Wednesday, September 22, 2021

Jackson Financial: Spin/Demerger, Technical Selling

Jackson Financial (JXN) is the largest variable annuity provider in the U.S. and was recently spun (or "demerged" in ex-US terms, good Google alert term btw) from Prudential PLC (different than Prudential Financial) which is a London listed insurance company that primarily operates in high growth areas of Asia and Africa.  Jackson is only listed in the U.S. and much smaller than its parent, as a result it is likely experiencing (or has already in the when-issued market) some forced selling by both geographically filtered and market cap filtered investment mandates or indices.  Directly from the Form 10:

Index funds that hold Prudential ordinary shares likely will be required to sell their shares of Class A common stock received in the Demerger to the extent we are not included in the relevant index. In addition, a significant percentage of Prudential Shareholders are not residents in the United States. Many of these shareholders may sell their shares immediately following the Demerger. The sale of significant amounts of our Class A common stock for the above or other reasons, or the perception that such sales will occur, may cause the price of our Class A common stock to decline.

In a variable annuity, the client deposits funds into a separately managed account in mutual funds that Jackson's asset management arm selects to be on its platform, then Jackson guarantees some minimal performance for a fee.  Jackson takes those guarantee fees and purchases hedges to protect against a sustained market downturn that would turn these insurance contracts upside down.  The hedges are marked-to-market in GAAP accounting while the corresponding liabilities are not, so a combination of opaque accounting with long dated market/longevity risk leads these variable annuity insurers being valued like death.  Jackson is insuring against the market collapsing, which seems like a difficult risk to forecast, especially in this environment when arguably the market is overvalued.  To see this in action, look towards Brighthouse Financial (BHF) which was spun from MetLife a few years back, BHF trades for 2.4x LTM adjusted earnings and 37% of adjusted book value (basically ex-AOCI), torturing value investors like David Einhorn for years.

Jackson just reported Q2 earnings last Friday, LTM adjusted earnings come in at roughly $2.4B or $25/share and adjusted book value at $91.38/share, versus the current trading price of $26/share which is 1x LTM adjusted earnings and 28% of adjusted book value.  So it's absolutely cheap and somewhat relatively cheap, but does have a lot of black box type risk to it, hard to fully grasp all the market risk they're taking and believe in their hedging strategies.  But just the math of something that's not a melting ice cube, trading at 1x adjusted earnings (feel free to pick at the adjustments), not a lot has to go right for that to work out reasonably well.

Other ways to look at the valuation:

  • Last summer, Jackson offloaded their fixed annuity risk to Athene (ATH, soon to be acquired by APO) and concurrently, Athene took an equity stake in Jackson.  Athene invested $500MM for an 11.1% economic stake in the business, which equates to a ~$45/share price, or 70+% above where it is trading today.  Apollo via Athene might have slightly overpaid, need to probably consider it in context of the reinsurance transaction as well, but unlikely they severely overpaid, especially when markets were still a bit dicey last summer.  I don't think ATH/APO would purchase the entire company as its now a pure play on variable versus fixed annuities (much different profile in my opinion for APO and investing the float), but a good valuation point nonetheless.
  • In the Form 10 and throughout their investor presentations, Jackson makes it clear that they will be a significant returner of capital to shareholders.  In year one, they expect to distribute $325MM to $425MM out in shareholder yield during the first twelve months.  At the midpoint of $375MM, that's 15% return of cash, either in the form of dividends or share repurchases.  Again, seems more of a black box than a melting ice cube, but over time that 15% return of capital should at least mirror the shareholders ultimate return without any re-rating of the rock bottom multiple.
  • Their statutory capital is about $4.4B, maybe a more conservative way to look at the book value, that would be $46.50/share or roughly trading at 56% of this more conservative number.  This is also an important number in context of the above bullet as they've guided to distributing 40-60% of the annual growth in statutory capital out to shareholders over time.
Other miscellaneous thoughts:
  • Another way I've thought about the cadence here, London based funds are selling and soon this will be have to be picked up by U.S. based funds and indices, so there could be a time period here where the stock is orphaned and as a result trading at an artificially depressed multiple.
  • Prudential PLC held back 19.7% of the JXN shares, they're going to monetize that over the next year, so maybe similar to the situation over at Technip Energies (THNPY), it could provide a small overhang until their divestiture is completed.
  • PPM is their internal asset manager, they mostly invest the corporate balance sheet in fixed income securities, they do manage some external capital for Prudential PLC related entities which may be at risk (they've had some of their funds withdrawn already) now that the companies are separate.
  • We all know about the long term demographic trends in this country, baby boomers are retiring and might look to annuities to offload that market and longevity risk.  They've even made some regulatory headway getting these products in 401(k)s, now I wouldn't recommend anyone actually buy them.  To that point, this is more a product that is sold rather than bought, maybe similar to a timeshare in that sense, and possibly the market is punishing this business similarly/unfairly.

Disclosure: I own shares of JXN

11 comments:

  1. Wholly possible the market takes a long time or even forever to come around on this, but I bought some -WI and regular-way because it's just so cheap and (low) IG-credit (for now) with a clear capital-return policy that will either boost BV or screen well for income investors. I think it's a really great idea, not least because of the extreme embedded pessimism. Thanks again for mentioning this!

    Much further down on the quality spectrum, bought some LTSF today. Acquirer Advisor Group has muddled through COVID, and the legacy Ladenburg bonds and prefs have been hammered by forced/spooked sellers as darkness descends on that corner of the OTC. Weirdly, Interactive would still let me buy. I figure it will inch back toward par, and if buyers don't emerge it's a perfectly fine YTM.

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    1. Looks like another interesting idea, thanks!

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  2. What are they going to do with another 85% of profits?

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  3. The story of technical selling pressure here is very enticing, but the valuation is hard.

    Athene purchased a 11.1% stake for ~$45/share as you mention, but they subsequently wrote down their position by ~50% (my best guess from what is disclosed in their 10-K).

    The book value doesn't mean much either and will likely change materially over the next year as new GAAP accounting goes into effect (ASU 2018-12 and ASU 2019-09). Rate assumptions for statutory capital will likely continue to decrease, eating away at capital there as well.

    I am long as well betting that muddy financials and technical selling pressure mean a cheap stock, but I still worry I am not learning from Einhorn's mistakes with BHF.

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    1. I had similar concerns about the ATH writedown, but I believe they only own 37% directly so its not as big as it appears. Here's the line from the June 2020 press release:

      "Utilizing the strategic benefits of ACRA, 63% of the total capital deployment will be funded by third-party investors, and 37% will be funded by Athene on a standalone basis."

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  4. @timidbid: I agree that anyone claiming to have anything close to an exact idea of what this is worth is probably high or otherwise deluded. But I still think there's enough here to say that it's worth more.

    I'd argue that BHF had more hair on it, and as a result wasn't able to start returning capital right away, but that it's been a fine investment (as always!) if you bought at the right price. Same here. Einhorn's mistake (maybe) is that he wasn't cheap enough. TBD whether people buying JXN now are.

    But I think we actually agree.

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  5. Do you guys have any idea when ETF's will need to start buying JXN? Can't find info about index inclusion.

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    1. I don't know the timing, but it's plenty big enough that being included in all the relevant indices shouldn't be a concern. Unless for some reason S&P doesn't like the dual share class, but its not a super-voting situation, only tiny question in the back of my head.

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  6. Is there a primer on the annuity businesses? This is a foreign territory for me so any help in understanding the business will be appreciated!

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    1. Sorry, I don't know of any offhand. I did spend an hour or two bouncing around on YouTube trying to get an idea of the pitch from a client's point of view.

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  7. https://www.wsj.com/articles/blackrock-is-adding-annuities-to-401-k-s-11633512600?mod=hp_lead_pos7

    BlackRock adding annuities to their 401k plan, Brighthouse and Equitable, not Jackson, but interesting nonetheless as Jackson cited the new law as a growth opportunity.

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