Editor's Note: This article was originally published on May 22, 2014.
Genworth's (NYSE:GNW) Australia debut raised $545 million in U.S. dollars and begs the question: Now what? Genworth announced that its subsidiary, Genworth Mortgage of Australia Limited, priced its initial public offering of 220 million shares at $2.65 Australian dollars for a total of A$583, or US$545. This 34% sale of the business values the entire business at about A$1.7 billion or US$1.6 billion. The IPO has been anticipated for two years while the company waited for a combination of good operating results from the unit and market conditions favorable to launching the IPO. Their patience paid off as shares were reasonably well received, trading up 14% from the offering price on its first day of trading according to Bloomberg.
Use of the Money
In the recent first quarter earnings conference call management discussed the possible use of IPO proceeds in response to a question on capital management (dividend resumption or share buybacks). They remain consistent holding debt reduction and a credit rating improvement as their priority but the question remained.
The company is holding about $780 million cash for 2014 debt maturity excluding proceeds from the IPO. CFO Marty Klein discussed the various options being considered for the IPO cash including: "Making sure our businesses are appropriately capitalized"; specifically mentioning the U.S. Mortgage Insurance unit being prepared for new Government Sponsored Entities (Fannie Mae and Freddie Mac) capital requirement guidelines, yet to be announced; and "accelerating the companies de-leveraging goals."
He concluded with: "We want to be making continued headway in improving our ratings so we want to be thinking about that…We also want to think about the dividend flows and capital generation within our businesses as we think about things like dividends and things like that. But those are the things that we're looking at and discussing with our Board, and we'll have updates later on in the year."
Management presents Genworth as a turnaround story with "multiple levers to create shareholder value." We agree; there are many levers and one lever we've been proponents of is share buybacks. Genworth's Q1 2014 book value is $31.27/share and shares can be purchased on the open market for about $17.50/share. This is a discount of about 45% to book value and clearly the most obvious and readily available way to create shareholder value today.
We like the job Tom McInerney, GNW's president and CEO has done during his 16-month tenure, along with CFO Marty Klein with the GNW management team in steering the company through the turnaround. The goals of reducing debt, improving credit ratings and assuring sufficient capital to run the businesses are straight forward and prudent.
In the Q1 2014 conference call management was explicit on the buyback of shares of Genworth Mortgage Insurance of Canada if a buyback did proceed at that unit; "Genworth Financial would currently plan to participate in the stock buyback, ultimately benefiting holding company cash while keeping our overall ownership percentage at its current level."
So where's the same explicit discussion around Genworth's potential buyback of Genworth Financial shares? Sure, there are unknowns that may need more clarity before implementing a buyback; there always will be unknowns. As the turnaround issues get worked, it seems management finds another question to queue up in front of returning capital to shareholders. The GSE's requirements may likely require more capital, fair enough. But now being queued up are the subjective hurdles of "dividend flows and capital generation within our businesses."
The refrain "multiple levers to create shareholder value" will soon sound hollow if management passes on the most obvious opportunity to create shareholder value; to buy the company's own shares at a significant discount, or explain why we should and they shouldn't.
What's wrong with an "if" qualified statement similar to what the company made on the Canada mortgage insurance unit? Something like; once the FHFA announces the new capital standards for private mortgage insurers and we know the new capital requirements for Genworth's U.S. Mortgage Insurance unit, share buybacks at these price levels will be a priority?
John Paulson a Strong Ally
Bloomberg reported on May 7 billionaire hedge fund manager John Paulson, known for bold calls and bullish on mortgage insurers, sees substantial upside for Genworth: "The billionaire said he expects gains because the stock trades for less than book value. His estimate of the measure of assets minus liabilities is $24 a share. Paulson said the stock can trade for at least that value, after the initial public offering of the Australia mortgage insurer frees cash that can be used for buybacks and debt reduction. A split would also help the stock, he said." Paulson in his letter to hedge fund holders suggested splitting GNW into a global mortgage insurer and a life insurance and LTC business to further add shareholder value.
Early in the financial crises, Highland Capital Management became an activist shareholder and vocal advocate to get the board of directors at Genworth to address needed changes at the company. It worked; perhaps a shareholder advocate is perpetually needed with this board and hopefully John Paulson, like Highland Capital Management, can get the boards attention.
Some of Genworth's "multiple levers to create shareholder value" will take years to bring to fruition. It is not often that you can buy your own company at a 45% discount for your shareholders. Investing $17.50/share in your own company to buy $31.27 in assets is an immediate 78% return. And, after all, what investment opportunities are out there with a better immediate return and where management can better understand the risk-adjusted return than the the company we pay them to manage?
An update later in the year may be too late for this lever. We can only hope it doesn't become a squandered opportunity for long-term shareholder value creation. Or are we missing something?
Disclosures: Long GNW.