Description
Company Description
Equitable holdings (“EQH”) is one of America’s leading life insurers with approximately 12,300 employees and more than $700 billion of assets under management (“AUM”). EQH holds two complementary and well-established principal franchises, Equitable Life (100% owned) and AllianceBernstein (trading independently under the ticker AB, approximately 65% owned).
Prior to its IPO in May 2018, EQH was a wholly-owned subsidiary of AXA. Following the IPO, AXA completed several secondary offerings, and as of September 30, 2020 EQH is a fully independent company.
EQH business is organized in four segments: Individual Retirement, Group Retirement, Investment Management and Research, and Protection Solutions:
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Individual Retirement—Individual variable annuity products
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Group Retirement—Tax-deferred investment and retirement services or products to plans sponsored by educational entities, municipalities and not-for-profit entities, as well as small and medium-sized businesses.
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Investment Management and Research—Diversified investment management, research and related services to a broad range of clients around the world.
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Protection Solutions—Life insurance products on attractive protection segments such as variable universal life (“VUL”) insurance and indexed universal life (“IUL”) insurance and our employee benefits business on small and medium-sized businesses.
EQH distributes its products through both a premier affiliated and third-party distribution platform, consisting of:
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An affiliated retail sales force: i) Equitable Advisors, which has over 4,500 licensed financial professionals who advise on retirement, protection and investment advisory solutions; and ii) more than 200 Bernstein Financial Advisors, who are responsible for the sale of investment products and solutions to Private Wealth Management clients.
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Third-Party distribution agreements with: i) more than 1,000 third-party firms including broker-dealers, banks, insurance partners and brokerage general agencies and; ii) an AB global distribution team of more than 500 professionals, who engage with approximately 5,000 retail distribution partners and more than 500 institutional clients.
Opportunity
EQH appears as an attractive opportunity as the core Equitable Life business is trading at extremely depressed operating earnings and cash flow multiples as the market struggles to understand the discrepancy between GAAP and non-GAAP earnings and is discounting for a significant tail risk on EQH legacy GMxB variable annuities in-force.
This discount appears unwarranted as EQH has recently demonstrated the solidity of its reserve assumptions and the validity of its economic value hedging program by signing in October 2020 a re-insurance transaction with Venerable Holdings.
With this transaction, EQH ceded $12.2bn of mostly legacy GMxB variable annuities for a valuation of $1.2bn, including:
In addition to the value consideration, the transaction enables EQH to significantly mitigate its pro-forma tail risk, including:
This transaction, which was executed at a premium ($300mm of positive ceding commission over $12.2bn of reserves ceded), validates the conservative liability assumptions and hedging program put in place by EQH, demonstrating the soundness of the balance sheet.
In addition to the validation presented by the Venerable transaction, EQH has demonstrated the validity of its conservative assumptions and hedging strategy in Q1 2020 where the $10bn increase in liabilities value due to the COVID crisis and market downfall was more than offset by an $12bn increase in economic hedges value.
Regarding interest rate risk, EQH is fully hedged and has adopted a 2.25% 10year Treasury regression over 10years, the lowest assumption among all life insurance peers.
Valuation
EQH current market cap is $11.8bn, composed of:
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$2.2bn for the 65% ownership stake in AB
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$1.8bn excess capital at holdco above the target $0.5bn buffer
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$7.9bn equity vale for Equitable Life Core Business
Base Case
Based on $7.9bn equity value Equitable Life is currently trading at 4.8x forward operating earnings and 11.3% Free Cash Flow yield, based on management base case organic growth rate of 3-4% and 50-60% operating earnings to FCF conversion rate. Including the 3.5% organic growth, total expected return is 14.8%.
Even in a downside scenario with 0% organic growth and 50% FCF conversion, Equitable Life segment trades at 5.0x forward operating earnings and 9.9% Free Cash Flow yield and total expected return.
Summary
While the GAAP accounting of variable annuities is complex and creates significant overhang on EQH stock price, from an economic value perspective Equitable Life Core Business Segment should provide significant free cash flow and total return over a majority of capital market scenarios. Management has demonstrated acumen in capital allocation and can be expected to continue to compound value generating share repurchases until the market re-rates to more normalized multiple and FCF yield levels.
Main Risks
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Sensitivity to equity markets, driving lower alternative investment yields and impacting AuM and account values
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Potential impairments to credit investment portfolio
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Increased competition in the buffered annuities space, impacting net flows and returns on invested capital
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
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Deployment of excess capital at holdco
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Further risk mitigation transactions, removing GMxB variable annuities tail risk overhang