Background &
Summary
Genworth (GNW) took a dive last week due to long term care (LTC)
concerns. The valuation looks absurdly low from a book value perspective. Is it
a bargain? Here’s my take on it.
- Sum of the parts analysis shows that GNW is trading within a range of fair value depending on where LTC comes out.
- To realize the value here, GNW should restructure and cleanly separate the various mortgage insurance (MI) subsidiaries from the life insurance businesses (life insurance, annuities, and LTC).
- However, GNW’s unique corporate and capital structure means that any restructuring would require paying down debt – the difficulties of doing so reduces upside from restructuring.
What Is It Worth
Here I did a sum of the part approach. I will intentionally leave
LTC blank for now and come back later. I
get to about $9.5 per share excluding LTC. If we say US MI is probably worth
more than I assigned here this thing could be worth $10-11+ excluding LTC.
·
Canada (MIC.TO) and Australia MI (GMA.AX) are valued
using their respective stock prices and exchange rates.
·
Segments that do not earn its cost of capital
(judged by ROE against tangible book) would certainly not deserve book value,
so I used a normalized earning x multiple approach. This is unfortunately most
of the businesses (US MI, Life insurance, fixed annuities, international
protection)
·
“Normalized earnings” are basically taking
average earnings for last 3-7 quarters and annualized.
·
I’m probably underestimating US MI here. Earnings
here should be growing due to legacy vintage losses running off. On the other
hand, US MI will have to raise about $500-700mm of capital due to new
regulations. Management plans to use reinsurance to meet that requirement and
that would decrease earnings. The $1.2bn I assigned here is equivalent to 75%
of tangible book value (ex AOCI and DAC)
·
Life insurance and fixed annuities earnings
could be at risk. Genworth just got downgraded so that could hurt sales.
·
Use book value for runoff segment.
·
Corporate is basically net debt. Netting $2.2bn of cash/investment against $500mm
deferred tax liabilities and ~4.2bn of debt leaves ~- 2450mm of book value at corporate.
·
Why only ~$4.2mm of total debt vs $6.7bn total? In segments that are valued using earnings,
we implicitly netted out the debt already so we have to be careful not to
double count. Interest expenses are already accounted for in Australia, Canada
MI, Life Insurance (not including LTC), so those related debt are excluded
here.
·
I noticed that international protection segment has
interest expenses allocated to it but I’m not sure which piece of debt that
should be attributed to. So maybe I’m overestimating the debt in corporate
segment, if that’s the case value would be even higher
An Ideal Restructuring
Let’s say LTC is not totally negative (a big assumption). At
$8.5 / share GNW would seem undervalued. But how do we unlock this value? I attempted a stub trade: buy GNW, short Australia and
Canada MI. Unfortunately my broker is telling me Australia MI is not available
to short. (I’m just an individual investor and I bet a big time hedgie can get
those share to short but even then international shorting surely have its own
complications).
For shareholders to realize value, GNW should cleanly separate
out the MI segments from Life insurance businesses. These businesses have little
synergies between them (aside from financial ones which I will discuss next
section). At this point, a highly specialized headache such as LTC would be
better served by dedicated management and analyst attention.
On the other hand I’m not sure it’s possible to separate out
life insurance between life, LTC, and annuities, as LTC is a capital hog. Those
3 will have to remain together in the near future.
Problem with Restructuring
A barrier to restructuring is the ~$4.2bn of debt at
Genworth Holdings, Inc. As seen in the
corporate structure below, Genworth Holdings Inc is just a holding company and services
its debt by 1) hoarding cash on hand, 2) subsidiaries to dividend upward. With life
insurance subsidiaries not planning for dividends in the near future, Genworth
will be even more dependent the various MI subs.
It’s fair to say any corporate break up would require paying
down debt due to 1) rating concerns, 2) current reliance on mortgage subsidiaries
for holdco debt service.
However, companies don’t just get to pay down debt whenever
they want. The bonds I looked at are all non-callable and make-whole premiums at
T+30 would be very expensive. Tender-offers would also be tough as most bonds
are still trading above par.
The valuation above already needs to be way above stock
price for an activist to take on the black hole that is LTC, having the
additional cost of retiring debt just makes it that much tougher.
Upside
That’s not to say a restructuring can’t be done. GNW can
selectively retire some but not all of the bonds and optimize between debt
service coverage, ratings, and costs.
Genworth has plenty of assets that can be converted into
cash. Australia and Canada MI are already publicly traded so Genworth can sell
more stakes. US MI should have plenty of bidders. Upstarts like ESNT and NMIH are
better buyers than RDN/MTG due to their lack of legacy issues and thus capital
needs. Also, I’m sure some banker is pitching AIG to combine United Guaranty with
Genworth’s US MI and be spun off into its own company. Because GNW holds some cash
cushion for debt service, deleveraging would itself free up some of that cash
on hand.
Maybe if 4Q reserve reviews leaves capital in a good
position and thus more visibility on the LTC end, management can start
deleveraging and set the stage for restructuring. I'm not counting on it.
Simplified Corporate Structure
Capital Structure
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