Description

Investment Thesis:

Delta Lloyd (DL) is a Dutch Insurance company focused on Life(Pension) Insurance, General Insurance, Asset Management, and Banking.  DL currently trades at a small discount to peers despite being on stronger financial footing than most: .8x P/B, .9x P/TBV, and 8.6x 2010 consensus EPS versus comps of 1.1x P/B, 1.9x TBV, and 9.6x 2010E P/E.

We believe analysts are being overly conservative due to recent results and DL can achieve a significantly higher EPS through realized cost savings, normalization of the Dutch pensions market, and gains from weaker competitors.  Management has demonstrated a history of profitable growth and good risk management (the only Dutch insurer to not need government support) which should limit the downside.

Applying a 10x multiple to 2010 estimated earnings of $2.50 (or 1.0x embedded value) yields a stock price of $25 per share, ~50% above today's stock price.   

Company Snapshot/Business Overview:

DL is a 200 year old Dutch Insurance Company, under the Delta Llloyd, ABN-AMRO, and OHRA labels.  DL is the #3 Dutch life/pension insurer with 17% share, with the top 6 controlling 85% of Dutch market.  79% of business is in The Netherlands, 11% in Belgium, and 10% in Germany (in the process of exiting Germany).  71% of operating result is from Life Insurance (largely pensions), 24% from General Insurance, 3% from asset management, 2% from banking.  Their investment portfolio is 71% in fixed income (mostly EU sovereigns and sub-sovereigns (2.7% exposure to Greece)), 17% equities(mostly Dutch), 10% real estate, and 3% Cash.  There is no gearing under the portfolio.  They had been 92% owned by Aviva Plc and 8% by Nuts OHRA, but Aviva IPO'd ~40% of their stake in November at 16EUR. 

Share Price:           17.24EUR

Shares:                  165.6M

Market Cap:             2.854B

Cash:                      1.5B

Debt:                      8.3B

Min Int:                  304M

EV:                          9.941B

Reason For Aviva IPO:

Despite 92% ownership Aviva had limited control of DL due to legacy corporate governance/Dutch Law.  Aviva had unsuccessfully tried to gain control in order to extract more capital from DL, because DL limited dividends somewhat to maintain a strong capital base.  Aviva and DL had been fighting in court but finally decided just to IPO in order to raise capital.  As part of the IPO, DL changed its corporate governance to match other Dutch companies.  Aviva has a 180 day lockup and has given indications that will reduce their holdings over time.

Management is Conservative and Focused on Growing Shareholder Value in Long-term:

• DL is the only Dutch Insurance company to not need government (or shareholder) support during 2008/2009. The other large Dutch Insurance companies all needed capital from government, guaranteed funding, and/or raised capital through share issuance.
• From 1999-2008 DL grew revenues by 9.9% (5% autonomous and 5% through M&A). By comparison, the Dutch market had a 1.5% growth rate in life and 3-4% in non-life during this span. The current CEO and CFO have been in their current positions since 2001 (and at DL for longer) and thus directly responsible for the performance.
• DL has paid out 1.2B Euros in dividends the past 12 years (versus current market cap of $2.9B) while maintaining strong capital base and growing revenues at 10% per annum.
• Management team is focused on "Delivering Sustainable Value For Shareholders Through Long Term Focus" and their "1^st objective is to get realistic value of Delta Lloyd Group in the market." And they are cautious regarding M&A, doing it only where accretive, and are risk averse, believing that they "can only destroy it once".
• DL has been focusing on removing costs from the business, primarily due to cost sharing between their 3 segments (1/3^rd of annual spend in IT removed in 2009). This is expected to result in $125M in savings in 2009 and $50M in 2010.
• Insiders: CEO bought 200K shares in IPO and board acquired 500K. Additionally, phantom options of Aviva were converted to 75% of real options during IPO; CEO and CFO got 544K and 351K real options in IPO.

Growth Opportunities:

• Pension Funds: The Dutch Government requires 105% coverage ratio for pension funds; if below this (which most were in 2008/2009) they don't allow them to transfer liabilities to insurers. This limited the life/pensions business in 2009 (which was responsible for most of decline in GWP in 2009), but should recover in 2010 and beyond.
• JV with ABN-AMRO: DL has a 30-year JV with ABN-AMRO. Currently only 20% of ABN AMRO's 4M+ bank customers buy insurance. DL thinks they can get this to 30% and would have access to 1.1M more customers if Fortis Bank Netherlands integrates with ABN AMRO Bank. Note: DL acquired a 51% stake in ABN AMRO JV in 2003 for 241M; ABN-AMRO tried to kick them out of JV but went to arbitration, where DL's stake was valued at 609M. ABN AMRO would have to pay 609M + 12% compounded + penalties to end JV so unlikely to occur.

Valuation:

• Valuation: We believe DL is worth 10x 2010 estimated earnings of 2.50EUR (or 1.0x embedded value), or 25EUR per share, ~50% above today's stock price. DL is currently trading at .8x P/B, .9x P/TBV, and 8.6x 2010 consensus EPS of 2 EUR/share, but we believe their estimates understate the real earnings power of the business. Competitors are trading at 1.1x P/B, 1.9x TBV, and 9.6x 2010E P/E.
• Dividend: ~6% dividend yield expected at current price. Targeted dividend payout of 40-45% of net operational result (earnings adjusted for marked to market changes).

Other:

• Reporting: DL reports IFRS earnings which are volatile due marked to market changes in assets and liabilities hitting the income statement as well as investment income. Additionally, DL reports operational earnings, which removes these distortions.
• Embedded Value: DL is the only Dutch Insurer to report embedded value using Market Consistent Embedded Value (MCEV) which results in a lower value than Traditional Embedded Value (TEV) which doesn't incorporate a risk premium. However, they switched to using the collateralized AAA bond curve instead of swaps curve (required under MCEV) as the swaps curve didn't match their liabilities and caused their true value to be understated.
• Company Targets: ROE of 10%, dividend payout of 40-45% of net operational result, twice per year, 45% at interim and 55% at final. Target an S&P AA capital ratio.
• Credit Rating: On 10/16 S&P assigned a credit rating of A+ with negative outlook. Had AA- with negative outlook as part of Aviva. Lower credit rating is due to lack of diversification.
• As of 3/2/2010, Delta Lloyd is included in the AMX index.

Risks:

• Insurance Claims: Insurance claims deviate significantly from expectations. Claims are traditionally higher during poor economic periods, which affected 2009 numbers.
• Unrealized Cost Savings: Unable to realize the 125M and 50M in cost savings in 2009 and 2010 projected by the company.
• Investment Returns Deviate from Expectations: DL expects 3.5%, 2%, and 0% spread on equities, property, and fixed income versus the collateralized AAA bond curve.
• Greece: 780M exposure to Greece government bonds (2.7% of own-risk investment portfolio) at 6/30/2009.

Catalyst

Realization of cost savings drives earnings higher

Pension funds will be able to transfer liabilities to DL

Wall Street discovers high dividend yield

Expectations set during the recent IPO are met and exceeded