in the U.S. and Canada runs through 2024 and 2021 in each jurisdiction, respectively.  System integration generally takes place in order to efficient sell and bind the products, which acts as a natural hedge against non-renewal.  As a result, the contracts are difficult to move, however a large-scale interruption of the Assurant technology systems or a significant deterioration in customer experience could result in a mass migration of distribution relationships to other protection product manufacturers.   Another mitigant here is the limited concentration, as no client / partner represented more than 10% of the Company’s consolidated revenue.

Technology obsolescence risk

The Company is betting on the continued growth of the mobile smartphone market to be a key driver of near-term results in the next 5 years.  It is not impossible, but if new technology replaces the smartphone that does not require as much, or any, protection insurance or warranty, Assurant’s Global Lifestyle business will require another strategic repositioning.

This risk is very limited given the future expectations around augmented or virtual reality, which will likely take the place of the smartphone as we know it today.  These advances are not expected to reach widespread adoption in the near term.

Valuation / scenario analysis

Assurant trades today at ~1.4x book value and ~12x 2021 EPS.  Given AIZ’s various business segments, there are no true peers for the entire business, but each segment has appropriate comps which will be included below.

Upside scenario 1: Split or sell LPI and Pre-need segments

Splitting / spinning off or selling both the LPI and Pre-need segments will leave Assurant RemainCo with the Global Lifestyle and Multifamily Housing businesses.  These businesses are primarily cash flow driven, and will trade closer in line with their Specialty / Personal lines peers (PGR, WRB, AFG, RLI, ARGO, KNSL, JRVR and PLMR) in a range of 16x-24x 2021E earnings and FrontDoor (FTDR), the leading home appliance warranty company, which trades at 27x 2021E earnings.  In this scenario, after proportionally allocating for segment interest expenses and corporate overhead, the operating earnings for 2020E should be approximately $350 million.  Applying the ranges of multiples suggested above would yield a RemainCo valuation of $5.6 – 9.5 billion, with a midpoint of $7.5 billion, or $128 per share.  This implies zero value to either the LPI or the Pre-need business.

Selling the LPI business might be difficult, however, if changes to the housing market were affected by another wave of COVID-19 or a change to current government policy, buyers may emerge.  Allstate now owns National General’s lender-placed business, as well as some others with homeowners business, including Progressive.   Additionally, a sale to run-off buyers in Bermuda (i.e. Enstar or Catalina) may be logical.  Assuming a sale is too difficult to execute, a spin-off to existing AIZ shareholders could maximize value as well.  In either case, the book value allocation of the LPI business is roughly $1.2 billion based on the Global Housing NPE contribution in AIZ’s reporting.  In the sale cases, receiving book value is likely a reasonable outcome, while a spin-off could result in slightly higher accretion.  Bermuda peers (RE, RNR, AXIS), a reasonable proxy for the growth and return profile of the business trade in the 1.0x-1.25x book value zip code.  Assuming the return of book value for the LPI business, proceeds would generate $1.2 billion or $21 per share.

The Pre-need business is much smaller and is likely much easier to dispose of than the LPI segment but will not generate a significant amount of value.  2020E earnings for the segment is approximately $50 million and applying a range of life insurance trading multiples (MET, PRU, AFL, LNC, VOYA, AXA, BHF, ATH) of 7x-13x earnings, would yield proceeds of approximately $500 million or $9 per share.  The Company has already announced their intent to “explore options” for Pre-need at the same time the HYLA acquisition was announced.

Ranging these outcomes, after completing these two transactions, the stock could re-rate to $158 and as high as $194 at the top end of the ranges.

Upside scenario 2: Completing the split-off or sale transactions and merging with FTDR

Completing the above transactions followed by a merger with FTDR could push the stock even higher.  Strategically FTDR’s home-warranty focus is the missing piece for a fully diversified Global Lifestyle segment at AIZ RemainCo.  FTDR’s 2020E operating earnings are forecast to be approximately $210 million, which combined with AIZ RemainCo’s $350 million, would yield over $560 million in combined operating earnings.  Assuming the same forward multiple that FTDR trades at today, the combined company would be worth $15 billion.  The FTDR takeover price of ~$4.0-4.5 billion could be financed by a combination of the cash raised from the LPI and Pre-need sales, as well as taking out incremental leverage in the capital markets.  For a transformative transaction of this nature, the rating agencies would likely give them 18-24 months to de-lever without impacting their BBB / Baa3 rating if they exceeded 35% debt-to-total capitalization (they are currently around ~27%).  Additionally, the transaction may have the agencies reconsider the balance-sheet centric view of leverage and view in a debt-to-EBITDA lens, which could yield some more room for leverage.  In this case If this transaction was consummated in all cash, the stock price could go as high as $255 per share.  A more conservative case, assuming $2bn of the purchase price is issued in stock at $175, still yields a pro forma price of $221 which is still significant upside.

Upside scenario 3: No transactions, continued growth path via management playbook

If none of these transactions come to fruition, Assurant represents a great opportunity to participate in the upside of the U.S. consumer post COVID-19.  The Company is expected to post double digit earnings growth for the next few years, and if it does, the stock will continue to gain momentum.  In the next 12-18, if earnings grow at a rate of 10% and the shares trade at 13x (a slight improvement to reflect the growth forecast), the shares will re-rate to $162 per share.

Downside scenario:

In mid-March, at the bottom of the market, the stock traded at $76, or approximately 8.5x LTM earnings.  If a similar downside here would be protected by incremental earnings plus the market’s likely appreciation of the Company’s actual, strong 2Q 2020 performance, which is probably in the $95 range, or 25% downside, assuming the LTM multiple contracts a turn less than earlier in the pandemic, given the historical performance and better understanding of potential issues.

Catalyst

- Continued tailwinds of the U.S. consumer and growing penetration of mobile, auto and home warranty business

- Completion of strategic repositioning, including sale / split of LPI and pre-need business

- Potential transformative M&A