Description
Genworth Financial (being spun off from GE), came public in an IPO last week at $19.50 after prior week price indications of $21 - $23. I recommend purchase of the common of GNW, which may be one of the largest market cap companies ($20 billion) ever proposed on VIC .... at least stock liquidity should not be a major issue!
GNW is a huge, complex company, and my write-up on VIC makes no attempt to capture all its intricacies. I am making a stab at a simplified (superficial?) analysis of the company with the objective of highlighting the idea while the stock price remains at an attractive level.
My investment thesis is that GNW, with reasonable long term prospects, currently trades at a significant discount to its peers – see the Valuation section below (and its intrinsic value) because of the following short-term factors:
(1) GE now owns 70% of Genworth, and plans to reduce its ownership to under 50% over the next two years, and sooner if possible. This overhang puts a lid on the stock.
(2) The GNW IPO was the largest of 2004, with 145 million shares sold for a total of $2.8 billion. Sold during a difficult period in the U.S. markets, the offering size probably swamped short-term demand, but the stock price should stabilize as value investors begin to purchase the shares.
While trading currently at 10x LTM EPS and below book, GNW explicitly states that “its objective is to increase operating earnings and enhance returns on equity”. I am hopeful that the GNW management team with its GE training is focused on the right objectives and the means to accomplish these objectives. For example, GNW states “As part of GE, the yield on our investment portfolio has been affected by the practice in recent years of realizing investment gains through the sale of appreciated securities and other assets during a period of historically low interest rates. This strategy was pursued to offset impairments and losses in our investment portfolio, fund consolidations and restructurings in our business and provide current income. As we transition to being an independent public company, our investment strategy will be to optimize investment income without relying on realized investment gains. We will seek to improve our investment yield by continuously evaluating our asset class mix and pursuing additional investment classes.” In other words, in this one area, GNW can get away from the GE requirement to produce “smooth” earnings, and focus instead on maximizing economic returns. My thesis is that many such opportunities exist across GNW to increase economic value once it is freed from GE’s priorities.
While it may be a stretch, I am also hopeful that if GNW continues to trade at current depressed levels, GNW could buy back directly from GE some of its shares, which would be mildly accretive to book value per shares and significantly accretive to EPS, while reducing the stock overhang.
BACKGROUND:
Given the huge Prospectus, I tried to extract the key points. If you choose to read the entire Prospectus, you can skip this background section.
We are a leading insurance company in the U.S., with an expanding international presence, serving the life and lifestyle protection, retirement income, investment and mortgage insurance needs of more than 15 million customers. We have leadership positions in key products that we expect will benefit from a number of significant demographic, governmental and market trends. We distribute our products and services through an extensive and diversified distribution network that includes financial intermediaries, independent producers and dedicated sales specialists. We conduct operations in 20 countries and have approximately 5,850 employees.
We have the following three operating segments:
Protection. We offer U.S. customers life insurance, long-term care insurance and, for companies with fewer than 1,000 employees, group life and health insurance. In Europe, we offer payment protection insurance, which helps consumers meet their payment obligations in the event of illness, involuntary unemployment, disability or death. In 2003, we were the leading provider of individual long-term care insurance and the sixth-largest provider of term life insurance in the U.S., according to LIMRA International (in each case based upon gross written premiums). We believe we are a leading provider of term life insurance through brokerage general agencies in the U.S. and that this channel is the largest and fastest-growing distribution channel for term life insurance. Our leadership in long-term care insurance is based upon almost 30 years of product underwriting and claims experience.
Retirement Income and Investments. We offer U.S. customers fixed, variable and income annuities, variable life insurance, asset management, and specialized products, including guaranteed investment contracts, funding agreements and structured settlements. We are an established provider of these products and, in 2003, we were the leading provider of income annuities in the U.S., based upon total premiums and deposits.
Mortgage Insurance. In the U.S., Canada, Australia and Europe, we offer mortgage insurance products that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages. We were the fourth-largest provider in 2003 of mortgage insurance in the U.S. and the fifth-largest provider in the first quarter of 2004 (based upon new insurance written). We are the largest provider of private mortgage insurance outside the U.S. The net premiums written in our international mortgage insurance business have increased by a compound annual growth rate of 46% for the three years ended December 31, 2003.
Market Environment and Opportunities
We believe we are well positioned to benefit from a number of significant demographic, governmental and market trends, including the following:
• Aging U.S. population with growing retirement income needs, resulting from large numbers of baby boomers approaching retirement and significant increases in life expectancy that heighten the risk that individuals will outlive their retirement savings.
• Growing lifestyle protection gap, with individuals lacking sufficient financial resources, including insurance coverage, to maintain their desired lifestyle due to declining individual savings rates, rising healthcare and nursing home costs and a shifting of the burden for funding protection needs from governments and employers to individuals.
• Increasing opportunities for mortgage insurance in the U.S. and other countries, resulting from increasing homeownership levels, expansion of low-down-payment mortgage loan offerings, favorable legislative and regulatory policies, and expansion of secondary mortgage markets that require credit enhancements.
Competitive Strengths
We believe the following competitive strengths will enable us to capitalize on opportunities in our targeted markets:
• Leading positions in diversified targeted markets. We believe our leading positions in our targeted markets, including term life and individual long-term care insurance, retirement income and mortgage insurance, provide us with the scale necessary to compete effectively in these markets as they continue to grow. We also believe our strong presence in multiple markets provides balance to our business, reduces our exposure to adverse economic trends affecting any one market and provides stable cash flow to fund growth opportunities.
• Product innovation and smart breadth. We offer a breadth of products that meet the needs of consumers throughout the various stages of their lives, thereby positioning us to benefit from the current trend among distributors to reduce the number of insurers with whom they maintain relationships. We refer to our approach to product diversity as "smart" breadth because we are selective in the products we offer and strive to maintain appropriate return and risk thresholds when we expand the scope of our product offerings.
• Extensive, multi-channel distribution network. We have extensive distribution reach and offer consumers access to our products through a broad network of financial intermediaries, independent producers and dedicated sales specialists. In addition, we maintain strong relationships with leading distributors by providing a high level of specialized and differentiated distribution support and by pursuing joint business improvement efforts.
• Technology-enhanced, scalable, low-cost operating platform. We have pursued an aggressive approach to cost-management and continuous process improvement. We also have developed sophisticated technological tools that enhance performance by automating key processes and reducing response times and process variations. In addition, we have centralized our operations and have established scalable, low-cost operating centers in Virginia, North Carolina, India and Ireland.
• Disciplined risk management with strong compliance practices. Risk management and regulatory compliance are critical parts of our business, and we are recognized in the insurance industry for our excellence in these areas. We employ comprehensive risk management processes in virtually every aspect of our operations, including product development, underwriting, investment management, asset-liability management and technology development programs. We have 130 dedicated risk management professionals supporting these efforts and approximately 200 additional professionals dedicated to legal and regulatory compliance.
• Strong balance sheet and high-quality investment portfolio. We believe our size, ratings and capital strength provide us with a significant competitive advantage. We have a diversified, high-quality investment portfolio with $61.7 billion of invested assets, as of March 31, 2004, on a pro forma basis. More than 93% of our fixed maturities had ratings equivalent to investment-grade, and less than 1% of our total investment portfolio consisted of equity securities, as of March 31, 2004, on a pro forma basis.
• Experienced and deep management team. Our senior management team has an average of approximately 17 years of experience in the financial services industry. We have adopted GE's recognized practices for successfully developing managerial talent at all levels of our organization and have instilled a performance- and execution-oriented corporate culture that we will continue to foster as an independent company.
Growth Strategies
Our objective is to increase operating earnings and enhance returns on equity. We intend to pursue this objective by focusing on the following strategies:
• Capitalize on attractive growth trends in three key markets. We have positioned our product portfolio and distribution relationships to capitalize on the attractive growth prospects in three key markets:
Retirement income, where we believe growth will be driven by a variety of favorable demographic trends and the approximately $4.4 trillion of invested financial assets in the U.S. that are held by people within 10 years of retirement. Our products are designed to enable the growing retired population to convert their invested assets into reliable retirement income.
Protection, particularly long-term care insurance, where we believe growth will be driven by the increasing protection needs of the expanding aging population and a shifting of the burden for funding these needs to individuals from governments and employers. For example, it is estimated that approximately 70% of individuals in the U.S. aged 65 and older will require long-term care at some time in their lives, but in 2001, only 7% of individuals in the U.S. aged 55 and older had long-term care insurance.
International mortgage insurance, where we continue to see attractive growth opportunities with the expansion of homeownership and low-down-payment loans. The net premiums written in our international mortgage insurance business have increased by a compound annual growth rate of 46% for the three years ended December 31, 2003.
• Further strengthen and extend our distribution channels. We intend to further strengthen and extend our distribution channels by continuing to differentiate ourselves in areas where we believe we have distinct competitive advantages. These areas include:
Product and service innovations, as illustrated by new product introductions, such as the introduction in 2002 of our GE Retirement Answer®, our introduction of innovative private mortgage insurance products in the European market, and our service innovations, which include programs such as our policyholder wellness initiatives in our long-term care insurance business and our AU Central® Internet platform in our mortgage insurance business.
Collaborative approach to key distributors, which includes a joint business improvement program (originally developed by GE), called "At the Customer, For the Customer," or ACFC, and our platinum customer service desks, which have benefited our distributors and helped strengthen our relationships with them.
Technology initiatives, such as our GENIUS® underwriting system, which makes it easier for distributors to do business with us, improves our term life and long-term care insurance underwriting speed and accuracy, and lowers our operating costs.
• Enhance returns on capital and increase margins. We believe we will be able to enhance our returns on capital and increase our margins through the following:
Rigorous product pricing and return discipline. We intend to maintain strict product pricing disciplines that are designed to achieve our target returns on capital. Over the past two years, we introduced restructured pricing on newly issued policies in each of our operating segments and exited products that were not achieving our target returns. We expect our returns on capital to improve as the benefits of these actions emerge and as we continue our focus on maintaining target returns.
Capital efficiency enhancements. We continually seek opportunities to use our capital more efficiently to support our business, while maintaining our ratings and strong capital position. For example, in 2003, we took actions to reduce the statutory capital required to support most of our new term and universal life insurance policies and to reduce excess capital at our mortgage insurance subsidiaries by operating at an "AA/Aa2" rating level.
Investment income enhancements. As part of GE, the yield on our investment portfolio has been affected by the practice in recent years of realizing investment gains through the sale of appreciated securities and other assets during a period of historically low interest rates. This strategy was pursued to offset impairments and losses in our investment portfolio, fund consolidations and restructurings in our business and provide current income. As we transition to being an independent public company, our investment strategy will be to optimize investment income without relying on realized investment gains. We will seek to improve our investment yield by continuously evaluating our asset class mix and pursuing additional investment classes.
Ongoing operating cost reductions and efficiencies. We will continually focus on reducing our cost base while maintaining strong service levels for our customers. We expect to accomplish this in each of our operating units through a wide range of cost management disciplines, including consolidating operations, using low-cost operating locations, reducing supplier costs, leveraging Six Sigma and other process improvement efforts, forming dedicated teams to identify opportunities for cost reductions and investing in new technology, particularly for web-based, digital end-to-end processes.
• Pursue acquisitions opportunistically. We intend to continue to complement our core growth strategy through selective acquisitions designed to enhance our earnings and returns, the breadth of our product portfolio, or our distribution reach. We have successfully completed the acquisition and integration of 13 key businesses since 1993. As a public company, we will have direct access to capital markets, which we believe will enable us to raise external capital in an efficient manner to facilitate selective acquisitions.
Risks Relating to Our Company
• Risks relating to our businesses, including interest rate fluctuations, downturns and volatility in equity markets, defaults in portfolio securities, downgrades in our financial strength and credit ratings, insufficiency of reserves, legal constraints on dividend distributions by subsidiaries, illiquid investments, competition, inability to attract or retain independent sales intermediaries and dedicated sales specialists, defaults by counterparties, foreign exchange rate fluctuations, regulatory restrictions on our operations and changes in applicable laws and regulations, legal or regulatory actions, political or economic instability and the threat of terrorism;
• Risks relating to our Protection and Retirement Income and Investments segments, including unexpected changes in mortality and morbidity rates, accelerated amortization of deferred acquisition costs and present value of future profits, medical advances such as genetic mapping research, unexpected changes in persistency rates, increases in statutory reserve requirements and changes in tax and securities laws;
• Risks relating to our Mortgage Insurance segment, including the influence of large mortgage lenders and investors, decreases in the volume of high loan-to-value mortgage originations, increases in mortgage insurance cancellations, increases in the use of simultaneous second mortgages and other alternatives to private mortgage insurance, unexpected increases in mortgage insurance default rates, deterioration in economic conditions, increases in the use of captive reinsurance in the mortgage insurance market, changes in the demand for mortgage insurance that could arise as a result of efforts of large mortgage investors and legal actions under the Real Estate Settlement Practices Act and the Federal Fair Credit Reporting Act;
• Risks relating to our separation from GE, including the loss of benefits associated with GE's brand and reputation, our need to establish our new Genworth brand identity quickly and effectively, our inability to present financial information in this prospectus that accurately represents the results we would have achieved as a stand-alone company, the possibility that we will not be able to replace services previously provided by GE on comparable terms, uncertainty of amounts and timing of payments that we have agreed to make to GE under our tax matters agreement and other matters relating to that agreement, potential conflicts of interest with GE and GE's engaging in the same type of business as we do in the future; and
• Risks relating to this offering, including future sales of stock by GE that may depress the price of our shares, fluctuations in our share price and regulatory and statutory requirements and contractual arrangements that may delay or prevent a takeover of our business
Pro forma
March 31, 2004
($ in millions,
except per share amounts)
Cash and cash equivalents $1,630
Borrowings and other obligations:
Short-term borrowings $2,400
Long-term borrowings 516
Total borrowings 2,916
Contingent note payable to GEFAHI 550
Non-recourse funding obligations 600
Borrowings related to securitization entities 973
3.84% senior notes due 2009
underlying Equity Units 600
Series A Preferred Stock,
mandatorily redeemable,
liquidation preference $50 per share 100
Total borrowings and other obligations 5,739
Stockholder's interest:
Class A Common Stock, $0.001 par value;
1.5 billion shares authorized; 145.0 million
shares issued and outstanding —
Class B Common Stock, $0.001 par value;
700 million shares authorized; 344.5 million
shares issued and outstanding —
Additional paid-in capital 9,994
Total paid-in capital 9,994
Accumulated nonowner changes
in stockholder's interest) 1,987
Retained earnings 267
Total stockholder's interest 12,248
Pro forma Pro forma
Three months ended Year ended
March 31, Dec 31,
(Amounts in millions,
except per share
amounts) 2004 2003 2003
Revenues:
Premiums $1,619 $1,478 $6,252
Net investment income 755 721 2,928
Net realized investment gains 15 20 38
Policy fees and other income 166 135 557
Total revenues 2,555 2,354 9,775
Benefits and expenses: Benefits and other
changes in policy reserves 1,086 996 4,191
Interest credited 330 343 1,358
Underwriting, acquisition,
and insurance expenses,
net of deferrals 414 404 1,614
Amortization of deferred
acquisition costs
and intangibles 286 251 1,144
Interest expense 43 25 133
Total benefits and expenses 2,159 2,019 8,440
Earnings from
continuing operations
before income taxes 396 335 1,335
Provision for income taxes 129 95 396
Net earnings
from continuing operations $267 $240 $939
Pro forma earnings from continuing operations per share:
Basic $0.55 $0.49 $1.92
Diluted $0.54 $0.49 $1.92
Pro forma shares outstanding:
Basic 489.5 489.5 489.5
Diluted 490.0 490.0 490.0
VALUATION:
(1) APPROACH 1 ….. Segment Valuation (P/E basis)
Pro forma Pro forma
Three months ended Year ended
March 31, Dec 31,
Revenues:
Protection $1,489 $1,393 $5,839
Retirement Income
and Investments 725 689 2,707
Mortgage Insurance 263 227 982
Corporate and Other 78 45 247
Total $2,555 $2,354 $9,775
Net Income:
Protection $123 $124 $481
Retirement Income
and Investments 32 26 93
Mortgage Insurance 103 85 369
Corporate and Other 9 5 (4)
Total $267 $240 $939
Let me say up front, that I need to use more comparables .... if anyone on VIC can suggest more direct comps, please post them, and I will fill in the comp analysis.
Using P/E multiples of comparables for the segments,
Protection
Using MET (MetLife) TTM P/E ratio of 11.6x
GNW segment (TTM NI = $480 MM) is worth $5,550 MM
Retirement Income and Investments
Using MET (MetLife) TTM P/E ratio of 11.6x
GNW segment (TTM NI = $99 MM) is worth $1,150 MM
Mortgage Insurance
Using MTG (MGIC Corp) TTM P/E ratio of 15.0x
GNW segment (TTM NI = $387 MM) is worth $5,800 MM
Ignoring the breakeven Corporate Segment,
Total of all segment values …. $12,500 MM or $25.50 per share
(2) APPROACH 2 ……. Aggregate comparable (P/B basis)
Using MET (MetLife) Price/Book of 1.21,
GNW equity value of $14,820 MM, or $30 per share
Using MET (MetLife) Price/Tang Book of 2.91x,
GNW equity value of $15,850 MM, or $32 per share
Catalyst
1) Once the huge supply related to the IPO has been digested, the stock should move up... I have seen this several times in the past when the stock issue initially overwhelms demand in a weak market, but eventually moves to its intrinsic value (see the ENH IPO last year for one example)
2) Earnings conference calls, when management articulates its strategy
3) Stock repurchases (highly accretive to EPS at current levels)would either move the stock price up, increase intrinsic value per share, or both. A large repurchase from GE would be particularly effective.
4) A better understanding of how GE plans to dispose of its current holdings of GNW stock
5) To the degree there is short-term selling pressure on GNW stock from convertible arbs, the completion of their hedging