UnumProvident UNM W
November 13, 2001 - 10:18am EST by
2001 2002
Price: 23.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 5,780 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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UNUM Provident, the dominant provider of disability insurance, is selling at only 1.01X its September 30 book value of $23.71, about 10.0X projected recurring 2001 EPS of $2.40, and 8.5X projected 2002 EPS of $2.80. Furthermore, we estimate that the company's earnings will reach the $3.30-3.60 per share range in 2003 as a new management continues to correct several errors that were made by the old management (which was replaced last year). The errors and related earnings disappointments are the apparent reasons why UNUM currently is selling at such a depressed and bargain price (in 1999, the shares sold as high as $57). In the late 1990's, before the errors became apparent, UNUM enjoyed the reputation for being a strong and well-positioned company - and its shares typically sold in the range of 14-17X EPS. If, in 2003, the company earns $3.30-3.60 per share and sells at 13X earnings, an investor purchasing the shares today will enjoy a 77-90% gain on his investment (plus a yield on the $.59 dividend). Should the new management fail to return UNUM's earnings to a respectable level, we believe there is a good chance that the company will be sold. The Maclellan family owns roughly 42 million of the 242 million outstanding shares, has two family members on the Board, and has expressed an interest in realizing shareholder values. Because UNUM enjoys such a dominant position in an attractive segment of the insurance business, we believe that many large companies (AIG, Hartford Life, and General Electric, for example) would be very interested in acquiring UNUM.

For purposes of analysis, UNUM has four product segments: (1) group disability insurance; (2) individual disability insurance; (3) group life insurance; and (4) Colonial, which sells payroll deduction insurance plans. Group disability works as follows. A company takes out a policy that covers all or most of its employees. If an employee becomes disabled and can no longer work, then UNUM pays the disabled employee a certain percentage of his or her salary (typically 60-75%) until the employee can return to work or reaches retirement age. Because an employee is more likely to become disabled than die, disability insurance, in many ways, is more valuable than life insurance - yet the market for disability insurance is much less penetrated. UNUM is the dominant factor in the group disability market with a 29% share (the largest competitor has a 9% share). Because of its size and power in the market, UNUM has a number of important efficiencies of scale and other competitive advantages that are the envy of the disability industry.

Individual disability is similar to group disability, except that a policy is sold to an individual rather than a company. UNUM has a 43% market share in the individual disability market (its nearest competitor's share is 13%) and enjoys large cost and other advantages.

Group life insurance normally is sold to UNUM's group disability customers - often as part of a package. Whereas to be successful in the disability business one needs scale, experience, and expertise (and thus there are strong barriers to entry), the life insurance business is quite straightforward and competitive.

Colonial sells disability, life, and cancer protection policies through payroll deduction plans. It is #2 in its business. Aflac is a strong #1. Colonial is a well-run and profitable subsidiary, but does not possess the strong competitive advantages enjoyed by UNUM's disability subsidiaries.

In the mid-1990's, UNUM's management became over confident and too aggressive. A number of acquisitions were made and attempts were made to increase premiums rapidly by gaining market share. As it turned out, most of the acquisitions were poorly conceived -- and much of the business that UNUM won from competitors was under-priced. Furthermore, the company's rapid growth stretched its capital. Last year, after the errors became apparent, the old management was replaced. The new management already has made substantial progress reversing the errors - and we believe that by 2003 UNUM's earnings should be back on track. UNUM's competitors and other insurance companies tell us that a "typical" disability block of business should earn a 10-12% return on employed capital. Because of its market position and other competitive and cost advantages, we believe that UNUM's returns should be at least 2% higher than "typical". Furthermore, UNUM's leverage (its debt equals about 28% of its capitalization) should add 1% or so to its ROE. Thus, we believe that UNUM should enjoy a ROE of 13-15% by 2003. This is in line with management's goal of a 14-16% ROE. By mid-2003, UNUM's book value should be about $27¾. Our conservative projection for 2003 is that UNUM will have a 12-13% ROE on a $27¾ book value - and therefore will earn $3.30-3.60 per share. After 2003, UNUM should have good growth potential, partially because the market for disability insurance is under-saturated.


Changes being made by the new management should cause earnings to increase sharply over the next few years. If earnings do not increase to a respectable level, we believe that UNUM, which is a strong and particularly well-positioned company, will be acquired at a large premium to its present price.
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