Description

We believe Primerica represents a timely investment opportunity with a tremendous risk / reward.  A few weeks ago, the company repurchased a significant number of shares from Citigroup (the company used to be wholly-owned by Citigroup), and last week, Citi sold its remaining stake in the company, removing a significant overhang for the shares.  

Primerica is a highly attractive business disguised as an insurance company, and we believe the shares have return potential of 50+%, without significant risk.  The stock currently trades at less than 8x 2013 earnings and a small premium to book value, which is far too cheap given the overall quality of the company’s business and cash flows. 

Primerica was IPO’d out of Citigroup in March 2010, with Citi originally retaining a roughly 40% stake.  Citi sold down a portion of their stake in an April 2011 secondary offering.  At the beginning of November, Primerica repurchased $200 million of Citi’s stake directly and last week Citigroup sold its remaining shares in another secondary offering.  We believe that this sale removes an overhang and will also help to increase liquidity, which should lead to a better valuation over time.

Business

Primerica is a distributor of financial products and term life insurance to underserved middle-income families through a sales force of 92,000 licensed representatives.  The business is split into 2 key segments: term life and investment and savings products.  The term life business sells plain vanilla term life insurance products that are underwritten by the company directly (with a portion of the legacy book having been retained by Citigroup).  The investment and savings products business is a fee-based business where Primerica distributes annuities, mutual funds and other financial products on behalf of 3^rd parties.  The key driver of value for both of the businesses is the company’s large sales force of independent commission-based reps that gives them a competitive cost advantage in selling financial products to middle income families.  We believe this is a growing market that is underserved by traditionally financial companies. 

In our view, the term life business is an attractive business that generates predictable, low-risk cash flows and the investment and savings products business is a great business that generates high-margin, largely recurring fee-based cash flows with no associated capital investment.  The investment business generates commission and fee revenue from 3 sources: commissions on the sales of new products, fees from existing assets under management and fees based on the number of existing accounts.  Primerica’s sales force is in turn paid a share of the commissions from new sales (roughly 70% share to the sales force) and assets under management (roughly 30% share to the sales force).  On a net basis, the company earns roughly 25% of its revenue from sales-based commissions and 75% from asset-based and account-based fees.  Operating margins are effectively in the 60% range when calculated off of net commission revenue, making this an extremely high-quality, royalty-like stream that we believe should trade at a high multiple.

Excess Capital

Primerica was originally IPO’d with an excess capital balance in order to satisfy regulators.  The company estimated the excess capital balance at approximately $350 million.  As mentioned above, Primerica used $200 million of this excess capital to repurchase 9 million shares directly from Citigroup.  The company is currently working on a reserve securitization financing which should allow them to free up about $150 million more from their insurance subsidiary.  We believe that the company will be aggressive going forward in using excess capital to repurchase shares.

Financials & Valuation

Pretax Income                          2011    2012    2013

Term Life                                 $188    $184    $193

Investment Products                   115      115      119

Corporate                                  (40)      (50)      (53)

Total                                        $262   $250     $259

EPS (36% tax rate)

Pretax Income                          2011    2012    2013

Term Life                                 $1.66   $1.90   $2.15

Investment Products                   1.01     1.19     1.33

Corporate                                (0.36)  (0.51)   (0.59)

Total                                        $2.31  $2.57   $2.90

Avg. shares outstanding              73          62        57   

For the above projections, we assume that the term life business has about a 200bp margin impact in 2012 from the implementation of new deferred acquisition cost accounting rules (this is accounting only – does not change the cash flows of the business).  We have also assumed that investment products earnings are roughly flat next year due to a lower level of assets under management from the decline in equity markets in 2H11.  Additionally, we assume that the company uses the remaining $150 million in excess capital to repurchase stock in 2012 at $24/share and then uses roughly 50% of its net income to repurchase stock beyond that.

We believe that it would be reasonable for the term life business to be valued at roughly 10x earnings and for the investment business to be valued at 15x which blends to a multiple of roughly 12x and would equate to a one-year price target of $34 on 2013 EPS of $2.90 and 55% upside versus the current price of $22 per share.  Additionally, the company will have tangible book $23 per share with minimal balance sheet risk, excess capital, a structurally high ROE and a significant fee-like revenue stream, which we believe makes the risk of losing money from here quite low.

Catalyst