Description

Summary

I am pitching Genworth Financial (GNW) as a compelling risk/reward trade.  No one in this environment can say that a leveraged institution such as a life insurer, can't under some circumstances, be a zero (i.e., unstable capital markets make regulators worry about capital adequacy).  However, I believe there is a reasonable case that GNW can go from $2.00 to $6.00.  I'm going to test out the new VIC formatting and try to paste in as many of my charts and assumptions as possible so that the community may fully vet this contrarian, yet potentially extremely lucrative, idea.  I think it will be best to print out these charts and then read the accompanying commentary.    

Genworth is a life insurer with problems.  Lots of problems.  It has three main divisions - Retirement and Protection, International Mortgage Insurance, and U.S. Mortgage Insurance.  Other VIC members have made the case for some of the other U.S. Mortgage Insurers, and I refer the reader to them for a more fulsome description of this business (MTG, PMI, etc.).  Despite the fact that many of those pitches have not worked out, their reasoning is sound and the ideas are solid.  That said, I am attributing no value to GNW's U.S. MI business.  The R&P and Int'l MI businesses are trucking right along, relatively speaking.  The company wrote international MI in Australia and Canada - two markets structurally different from that of the U.S.

In terms of analytical methodology, I feel the best way to value insurers in this market is to attempt to mark their assets to "real" market, and then make some sort of qualitative judgment of what their earnings power might be going forward in a normalized environment to gauge one's margin of safety.  Below I have laid out GNW's assets and liabilities and tried my best to roughly "mark" the assets.  Undoubtedly there are readers who will disagree with my admittedly rough valuations (5% discount on corporate bonds?  How do you derive that?), but my hope is that all who are interested in this pitch can plug in their own assumptions and gauge the potential return characteristics. 

In terms of valuation, I have 1) marked down the entire "fair value" asset portfolio (from 9/30/2008) by approximately 8% (see below for the breakdown), 2) attributed NO VALUE to the U.S. MI business, 3) subtracted off goodwill and other intangibles, and 4) added back the tax benefits from losses (excluding U.S. MI).  This gives me a tangible book value per share of $5.77.  Each 1% change in the value of the assets changes this valuation by approximately $1.00 of tangible book.  Thus, I feel an investor is paying 1/3 of "real" book value and attributing no value whatsoever to the ongoing cash flow capability of the business, PLUS one has a free option on the company receiving ANY value for the U.S. MI business (through a spin-off or otherwise). 

The company has $1.1 billion in debt maturities in 2009.  The company has $1.3 billion of cash at the HoldCo entity, as well as approximately $1 billion of incremental revolver availability, if needed.  In addition, the company is free cash flow positive.  A few months ago the two 2009 maturities were trading in the mid 50s and 60s on concern that GNW could not pay them off.  As those concerns abated, the bonds have traded to near par once again.  I believe that over the next 12 months, as the company addresses its near-term maturities, people will begin to look beyond the near-term headwinds and examine the real, fundamental value of the business, and we could see a massive repricing of the equity.  All of the large life insurers have announced bad news over the past several months - HIG, PRU, GNW, and others.  Each time one insurer announces a problem, all of the insurers trade down.  GNW has gone down every time one of the other insurers has disclosed something - whether or not GNW has a similar problem or not. 

Not every single financial company in America is a zero.  For GNW, on a probability weighted basis, the risks lie to the upside, not to the downside.  As a final note, unlike many financial companies, GNW gives a great deal of disclosure (almost too much!) and there are a lot of nuances to discuss further if members are interested.  

Capital Structure

Consolidating Balance Sheet

Adjusted Book Value - Excluding MI - Q3 08

 Adjusted Investments

Subprime Assets by Vintage and Rating

Alt-A Assets by Vintage and Rating

Catalyst

The company successfully addresses its debt maturities in 2009.