Long idea: EQH- buying a 160-year old business at less than 4x earnings
Long idea: EQH- buying a 160-year old business at less than 4x earnings
Normal investment disclosures, I have a position in the security, it could change at any point, this isn't investment advice, DYODD, etc.
Equitable Holdings Inc. (symbol: EQH) is a 160 year-old life & retirement insurance company that was spun out of French insurance conglomerate AXA in 2018. Since listing in 2018, EQH has repurchased 32% of public shares outstanding, grown policy value by $81B to $116B, and grown client AUM in their investment management business from $618B to $908B. Despite owner-oriented management and an organically growing business, EQH still trades at less than 4x trailing 12 month operating earnings and 5x forward operating earnings despite peers trading at double-digit multiples. As traditional L&R investors warm-up to EQH’s newest and unique product offering (SCS) and business model, the business will re-rate to peers:
We can observe in the market that AllianceBernstein (symbol: AB, 63% economically owned & consolidated on the EQH financial statements) trades at a 10x forward multiple of earnings, which on an economic look-through basis would represent less than 10% of EQH’s earnings ($200M/$2.55B of net income estimated for 2022).
Life & retirement insurance companies make money writing annuity and life insurance contracts, collecting premiums and investing them for the company’s general account. After covering client insurance and annuity payouts, what’s left for the general account is profit for the company. In addition to this, fees and policy charges are earned on the investment portfolios wrapped in the insurance contracts.
On a GAAP basis, EQH has lost nothing but money over the past 3 years. Book value per share has contracted from a high of $40/share to $16/share as of the most recent quarter. Why has this happened? EQH judges itself on its measure of non-GAAP operating earnings: this measure primarily seeks to remove the impact of parts of the volatile SCS business, fair value hedge accounting, and other market-based movements. EQH has shifted the business’s product portfolio since 2008: in order to optimize capital efficiency and improve overall return on capital/profitability, EQH has moved most of their new business to Variable Universal Life, a more volatile enterprise with associated reward:
The below table reconciles GAAP losses to non-GAAP operating earnings, showing a profitable and growing business after backing out certain items:
Using non-GAAP reconciliations as KPIs as an investor require faith in management to accurately understand GAAP considerations and honestly assess whether adjustments are required for the business. Why does GAAP require, and management later back out, a $4.145B charge to the Variable Annuity business for 2021?
Management gives us the answer: “The most significant of such adjustments [from GAAP to non-GAAP operating earnings] relates to our derivative positions, which protect economic value and statutory capital, and are more sensitive to changes in market conditions than the variable annuity product liabilities as valued under U.S. GAAP. This is a large source of volatility in net income.”
EQH’s hedges their variable annuity payouts, affecting their balance sheet and statutory capital. Their best selling and unique product offering, “Structured Capital Strategies” or “SCS” are equity linked instruments that have payouts linked to equities. Not exactly unable to be replicated, but nonetheless winning market share. EQH agrees to “buffer” these products, assuming a portion of the downside, and hedges out their general account exposure in the first year after collecting premium and the associated liability.
Complex and volatile, EQH provides a description of SCS as a product line:
•Structured Capital Strategies. Our index-linked variable annuity product allows the policyholder to invest in various investment options, whose performance is tied to one or more securities indices, commodities indices or ETF, subject to a performance cap, over a set period of time. The risks associated with such investment options are borne entirely by the policyholder, except the portion of any negative performance that we absorb (a buffer) upon investment maturity. Prior to November 2021, this variable annuity did not offer GMxB features, other than an optional return of premium death benefit that we had introduced on some versions. In November 2021, we introduced a new version of this variable annuity offering a GMxB feature. [GMxB= Guaranteed Minimum _____ Benefit]
Said another way, as EQH is writing new business, they’re selling equities forward through hedges; EQH takes the short-term losses in the name of winning high-margin, long-term profitable business.
In the years they’ve written the most first-year premium in SCS, 2019 and 2021, there is an associated jump in the reconciliation losses to their non-GAAP operating earnings:
SCS will be the engine of growth for EQH going forward- this was a long-term decision made back in 2008 to run-off their Universal Life/GMxB business and focus on VUL, specifically SCS. Backing out of the GMxB business has given EQH a leg-up over other L&R businesses, with only 15% of the business having a guaranteed return (this was accelerated by the Venerable transaction in 2021):
Analog, downside case:
MetLife spun out Brighthouse Financial (BHF) in a similar fashion of AXA to EQH, yet the businesses couldn’t be more different. BHF has significant problems in their Run-off business, dealing with expensive policy riders that have been a nightmare for consistent earnings growth (even when adjusted). That portion (40%~)of BHF’s book is shrinking without any corresponding growth in the business. Let’s not forget EQH’s world-class investment management and research segment at AllianceBernstein- a jewel of an asset at an industry-leading multiple. Fair to say these are apples and oranges businesses, but trade at near identical multiples. Pair traders might see a Long EQH/Short BHF work well longer term.
Conclusion/Catalysts:
L&R companies and investors are by their nature more risk averse to new product offerings, especially ones that require significant upfront loss-making. I believe that this is the core reason behind EQH’s lower multiple in comparison to peers. As EQH proves out the profitability of their business and grows accordingly, we will see the business re-rate to peer multiples.
Without an immediate catalyst, this story will play out over the next few years as management continues to shrink EQH’s share count until the asset is too cheap for a larger L&R player to pass-up: EQH is a ripe acquisition target. Blackstone has been acquiring smaller L&R players and has a stake in AIG’s future L&R spinout. There’s precedent for L&R spinouts to be acquired after repositioning successfully repositioning their book of business.
Normalized earnings power of $2.5B capitalized at 10x gives a share price of roughly $70~ while downside is likely capped at book value or $16 as of EOQ1 (assuming returns in the SCS business are competed down overnight to cost-of-capital).