Newsletter Value Investor Insight carried an interview October 30th with Value Investors Club founder Joel Greenblatt. The interview contained examples of ideas submitted to the Value Investors Club by its members. Here's the summary of a long idea presented to the club, for Ameriprise Financial, which was trading at $51.95 when the interview was published (current price and chart here):
Spun off from American Express in September 2005, AMP is a financial planning and services company consisting of a variety of businesses in asset management and insurance. With around $425 billion in owned, managed, or administered assets in the U.S. and U.K., AMP provides services to 2.8 million customers through over 12,000 financial advisors. AMP operates under its own name as well as its newly created RiverSource fund platform in the U.S. and recently acquired Threadneedle arm in the United Kingdom.
Why shares are mispriced:
AMP’s low valuation is due to several factors: 1) A lack of detailed and logical financial disclosure makes AMP somewhat of a “black box” for investors, even after a year as a public company; 2) The company’s adjusted return on equity of 11% in Q2 2006 is low relative to peers with a similar business breakdown; 3) AMP is considered to be a below-average fund manager by investors.
Deciphering obtuse financial reporting:
AMP is a hybrid between an asset management company and a diversified insurance company. It has financial products in mutual funds, wrap accounts, managed accounts, annuities, banking services and life, auto, home, and health insurance. The important question is what percentage of normalized profits come from fee-heavy, asset-light investment management revenues and what percentage come from capital-intensive, commodity-like insurance revenues and premiums? Management refuses to precisely break down this number, making many investors and sell-side analysts uncomfortable. The Citigroup analyst who covers AMP says that many institutions refuse to invest in AMP because of its poor disclosure. We know that asset-management revenues account for 20% of the total and that most decently run asset management firms can generate pre-tax margins in the mid-20% to low-30% range over a full cycle. Pre-tax margins for insurance businesses similar to AMP’s are in the high single-digits to mid double-digits. Consequently, asset management likely earns 25% to 33% of operating profits for AMP, with the insurance businesses earning 67% to 75% of operating profits. During a conference call around the time of the spin-off, AMP did not believe this range was aggressive or inappropriate. This would indicate that asset management pre-tax margins are approximately double those of the insurance businesses.
Potential for ROE improvement:
Because of its business mix relative to industry peers, it’s likely AMP can generate a ROE at the high end of its target range of 12-15%. Most publicly traded asset management competitors have ROEs of between 20% and 30%, which AMP should be able to earn on the approximately 30% of its profits that are from asset management. The 70% of profits generated from insurance should earn a consistent [industry-average] 11%- 12% ROE. AMP’s insurance businesses are characterized by straightforward product pricing, low yield-curve sensitivity and few unquantifiable risks, making this insurance ROE goal modest and attainable. Overall, AMP should be able to achieve a 15% ROE on 2009 earnings. The CEO has specifically stated that there is nothing different about AMP that would prevent it from earning industry returns over the long-run.
Upside in fund business:
Many investors believe AMP’s outflows in the flagship RiverSource funds will continue, due to poor performance in the 5-year and 10-year Lipper rankings. AMP is considered to be a second-tier manager with mediocre performance, limited marketability and not much potential for growth. That said, recent data show that 66% of RiverSource equity funds outperformed competitors in the last 12 months. AMP CEO James Cracchiolo fired the old management team and the new one is taking the right steps to improve performance. A lot of RiverSource’s poor performance was based on owning over-valued growth stocks from 2000 to 2002. With the DJIA and S&P 500 valued at about 15x forward earnings, valuations are more reasonable now and the prospects of large continued withdrawals and lousy absolute performance are less likely. Finally, RiverSource and other mutual fund families are positioned to benefit from the Pension Protection Act of 2006 signed by President Bush. Many workers will now be automatically enrolled in retirement plans through mandatory contributions – versus an estimated 1/3 of workers who elect to not enroll in defined-contribution plans. Given RiverSource’s strong marketing platform, the inherent “stickiness” of its customer base and its long company history free of scandals, it should get at least its fair share of an increasing amount of retirement savings invested in the stock market over time.
Valuation and price target:
Assuming 30% of the profits are from asset management and 70% of the profits are from insurance, AMP deserves a 13.5x to 14x multiple of forward earnings as a stand-alone company. This is based on the asset management segment deserving a comparable 19x multiple of forward earnings and the life insurance segment deserving an 11.5-12x multiple of forward earnings. Earnings per share in 2007 and 2008 should continue to accelerate dramatically from the $3.20 per share run-rate in Q2 2006. A combination of decreased separation and overhead costs, Threadneedle integration, removal of excess capital from the life insurance subsidiaries and corporate segments, decreased fund outflows and improved fund performance, and a properly geared balance sheet permitted by the ratings agencies will drive profitability. By the end of 2009, AMP should be earning $5.50 to $6.00 per share. Applying a forward P/E multiple of 13.5-14x to those earnings yields a $79.00 price target by January 2009.
1) AMP beats earnings estimates throughout 2007 and 2008 as ROE expands; 2) Investors realize and appropriately value that the asset management division provides a significant percentage of company profits; 3) AMP is sold [when related tax-issues expire] sometime after the fourth quarter of 2007.