Genworth plans to keep a steady course despite harsh criticism from some investorsApril 29, 2011 6:00 AM
by Tim Loughran
For all the wrong reasons, Genworth Financial’s teleconference call with analysts and investors last October is now part of modern Wall Street history.
A week earlier the company had announced it would buy the Altegris investment group for $35 million to bolster its growing wealth-management group. CEO Michael Fraizer was using the purchase as an illustration of how Genworth was diversifying and rebuilding after a string of nine-digit losses on its private mortgage insurance products. Suddenly, the call turned contentious. Blunt criticism from investor Steve Eisman, a hedge-fund manager who made millions betting against mortgage-backed securities, surprised many people listening in.
“Frankly, the only accomplishment that this management team can truly point to is the survival of this company, which I don’t mean to minimize, but otherwise, this management team has overseen a massive destruction of shareholder value,” snapped Eisman.
Made famous by Michael Lewis’ book “The Big Short,” Eisman threatened Fraizer with a proxy battle to “throw you out of there” if he bought any more companies instead of using some of its healthy cash reserves to repurchase the company’s depressed shares or pay a dividend on its common stock.
Eisman expressed the frustration of some investors who say Genworth, a Fortune 500 company based in Henrico County, had failed to follow through on repeated hints since 2008 of future dividend payments, share repurchases, the sale of money-losing divisions or even the complete spin-off of its beleaguered mortgage insurance business.
Others, however, prefer to see Genworth as the survivor of a near-death experience in 2008-09 with the smarts to weather the current mortgage storm. They share Fraizer’s confidence that the slowing rate of new defaults on U.S. home mortgages and falling unemployment means the company’s worst days are behind it. Fraizer says Genworth will not need a major restructuring to survive or generate handsome profits for stockholders.
“Based on a comprehensive evaluation, with input from external advisers, we believe that greater value will be created for shareholders by executing against our current strategic plan,” he told investors in a February conference call. (A company spokesman said Fraizer was unavailable to comment for this article.)
Genworth’s first-quarter earnings will be announced May 3. Its annual meeting is scheduled for May 18.
“Genworth took a series of actions from 2008-2010 that put most of the challenges experienced from the financial crisis and its aftermath behind us. . . ,” company spokesman Al Orendorff said in a statement. “We are intensely focused on rebuilding shareholder value, taking into consideration such things as capital allocation, business mix, relevant financial and external factors and our competitive strengths.”
Once trading at more than $35 in February 2007 when U.S. home sales were surging, Genworth shares plummeted to 84 cents in March 2009 after the company reported large mortgage-insurance losses in the nation’s worst housing meltdown. (The month also marked the low point for the overall stock market during the recession.)
Fairly or unfairly, those well-publicized mortgage insurance losses undermined confidence among independent brokers, financial advisers and consumers in Genworth’s ability to pay claims on its other insurance products, so its revenue in those business lines suffered as well. In April 2009, the company got more bad news: Its bid to buy a Minnesota savings bank, launched in an effort to qualify for millions of dollars under the federal government’s Troubled Asset Relief Program (TARP), was rejected by the Office of Thrift Supervision.
To keep the company afloat, Fraizer raised an estimated $700 million by selling 44 percent of Genworth’s Canadian subsidiary in an initial public offering. He also repaid more than $660 million in short-term debt and raised more than $600 million in fresh capital after the company sold new shares. In an effort to cut about $100 million in additional operating costs, Genworth laid off about 1,000 workers worldwide, including about 600 in Richmond and Lynchburg. And the cost cutting continues. This past January the company eliminated about 130 jobs in Virginia when it discontinued sales of its variable-annuity products.
These efforts resulted in a partial recovery in the company’s stock price. When analysts have marked the anniversary of the stock market’s 2009 nadir in each of the past two years, Genworth has been singled out for recognition. In 2010, when the stock had risen to about $17, Bloomberg Businessweek magazine and other media outlets dubbed it the S&P 500 Index’s “Comeback of the Year.” Earlier this year, even as mortgage insurance losses continued to weigh on investor sentiment, some news outlets noted that Genworth’s 1,300 percent price increase during the previous two years made it the best performer on the S&P 500. However, falling returns from its investments and more negative news from the housing industry have combined to hamstring Genworth shares at about $13 as this issue went to press.
Some Wall Street analysts say a combination of management and investor relations missteps during the past six months also have hurt the stock. They cite the company’s inaccurate assessment of the U.S. real estate market during late 2010, the unexplained cancellation of an Investor Day conference in New York in early December (an event held in 2007 and 2009) and what one analyst called a “disappointing” explanation in February of the company’s performance and its growth plans for 2011 and 2012.
“It’s a question of what management is doing, versus what they are saying,” says Wayne Dalton, who follows Genworth and other insurers for Charlottesville-based SNL Financial.
Adds Suneet Kamath, senior analyst at Bernstein Research in New York, “Investors are looking for significant changes, but that’s not what they’re getting.”
Profit in 2010
Fraizer’s current game plan, however, may be working after all. Last year the company posted $142 million in net income, reversing annual losses of $460 million in 2009 and $572 million in 2008. The company had healthy profits from international operations in Canada, Australia, Mexico and Europe ($444 million) and $403 million from its U.S. retirement and income-protection division (life insurance, long-term care insurance, annuities and wealth management products). These profits, however, almost were erased by a $559 million operating loss from its U.S. mortgage insurance unit, a business that lost $427 million in 2009 and $368 million in 2008.
Instead of using profits to pay a dividend on its common stock or repurchase shares as some investors want, Genworth intends to avoid any repeat of the credit ratings downgrade it suffered in 2009. It has decided to pay down about $600 million in debt during the next 24 months so it can maintain its credit rating as high as possible.
Former CFO Pat Kelleher (recently succeeded by Barclays Capital and Lehman Brothers veteran Martin P. Klein) said during the February teleconference with analysts and investors that influential rating firms like Moody’s, Fitch and Standard & Poor’s, which gauge a company’s ability to repay its outstanding loans, “have communicated to us that they would not look favorably upon share repurchases in the near term, and are supportive of our plans to reduce leverage over the next couple of years.”
It’s this traditional, far-sighted use of excess cash that attracted investor Matt Reiner and the $57 million Adirondack Small Cap Fund to Genworth shares back in 2009 when most investors were dumping the stock. Throughout the financial crisis, he was impressed with the company’s conservative underwriting standards compared with insurance industry peers and its “very clever” repurchase of its devalued bonds in a bear market (at about 40 cents on the dollar, he says) to lower borrowing costs.
In spite of its myriad problems since 2008, Genworth appears to have retained access to affordable credit. One example of how much faith some investors still have in Genworth came in late March when the company sold $400 million in 10.5-year bonds through Deutsche Bank and Goldman Sachs at about 7.6 percent (a little more expensive than the 7.2 percent it paid for $400 million in 10-year notes it sold last November). Demand for the company’s most recent debt sale was so high the offer was raised from $250 million, according to company spokesman Orendorff.
“They’ve always impressed us as sensible capital allocators, and that is one of the indicators we look for” in companies his fund buys, says Reiner.
Genworth expects mortgage insurance losses from the sluggish housing market to continue affecting overall profits this year and next year. Nonetheless, management hopes to generate 5 to 7 percent in additional annual revenue from its life insurance and long-term care divisions to cover those losses.
Already a market leader in term- and universal-life insurance policies worth less than $500,000, the company plans a major push in the next 24 months to sell policies of up to $1 million to affluent customers. This is an “underserved population,” company executives say, that is preparing for retirement. Also, with the U.S. population aging and medical costs rising, the company hopes the 18 percent increase in premiums levied recently on its existing long-term care customers will deliver annual revenue gains of $40 million to $50 million to the unit by the end of 2012.
Expanding the company’s investments in consumer-focused financial planning activities is another central part of Genworth’s revenue road map through 2012. Last year, the company said, it added 400 advisers and increased assets under management by more than 30 percent.
No spinoff expected
Even with higher revenue from other business divisions, Fraizer will remain under pressure to take a hacksaw to Genworth’s mortgage insurance business, something he’s very reluctant to do. Instead of dividing the company, management plans a simple internal reorganization. By the end of 2011 the company will group all its global mortgage insurance operations in one division and all retirement and income-protection operations into another.
“This alignment allows us to sharpen our focus on common aspects within each group of businesses while taking advantage of current financial synergies,” Fraizer said in February. “If, at some point in the future, the balance of considerations shifts such that splitting the company into two separate pure-play entities, or some other strategy, becomes the best path to create shareholder value, we, working with our board, will take appropriate actions. We will not shy away from it.”
Unpopular with investors like Eisman, that plan makes sense to Reiner. “I understand the ‘pure-play’ aspect completely, but I also understand why management would not want to spin a part of the company off when it’s limping so badly. It’s probably because things are still not very pretty right now … But we think that [the housing industry] is beginning to turn around, and separating the mortgage insurance business might make a lot more sense a year or two down the road.”