Market Musings - November 4, 2017
We continue our blog series: Market Musings, Volume 1, Edition 2, giving our (hopefully not too random) thoughts on recent goings-on in the markets and to document our stock market views and long/short ideas for posterity (knock on wood, not in a way that looks foolish retrospectively).
More Earnings News - Continuing yesterday's edition recapping certain recent earnings reports, the following of our holdings reported financial results:
Importantly, the company did not need to increase its long-term care (LTC) reserves this quarter (in Q3 2016 it increased these reserves by $435 million), however LTC did register a $5 million operating loss versus $33 million in operating income in Q2 2017, or down $38 million sequentially--something to keep an eye on going forward. Genworth stated that this decline "reflected less favorable existing claim terminations, higher benefit payments, and less favorable new claim experience". In addition, the company will need to perform loss recognition and cash flow testing for its LTC products in Q4 2017.
Genworth also updated the market on the status of the closing of the China Oceanwide merger (as a reminder, our long thesis regarding the transaction is available at this link):
The main stumbling block appears to be getting the deal approved by CFIUS, which has balked at a Chinese company having access to the confidential health information of Genworth's millions of LTC policyholders. If (and it's currently still a large "if") the China Oceanwide merger goes through as planned, there is 58% upside awaiting shareholders to reach the $5.43/share buyout price.
GNW stock closed yesterday at $3.43/share, in comparison with net book value (ex-AOCI) of $20.10/share as of September 30, 2017. Genworth is thus trading at just 17% of book value. We believe that long-term downside is limited for GNW shares, because even if one assigns a zero valuation to its life and annuity businesses (assuming the China Oceanwide merger is terminated), the sum of the parts of the remaining businesses minus the holdco net debt equals $5.25/share, as per the following calculations (share percentages for GNW Canada and GNW Australia sourced from GNW's 2016 Form 10-K, pages 11 and 13, respectively; U.S. M.I. sourced from GNW LTM earnings releases):
Genworth Sum-of-the-Parts Valuation (ex-L&A businesses) = $2.65B, or $5.25/share, 53% above the current market price, calculated as follows:
1. Value of GNW Canada equity = 57.2% X C$3.91B X 0.78 f/x = $1.74B; plus
2. Value of GNW Australia equity = 52.0% X A$1.39B X 0.77 f/x = $0.58B; plus
3. Value of U.S. M.I. = 12X $298MM LTM Operating Income = $3.58B; minus
4. Estimated Net Holdco Debt @ 9/30/17 = $3.25B.
GNW is therefore currently trading at a 37% discount to the SotP (ex-L&A), which seems extremely and unnecessarily pessimistic, especially since the capital maintenance agreement of the holdco to support the L&A insurance subs terminated in October 2016, per the following excerpt from page 7 of the 2016 Form 10-K filing (note: this means that dividends from GNW's mortgage insurance subs do NOT need to be contributed by the holdco to the L&A insurance subs to maintain the latter's capital levels):
Below is the recent stock chart:
We believe that EMGC is interesting because it trades at a 74% discount to its net book value ($52MM fully diluted market cap versus $199MM in shareholders equity). If the stock were to trade at book value per share of $1.46, the stock would be 284% higher (a fact that certainly captures an investor's attention--at least, it captured ours). In addition, we believe that there is an alternative method of valuing EMGC's equity by using certain facts disclosed in its SEC filings (which method also indicates substantial undervaluation). However, we will table the rest of this discussion pending the release of a formal investment writeup on EMGC shares (which we will post under our Research tab). Thus, EMGC is in the "To be continued..." category.
DISCLOSURE: We are long GNW and EMGC.