|Shares Out. (in M):||50||P/E||55.5x||0|
|Market Cap (in $M):||323||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|Borrow Cost:||Available 0-15% cost|
Short Citizens Inc (CIA) Stock:
Citizens is an insurance company that operates in an illegal activity, has numerous red-flags, trades at an absurd valuation and now has a potential catalyst for increased regulatory scrutinty. We think CIA is worth between zero and $2 per share compared to its current $6.45 price. There has been some commentary about CIA on the NWLI thread recently so I thought I would post this since the recent 8K has introduced a timely catalyst.
1. CIA’s core international life insurance business is based on illegal activity in Latin America
2. Their business is tailored to exploit people to invest in their stock and inflate its value through the quirks of their policyholder dividends
3. There is potential regulatory scrutiny in Brazil and other markets
4. There could be potential liability from a Texas class-action lawsuit
5. The company trades at 55x earnings, 1.5x stated tangible book value and 10x adjusted tangible book value (excluding AOCI and DAC)
6. Most importantly, the recent 8K disclosure about non-compliance with IRS requirements could be a significant financial liability for the company and increase additional scrutinty on the company’s operations - from the SEC to state insurance commissions
1. Core business:
Citizens sells US dollar-denominated life insurance in international markets, predominantly Latin America, without any local presence, offices or branches. This business is illegal since it violates most local insurance regulations that require insurance companies to register with local insurance commissions. The company’s risk factors disclose the dubious nature of its operations.
2. Citizens’ policies are very odd in that they pay cash policyholder dividends, which are then re-invested in the parent company’s stock. We are not aware of any stock or mutual insurance company with such an unusual arrangement. It seems very odd that an insurance company would allow its policyholders to buy its common stock through their policy at all, but it is even more absurd when the stock trades at over 50x earnings and well above book value. CEO Harold Riley tried to explain the logic behind this practice in this clip (see 6:10 mark):
“Now we have these trusts that invest back in what? Into Citizens’ stock. Are they gambling? No. They are simply taking an opportunity to get a market gain because the market has no ceiling.”
It’s very difficult to know how much stock the policyholders actually own now since the purchases were done through a Panamanian trust and the disclosure has been changed from time to time. It is possible that a large portion of the company’s shares are (perhaps unknowingly) held by policyholders, all while the Riley family has been slowly selling their holdings.
3. As mentioned on the recent NWLI thread, the Brazilian insurance regulator fined NWLI (with a $900 million market cap) an amount equal to $6 billion (with a B) for operating as an insurance company in Brazil without due authorization. While it is nearly impossible to enforce that fine since NWLI or CIA have no assets in the country, we think that this illustrates the questionable business practices that both companies follow. I should note that NWLI, which has a part of their business that does the same thing as Citizens, but to a less nefarious degree, was where CIA CEO Riley began his career.
4. There has been a Texas lawsuit that has sought class-action status and has been pursued for many years against Citizens, essentially arguing that the company violated US securities regulations by selling these insurance policies. The case was scheduled trial in late 2014 but has been delayed to the best of my knowledge and I have no view on the timing given how long it has dragged on.
The risks and red-flags go on and one, as evidenced by the increasing risk factors in the company’s 10K:
5. The company trades at nonsensical valuation metrics for a life-insurance company, largely because there is artificial demand for its shares from the policyholder dividends that buy stock in the open market. If CIA were to valued similar to NWLI, its stock would be down between 40% and 80%.
6. Most importantly, last Wednesday the company put out an 8K that stated:
As part of an internal operation review of the life insurance products issued by our subsidiary insurance companies, the Company’s management determined during the first quarter of 2015 that a substantial portion of its endowment policies and whole life insurance policies do not qualify for the favorable U.S. federal income tax treatment afforded by Sections 7702 and 7702A of the Internal Revenue Code of 1986. The policies at issue were primarily sold to non-U.S. citizens residing abroad. The failure of these policies to qualify under Sections 7702 and 7702A is expected to result in charges to the Company’s consolidated financial statements for the fiscal year ended December 31, 2014. At present, the Company is unable to quantify with reasonable certainty the magnitude of the charge expected to result from this tax compliance issue, but it is expected to be material to the Company’s financial condition and 2014 results of operations.
While we are not tax experts, we believe that there could be substantial financial penalties levied on the company or its policyholders (who would likely seek reimbursement from the company). The implications could be significant as many policyholders are also shareholders of the company, often with policyholders loans that the company itself provided. It is not inconceivable to see a run-on-the-bank based on the liabilities involved.
Also, we think (hope) that an IRS investigation into the company’s business practices could lead to additional scrutiny, from the SEC or the Texas state insurance commission. We believe that the vast majority of this company’s operations are illegal.
Link to full write-up with much more detail:
IRS tax liabilities
|Entry||03/19/2015 06:16 PM|
nice write up. i do agree that this company is slimey. i have looked at it before with respect to shorting but it was hard for me to determine how big the float was. and if the policyholders would actually stop buying shares. otherwise this could go on for years. it's unclear to me if this most recent 8k will be the catalyst - unless they have to stop writing new business - i don't think policyholders in columbia will be reading the 8k filings (although i hope they do!)
your math and analysis outside of this issue above i agree with.
i do disagree with your lumping them totally with NWLI. NWLI focuses on wealthy foreigners - take a look at the average balances. They provide a real product. CIA to me is a lower dollar product and more of a "scam". But that's just my view. The valuation obviously is quite different. If anything i would recommend buying some NWLI as a hedge to a CIA short (which we have done in the past).
nice write up.
|Entry||03/20/2015 04:12 PM|
I agree that finding a catalyst to this short was always the key question. I do think this recent 8K filing on the IRS section 7702 noncompliance could be a significant catalyst.
First, the company has already said that it would have a "material" impact on their financials.
Second, the stated penalties and liabilty for 7702 noncompliance is pretty severe. While we don't know the exact nature of the noncompliance and the total exposure, the company said that a "substantial" portion of their policies are non-compliant. Given how long the company has been in this business, it could be a big hit - see p. 1033/1034 https://www.dropbox.com/s/rantablgsgfbmk9/7702%20Record%20of%20Society%20of%20Actuaries%201995.pdf?dl=0
Third, for a company of these characteristics, any additional scrutiny is bad, so whether it is delaying your 10K or the IRS probing your policies, the more eyes on Citizens, the worse it is for them.
Lastly, we've heard that CEO Riley is in very poor health, the family has been selling their stock, the brother and son aren't as involved/competent (crooked?). Even the best-run schemes eventually run out of steam, no?
While I think that NWLI's international business is not entirely kosher, at least NWLI has other business lines and a reasonable valuation.
Bowd - I think the above answers your questions/comments also, but I would note that this company pays no dividend, costs less than 1% to borrow and is unlikely to be viewed as an open-ended growth story, so it's a decent short in my view if you just have the patience to wait it out until it blows up. Hopefully that day is sooner rather than later.
|Subject||Re: Re: catalyst?|
|Entry||03/20/2015 04:57 PM|
Without timely financials (delayed 10-K) - surely they are not allowed legally to buy their own shares with these offshore trusts on behalf of their policy holders? Companies can't buy back their own stock if financials are not timely and I think there is even a delayed cure period, no?
|Subject||Re: Re: Re: catalyst?|
|Entry||03/21/2015 03:53 PM|
not sure you need an effective registration statement to continue to make sales to an offshore trust. i think the materiality will be related to federal taxes due, rather than any halt in stock sales
|Subject||Re: Re: catalyst?|
|Entry||03/23/2015 11:44 AM|
The valuation on NWLI is MUCH cheaper - and they are targeting a much different client with a different product. NWLI of course is more universal life type of policy. My understanding - and i haven't done as much work is that CIA is more endowment and whole life policies - which are much tricker to follow per the code. From my contacts what i heard back was "they plain screwed up the policy structure".
question is whether or not columbia, peru has tax treaty with US and whether or not they go after these small dollar policies.
the other unknown on the short is how much is actually in the float? i don't have a good handle on that. also, i agree with the other posters that it's not clear that they have to stop buying shares for the trust.
the 1% borrow costs helps make this easy as you say - but who knows how many shares these guys are buying each month.
should this stock be lower - agree completely. just not sure if this is the catalyst. i hope you are right!!
|Subject||Share purchases suspended|
|Entry||04/10/2015 12:48 PM|
The Company has suspended the purchase of shares of Class A common stock by participants under the Plan until the Amended Registration Statement is declared effective.
|Subject||Re: Share purchases suspended|
|Entry||04/10/2015 03:24 PM|
Thanks RJM. Yes, this is definitely a short term negative, but I hope that the Stock Investment Program is dismantled long term so there is no artificial buying anymore.
There was also some interesting new disclosure in the recent 10K - regarding additional risk factors and the liability on the 7702 noncompliance.
As a result, we have established a reserve of $11.4 million for probable expenses and liabilities associated with this tax compliance matter, which amount represents the low end of management’s estimated range of those probable expenses and liabilities of $11.4 million to $40.0 million net of tax. This estimated range includes projected toll charges and fees as well as increased claims liability for past claims, reserves increases to bring policies into compliance.
It seems that this $11 million figure is only for toll charges and not any tax withholding liability, which could be much larger. Even $11 million is significant for this company, but the higher end of $40 million or the actual liability could be much more damaging to the company compared to its true book value:
Book Value: $258 million
|Subject||Re: CIA +17%, any news out there?|
|Entry||06/01/2015 06:36 PM|
Woolly - not sure. It was on decent volume too, but I didn't find any news. The annual meeting is tomorrow but that's usually not a catalyst. There is always the possibility that the trusts/Stock Investment Plan has been re-instated and the 8K hasn't been sent out yet, but that's just me speculating.
Or it could have just been nothing since the stock ended up 4%.
|Subject||Well, this sucks|
|Entry||06/17/2015 12:58 PM|
CIA has gone from $5.50 back to $7.60 in basically a straight line and with some odd trading behavior. There is heavy volume (for this stock at least) with sharp intra-day moves on no news.
I think it is likely that the company is behind this since they have some discretion as to when and how much the trusts buy in the open market for the Stock Investment Plan and the registration statement for the plan went effective on 5/19. I should have used that as a reason to cover but I didn't because I'm an idiot.
Fundamentally, I think CIA is still a very attractive short given the continued legal, regulatory, tax and other risks to their business model and the (pretty clear) manipulation of their stock . . . but this is a mea culpa for not exiting the position on 5/20.
|Subject||Another IRS failure|
|Entry||08/06/2015 08:45 PM|
From CIA's 2Q15 10Q published today:
In addition, as part of our continuing review we identified in July of 2015 certain annuity contracts which do not contain qualifying language under IRC 72(s) as intended that would have provided for favorable tax treatment of the annuities.
Like the IRC 7702 failure disclosed earlier this year, it looks like CIA is once again selling something that isn't as advertised (selling "life insurance" that isn't really, now selling "annuities" that aren't really).
|Subject||Re: Another IRS failure|
|Entry||08/07/2015 05:55 PM|
Thanks TML . . . I did not catch that. Not surprising . . . just a matter of time, in my view