Description

JACKSON FINANCIAL INC.

I learned a long time ago that when I am in a room with a lot of smart people, many of whom know a lot more about a particular subject than I do, I shouldn’t pontificate on that topic.

However, Jackson Financial, a newly spun-off purveyor of annuities, is potentially so cheap and seems to have the possibility for such large gains (100% short-term; maybe 500% to 1000% over a decade) that I am going to talk about annuities here, in the hope that some VIC members help me understand this better and correct any of my misconceptions, and maybe even convince me that I am completely wrong here. Having already bought the stock, I am hoping that my thesis is correct and that the annuity experts in this forum agree with me. But if I am wrong, and the facts (as I understand them) change, I’m willing to change my mind, as that economist once said.

For any among you who are tempted to buy a stock just because a VIC member recommended it, I say caveat emptor. As I’ve indicated above and you will see below, the gaps in my knowledge on this company and its wares are huge, and I am looking to you to help me plug some of these holes.

First, please bear with me while I share my limited knowledge.

Annuities

“Annuities” has long been a dirty word in my lexicon. Annuities are products that are generally sold, not bought, and the buyer often has only a vague sense of the risks and costs involved. I associate the word with scandals dating back to at least the 1980s along with fines paid by insurers, sleazy salespeople earning high commissions by foisting off poor-performing investments on the financially unsophisticated, resulting in retirees losing large chunks of their hard-earned life savings.

But there are apparently useful annuities too, ones that can fill a need for people planning for steady retirement income, while providing tax-deferral benefits. And there are apparently honest vendors of annuities (or is that an oxymoron?) who are much loved—if only for the fees they generate—by the middlemen who sell them to their clients. And presumably there are happy clients too, or we are sitting on a gigantic house of cards—there were over $3 trillion of deferred annuity assets out there at the end of 2020.

Background

First a little history on Jackson. Jackson National Life was founded in 1961 in Jackson, Michigan. It was acquired for $608 million in 1986 by Prudential plc, a London-based insurer which has been in business since 1848.

In February 2020, Dan Loeb of Third Point sent a letter to the board of Prudential plc, calling on the company to separate its U.S. business (Jackson) from the rest of the company. Despite being based in London, Prudential does no business there: the vast majority of its operations are in insurance businesses across Asia and, to a lesser extent, Africa. Loeb had purchased an economic stake of just under 5% in Prudential (including derivatives). At that time Prudential’s market value was almost $50 billion, and analysts were reported to be estimating that Jackson was worth somewhere between $5 billion and $10 billion (or between $53 and $106 per share).

Prudential owned 100% of Jackson until July 2020, when it sold 11.1% of the shares (with 9.9% of the voting rights) to Athene, leaving it with an 88.9% economic interest. In September 2021, Prudential spun off 69.2%, retaining 19.7% of Jackson’s outstanding shares, approximately 18.6 million shares. The spinoff ratio was 1 Jackson share distributed for every 40 Prudential shares owned; this translated into shareholders receiving about $3 worth of Jackson shares for every $100 worth of Prudential owned (Prudential shares trade on the LSE; ADRs trade in the U.S. under the ticker PUK). The transaction was taxable to Prudential’s U.S. shareholders. Presumably many recipients chose to sell their just-received Jackson shares. Prudential plans to reduce its Jackson stake to less than 10% over the next 12 months.

Athene

In June 2020, Athene reinsured $27.6 billion of Jackson’s in-force fixed annuity and fixed index annuity book. The following month Athene bought 11.1% of Jackson for $500 million, equivalent to a price of $47.64 per share, vs. $27.90 today. It’s hard to know whether Athene paid what they considered an attractive price for these shares, or whether they overpaid because they were making it up on the reinsurance transaction.

Business

Jackson is the U.S. leader in individual annuity sales, with 2020 sales of about $18 billion and market share of 8.2% of total annuity sales, and 16.8% of variable annuity sales (see Table III below), though its market share dropped to 7.8% and 15.5% in the first quarter of 2021. It has been the top-selling retail annuity company in the U.S. for eight of the past nine years. It sells variable, fixed index, and fixed annuities, designed to meet different needs. The company claims that it has an edge over the competition because of its differentiated products and its strong distribution network and that its brand is well-known among distributors and advisors. It believes that its market leadership combined with its efficient and scalable operating platform will enable it to grow profitably as the U.S. population ages with large numbers of people planning for and entering retirement. Jackson boasts a broad range of different annuities, apparently offering a wider range of investment options to variable annuity policyholders than competitors. Although it does sell fixed annuities and fixed index annuities, these are a small part of Jackson’s business, accounting for less than 8% of the company’s total 2020 annuity sales.

Jackson’s products are sold through independent broker-dealers (71% of 1Q 2021 sales); wirehouses and regional B/Ds (13%); banks and other financial institutions (13%); and independent professionals (3%)—these last include RIAs, insurance agents, and third-party platforms.

TABLE I

TABLE II

TABLE III

Jackson’s portfolio of offerings has had one big hole in it. Management sees a big opportunity in the rapidly growing market for Registered Index-Linked Annuities. (RILAs are a type of variable annuity that use a stock-market index to determine gains or losses, while letting the owners of the annuity determine the maximum loss they are willing to incur.) Just last month Jackson introduced its first RILA offerings. As illustrated in Table IV below, Jackson is the leader, by a big margin, in traditional variable annuities (left section), but has no presence in RILAs (right section). Table V further down shows the rapid growth in RILAs over the last five years—45.6% CAGR—and RILAs have gone from being less than 3% of variable annuity sales in 2015 to almost 25% in 2020. RILA sales were $28.4 billion in the first nine months of 2021, 81% higher than prior year levels.

https://www.limra.com/en/newsroom/news-releases/2021/secure-retirement-institute-variable-annuities-propel-total-annuity-sales-to-double-digit-growth-in-third-quarter-2021/

https://www.limra.com/en/newsroom/news-releases/2021/secure-retirement-institute-second-quarter-2021-u.s.-annuity-sales-highest-since-fourth-quarter-2008/

TABLE IV

TABLE V

Low-cost provider

Jackson claims to be a low-cost provider in its business. It says that its combined statutory operating expense to asset ratio of 26 basis points is among the lowest in the life and insurance industry, while variable annuity peers (Brighthouse, Equitable, Lincoln, and Prudential) average 57 basis points. I don’t fully know how to quantify this, but if the “combined statutory expense” is the bulk of the “Operating Costs & Other Expenses, Net of Deferrals” line in Table VI below, that appears to give Jackson a cost advantage amounting to hundreds of millions of dollars annually over its competitors, right? Please correct me if I’m wrong here.

Accounting

I have read my share of Graham & Dodd and Buffett but I don’t know how to make sense of the financial statements of Jackson.

Table VI below is Jackson’s balance sheet for recent years, along with the pro forma adjusted book value at the end of June.

TABLE VI

Again, I lack the expertise to fully understand the nuances of the details here. But a couple of things jump out at me:

1. Adjusted BV/share (net of AOCI) is over $91—the stock is trading at 0.3x this number today.

2. DAC, at $13.8 billion, is about 160% of the Adjusted BV of the company. My fear is that if they are regularly overcapitalizing/underamortizing DAC, the economic equity could be much lower, and potentially less than zero. I think of DAC as expenses incurred to acquire assets on which the business will earn fees and possibly a spread. But I don’t know how to put Jackson’s DAC number in perspective. Insights on this would be welcome.

3. Not included in the table above is that Jackson, to enhance liquidity, took on $2.35 billion in debt as part of the spinoff, which increased its cash balance by that amount. Their targeted long-term total financial leverage ratio (total debt / debt + adjusted BV) is between 20% and 25%, and they are currently in the middle of that range. I assume that the additional liquidity is a good thing.

Table VII below is the reported GAAP income statement for each of the last three calendar years, and the first half of this year. I rarely consider investing in a company where the fluctuations in the bottom line are so great from one period to the next.

TABLE VII

But now for the alchemy. Or is it accounting legerdemain, shenanigans, or even chicanery? Or maybe even the honest truth? Table VIII below presents the income statement organized by business segment, and supposedly presented to highlight the true underlying operating income of the company (“Adjusted Operating Earnings”):

TABLE VIII

Wait, WHAT??

Management is representing in this table that Jackson has fairly consistent annual earning power of maybe $2 billion, or $20 per share. Not only that, but the book value on June 30th was $91.37 per share. In effect, they are saying that the stock today is trading at 0.3x BV and less than 1.4x annual earnings.

Could this be right? Can we expect this financially incomprehensible, inscrutable company to earn $2 billion annually? And they are talking about growth ahead. Could it be that a company selling annuities—a product I have always thought belongs somewhere between shady and sleazy—is capable of consistently earning well north of 20% ROE while providing a useful service to those planning for retirement? Is it possible that Jackson, with its large established distribution network and low-cost structure, is the class act of this industry, and that the stock is actually worth—today—well over double its current price? And—I dare not say this out loud, so I’ll whisper it—could Jackson’s stock have the potential to be at 4x to 10x the current price in a few years or a decade?

If JXN’s underlying per-share earning power indeed exceeds $20 today, EPS of $30-plus a decade from now doesn’t feel like a stretch. If BV is over $91 today and ROE indeed exceeds 20%, if most of the earnings are retained and stock is bought back at below book for some years, BV should more than double over the next decade. With this level of earnings and BV, we should be able to imagine the stock price at over $200, and maybe even $300, ten years from now. (That would make it less than 10x EPS and not much over BV.) Throw in some dividends and we get an IRR exceeding 25% over a decade. Even a P/E of 5x, or a price of $150, will give us 18.5% IRR over 10 years, before dividends. Pinch me, someone.

Credit Ratings

For what it’s worth, Jackson National Life Insurance Company, the primary subsidiary, is rated A by S&P, Fitch, and A. M. Best, all with a stable outlook. Moody’s rates it A2 with a negative outlook.

Comparables

Brighthouse Financial (BHF) is probably the best comparable for Jackson, given its large annuity business, most of which is variable annuities. BHF was spun off from MetLife and started trading publicly in July 2017.

BHF’s GAAP reported profits are all over the place. If anything, the numbers appear worse than Jackson’s GAAP numbers. See Table IX below. Also, like Jackson, BHF performs its own alchemy and arrives at its “Adjusted Earnings” numbers, showing solid adjusted profits virtually every year. See Table X. Table XI has some book value information on BHF.

Again, I don’t know what to believe. BHF’s adjusted numbers showed adjusted profits of between $625 million and $920 million annually between 2016 and 2019, and an adjusted loss of $229 million in 2020. An average of these five years is $580 million, or about $7.25 per share (using the current share count). If we believe this to be the real earning power, the stock is trading at about 7.3x these earnings. In the first nine months of 2021, “adjusted” EPS was $15.74. If we believe this, the stock is at about 2.5x the adjusted annualized earnings run-rate.

Book value per share (excluding AOCI) was $128 at the end of September; BHF is trading at about 0.42x that number.

Regardless of which of these we choose, Jackson looks remarkably cheap in comparison. At BHF’s 0.42x BV, JXN would be at over $38, more than 35% higher than the current price. At 2.5x its adjusted earnings, JXN would be at about $50; at 7.3x it would be over $145. That last is more than five times today’s price. Also, JXN’s adjusted ROE levels are significantly higher than those of BHF, so a comparison of earnings multiples is probably more appropriate than a comparison of book value.

TABLE IX

TABLE X

TABLE XI

Starting in September 2018, BHF has steadily repurchased its stock, spending about $1.42 billion on stock buybacks in just over 3 years. See Table XII below. The number of shares outstanding has declined from 120 million at the time of the spinoff to just under 80 million today (early November). In the months immediately following the spinoff BHF stock traded between the mid-50s and the high 60s (see Table XIII). Four years later the stock is below $54, having traded in the 30s and 40s during most of that period, and briefly traded below $16 in March 2020.

TABLE XII 

TABLE XIII

Hypothetically, what if BHF had not repurchased any shares but instead distributed the same $1.42 billion over the last three-plus years. That translates to almost $12 per share (on the 120 million starting base), or about $3.75 per share annually. If I had owned shares three or four years ago, would I be better off under an all-dividend scenario than I am today? Yes, BHF would have more shares outstanding and I would own a smaller piece of the company than I actually do today. But I would also have received almost $12 pre-tax in dividends per share. And surely a $3.75 annual dividend rate would have resulted in a higher price than we have today? Perhaps $75 for a 5% dividend yield, or even higher? My sense is that BHF has not served its shareholders well so far with its no-dividends, only-buybacks policy. The buyback rate today is over $400 million annually, or over $5 per share now (based on shares now outstanding). Unless a shareholder is very confident that the company is indeed creating tremendous value in its business, has huge earning power, is not subject to catastrophic risk, and the stock is still extremely cheap, shareholders are likely to be better off if the policy was changed to focus more on cash dividends.

Capital Allocation: Buybacks or Dividends?

Jackson National Life, the principal operating subsidiary, paid $4.2 billion in combined statutory dividends (to its parent), net of capital contributions, from 2011-2020, i.e. an average of $420 per year, suggesting that Jackson has been generating at least that much in excess capital annually. Dividends were paid in 9 of the last 10 years.

Jackson intends to distribute 40-60% of the increase in its excess capital annually. It expects to distribute between $325 million and $425 million in the form of cash dividends and stock buybacks over the 12 months following the spinoff. (This seems to imply that excess capital of between $540 million and $1.06 billion will be generated over the next 12 months, or between $5.70 and $11.20 per share.) The $325 - $425 million distribution target for the next year translates to between $3.40 and $4.50 per share, or over 14% of today’s stock price in the middle of the range. That sounds attractive. With the stock at 0.30x BV, buybacks would be hugely accretive to book value. Perhaps they should only be buying back stock, and not bothering with cash dividends.

But wait. What if the numbers they’ve presented to us on the balance sheet and in the “adjusted” income statement are not to be believed? What if they’ve been grossly under-amortizing DAC, an intangible which is about 160% of shareholder’s equity? What if the derivatives used to hedge their risks have been grossly mispriced by them on the balance sheet? In that case the real BV could be vastly lower than the stated number. Is that what the market is telling us by pricing the stock at 30% of book value? Maybe I should prefer only cash dividends, and little or no buybacks. Maybe the best thing for me would be to get $3 or $4 of cash dividends each year, dividend-tax-inefficiency be damned. That should get the stock up to over $50 in a hurry.

But wait. If it’s that easy to get the stock up to $50, maybe they should be buying stock aggressively at less than $30 today. They can rapidly buy 10% of their stock for less than $300 million, potentially creating enormous value for us remaining shareholders.

But wait. Going back, what if the numbers are not to be believed yet. I think of management as being on probation until they have proven themselves. Now I’m really confused. But all in all, my conclusion is that I would rather see the hard cash today. One in the hand and all that.

Also, if every $1.00 of earnings retained today (rather than distributed to shareholders) promptly becomes worth thirty cents (given that the stock is trading at 0.3x book), or even fifty cents, then I would prefer the cash to be given to me. I’m perfectly capable of decimating my own capital without the help of management. And if the company is indeed earning anything like $20 per share today, then please distribute as much as you can to me. $10/share of dividends annually would be wonderful. I can pretty much guarantee a stock price of over $100 if that happens.

Jackson will be reporting its third-quarter earnings after the close on November 9. This is its first earnings report since becoming an independent public company, and I am very interested in what they say, particularly on dividends vs. stock buybacks.

I welcome any opinions on this capital allocation issue.

A Note on VIC Ratings

To any in this audience who think that this deserves a 1 or 2, particularly on performance, I am open to your rating. But please, please explain why you think such a rating is warranted. The more detailed the explanation, the better. And, ideally, I would love to see a full writeup of Jackson with a recommendation to short the stock. I sincerely want to hear the other side. If I’m wrong, the sooner I find out the better. I can take my losses (or maybe even a small profit at today’s price) and look for something else to bang my head against. I value my capital more than my wounded pride.

In particular, there are VIC members who seem to understand this space well. PCM983 has written up Athene (ATH) and Brighthouse (BHF) as shorts, and Lincoln (LNC) as a long recommendation. Another member made a comment last year that Jackson was “the worst of the lot imo.” And just a few weeks ago someone asked whether Jackson was worse than BHF. I welcome any input from all of you.

“I welcome your answers”

When providing testimony to Congress, it’s customary to end prepared remarks with: “I welcome your questions.” But since I have many more questions than answers, I will instead say,

“Thank you for reading. I welcome your answers.”

Risks

-   The adjusted BV of $91 and the adjusted EPS of $20 are not real, so that the stock is not actually cheap.

-   Volatile markets and interest rates weaken the company.

-   Management doesn’t use excess capital wisely.

Catalyst

Earnings report this week includes a large initial dividend--minimum $1.00 annually, and preferably over $2.00 annually.