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Summary

  • ING Groep is a forced seller of NN Group to meet European regulatory deadlines; extracting the best market price was not the primary criteria for the sale.
  • IPO timed when many US and European buyers are on summer vacation. Demand by US investors further curtailed due to short trading week prior to July 4th.
  • NN Group is a high quality business with a leading market share in countries in Western Europe, Eastern Europe and in Japan and Turkey.
  • Shareholder friendly management: 6.3% dividend yield. Further capital return expected after completing ongoing restructuring of the business to free up excess capital.
  • 60+% upside. Minimal downside: price to tangible book of 0.57; price to estimated 2014 earnings ratio of 9.3; free cash flow yield of 6.1%, dividend yield of 6.3%.

Source: Prospectus.

Note: The stock does not trade in the US. It trades approximately US$ 14.16 million a day on the Amsterdam Stock Exchange (NN NA; ISIN: NL0010773842).

Forced seller

ING Groep (NYSE:ING), like other major financial institutions in the Netherlands, received aid from the Dutch State in 2008 and 2009. As a condition to receiving approval from the European Commission (EC) for such State aid, ING was required to develop and submit a restructuring plan to the EC. The 2009 Restructuring Plan included, inter alia, the divestment of the insurance and investment management business, including NN Group (OTC:NNGPF). ING is required to divest more than 50% of its shareholding in NN before 31 December 2015 and the remaining interest before 31 December 2016.

As part of the same restructuring plan, ING was a forced seller of its US insurance and money management business (NYSE:VOYA) in May 2013. The initial public offering (IPO) price of VOYA was at $19.5 per share and the stock closed at $20.84 on the first day of trading. VOYA currently trades at $36.49 (+87%) after continuing to streamline its operations post carve-out from ING and after investors focused on the wide valuation discrepancy between VOYA and its peers.

IPO at a time when many investors are on vacation

Historically, global trading volumes fall materially during the summer months when many investors go on summer holidays. For this reason, IPOs tend to be scheduled before or after summer. Further, it is even more rare for an IPO to be scheduled during one of the least active weeks of the US markets (the shortened July 4th week).

ING scheduled the IPO of approximately 30% of NN (the last of its insurance businesses) keeping in mind its need to meet the two deadlines for full separation. Due to the bad timing of the IPO, the offering price was further depressed to ensure adequate demand.

About the company

NN Group is a public limited liability company incorporated under the laws of and domiciled in the Netherlands. NN is an insurance and investment management group with leading positions in life and non-life insurance in the Netherlands, a strong life and pensions presence in a number of other European markets (such as Poland, Hungary and Romania) and in Japan and a growing position in Turkey. NN's insurance business is active in mature markets in Western Europe and Japan as well as growth markets in Central and Eastern Europe (CEE) and Turkey.

The company has seven reportable segments:

  1. Netherlands Life (55% total operating result (before tax) from ongoing business, excluding the Other segment).

    In the Netherlands, NN was the second largest provider of pensions and the largest provider of individual life insurance with a market share of 20.6% and 19.9%, respectively, in 2012.

    NN's Netherlands life insurance business is organized along the following two product lines: Pensions and Individual Life Closed Block.

    Within NN's Pensions product line, NN offers group life products and individual pension products. Group life products are life insurance products under which employers offer certain pension and other insurance benefits to their employees, typically as part of larger benefits packages. NN's group life products are primarily group pension products.

    NN's Individual Life Closed Block product line primarily consists of the closed block operation of the individual life portfolios (comprising a range of discontinued products sold prior to 2012). Approximately 40% of the policies in the individual life closed block are expected to still be in-force by 2025. The remaining part of NN's Individual Life Closed Block product line relates to the sale of individual life insurance policies in the form of new term life insurance and immediate annuity products introduced in 2012.

    Management strategy: improve the business by de-risking its liabilities to release capital, reduce expenses by roughly 15% and gradually shift to higher yielding assets; benefit from its strong position in the pension market to selectively capture growth opportunities; maintain operating-results-before-tax broadly stable.

  2. Insurance Europe (16% of total operating result).

    This segment comprises NN's business in CEE (which includes, for purposes of the Insurance Europe segment, Poland, the Czech Republic, the Slovak Republic, Romania, Hungary, Bulgaria and Turkey) and in the rest of Europe (which includes, for the purposes of the Insurance Europe segment, Belgium, Spain, Greece and Luxembourg).

    NN primarily offers life insurance products through Insurance Europe. NN also offers pension products, in particular mandatory and voluntary pension funds in CEE and Spain as well as non-life insurance products in Belgium and Spain. The life insurance and pension products are offered to retail, self-employed, Small and Medium Enterprises (SME) and corporate customers and the non-life insurance products are offered to retail customers and corporate customers.

    Management strategy: leverage its platform to generate growth and increase profitability; achieve an annual mid-single-digit operating result before tax growth rate.

  3. Japan Life (13% of total operating income).

    In Japan, NN primarily offers a range of corporate-owned life insurance (COLI) products to SMEs and owners and employees of SMEs through independent agents and bancassurance. COLI products are traditional life insurance policies that a company, typically an SME, takes out on the lives of executives or employees, whereby the company is both the policyholder and the beneficiary of the policy. COLI products are designed to address the protection, savings and retirement preparation needs of SMEs and owners and employees of SMEs in a tax-efficient manner. In Japan, NN was the third largest provider of COLI products measured by APE with a market share of 9% in the financial year ended 31 March 2013.

    Management strategy: focus on channel diversification and product diversification; achieve an annual low to mid-single digit operating result-before-tax growth rate.

  4. Investment Management (10% of total operating income).

    Assets under management (AuM) of EUR 168 billion.

    NN Investment Partners offers a wide variety of actively managed investment products and advisory services to retail and institutional customers in all major asset classes and investment styles. In addition, NN Investment Partners manages the assets of NN's insurance businesses. In the Netherlands, NN Investment Partners was the largest retail investment management company measured by AuM with a market share of 13.8% in 2012. Netherlands is its main investment management hub. It offers its products and services globally through offices in several countries across Europe, the United States, the Middle East and Asia.

    Management strategy: grow its third party business; achieve mid-single digit operating-results-before-tax growth rate.

  5. Netherlands Non-life (6% of total operating income).

    NN Group is the third largest market share in non-life insurance (excluding healthcare) in the Netherlands; market share of 10.1% in 2012.

    NN's non-life insurance products can be categorized as follows: (A) income/ accident, comprising disability and accident (D&A) and travel insurance, and (B) property and casualty (P&C), comprising fire, motor and transport insurance and other insurances. These products are offered to retail, self-employed, SME and corporate customers in stand-alone as well as bundled form.

    Management strategy: focus on capital generation by improving underwriting performance and reducing operating expenses by approximately 10-15% by 2016; expand in specific market segments where there are clear opportunities for profitable growth.

  6. Other: this segment comprises the business of NN Bank and NN Re (NN's internal reinsurer), the result of the holding company and other results.

    NN Bank offers a range of banking products to retail customers in the Netherlands, providing diversification and strong cross selling potential with NN's insurance business in the Netherlands.

    NN Re is NN's internal reinsurer located in the Netherlands. NN Re primarily offers reinsurance to NN's insurance businesses. NN Re manages its risks through ceding excess insurance risk to external reinsurers and hedging (a major part of) its market risks.

    Results of holding Co.: includes the interest paid on hybrids and debt, interest received on loans provided to subsidiaries and on cash and liquid assets held at the holding company, the amortization of intangibles and the head office expenses that are not allocated to the business segments.

    Other results: results that are not allocated to the business segments, including the results of claims and lawsuits the results of Nationale-Nederlanden Overseas Finance and Investment Company in relation to a guarantee provided to the Institute of London Underwriters.

  7. Japan Closed Block VA (11% of life insurance value).

    This segment comprises NN's closed block single premium variable annuity (SPVA) individual life insurance portfolio in Japan. This portfolio consists of SPVA products with substantial minimum guarantee obligations sold predominantly from 2001 to 2009. In 2009, NN ceased the sale of these products and placed this portfolio in run-off. The majority of the closed block SPVA portfolio is projected to run off relatively quickly due to the short-term maturity profile and short outstanding policy life of the SPVA products. Approximately 90% of all SPVA policies are expected to have matured by the end of 2019.

    Management strategy: aimed at capital release over time following the run-off profile of the portfolio, while limiting the impact of volatile markets through active hedging.

Shareholder friendly management

Management has stated that it intends to return 40-50% of net operating result from ongoing businesses. Further, it has stated that capital generated in excess of NN Group's capital ambition, which may change over time, is expected to be returned to shareholders, unless it can be used for any other appropriate corporate purpose, including investments in value creating corporate opportunities.

Management has also laid out formal targets for the business including a focus on improving net operating return on equity, which ensures that its interests are aligned with those of the shareholders.

Valuation: EUR 32-36 (60+% upside); minimal downside

Relevant data:

  • Current stock price: EUR 21.26
  • Number of fully diluted shares: 350 million (investor relations at NN Group confirmed that shares to be issued to the convertible note holders will be from shares held by ING Groep and will not increase the total outstanding shares of NN Group)
  • Tangible book value: EUR 37.03 per share (thus price to book = 0.57x)
  • Estimated earnings per share (2014): EUR 2.29 (thus price to earnings = 9.3x)
  • Estimated dividend per share (2014): EUR 1.34 (thus dividend yield = 6.3%)
  • Estimated free cash flow per share (2014): EUR 1.3 (thus free cash flow yield = 6.1%)

Management targets:

  • Expects to generate free cash available to shareholders in a range around NN Group's net operating result of the ongoing business
  • Aim is to achieve an annual operating result before tax of the ongoing business growth rate on average of 5-7% in the medium term
  • Reduce administrative expenses in Netherlands Life, Netherlands Non-life and corporate/holding entities by EUR 200 million by 2016, compared with 2013
  • Aim is to increase the net operating return on equity of the ongoing business (from a pro-forma 7.1% in 2013) in the medium term

Assumptions:

  • Return on equity improves by 2% over the next few years
  • Stock trades in line with comps: price earnings ratio of ~14x, dividend yield of 4.7%
  • Stock trades at a discount to comps on a price to book value basis due to lower return on equity and significant run off business.
  • Comps include: Legal & General Group PLC (OTCPK:LGGNY), Aviva PLC (NYSE:AV), Prudential PLC (NYSE:PRU), Standard Life PLC (OTCPK:SLFPY), Phoenix Group Holdings (OTC:PHXXF), AXA SA (OTCQX:AXAHY), Allianz SE (OTCQX:AZSEY), Assicurazioni Generali (OTCPK:ARZGY), Aegon NV (NYSE:AEG), CNP Assurances (OTCPK:CNPAY), Zurich Insurance Group AG (OTCQX:ZURVY) and Talanx.

Given the extremely low price to book ratio, low price to equity ratio, high dividend yield, potential improvement in return on equity, potential for return of excess capital via buybacks and/ or special dividends and leading market position with a high quality business, the downside is minimal.

Risks

Share overhang: ING intends to divest more than 50% of its shareholding in NN Group before 31 December 2015 and the remaining shares before 31 December 2016, in line with the timeline ING has agreed with the European Commission.

Complicated financial statements: The financial statements are complicated due to multiple distinct and geographically diverse business segments and significant non-operating items. This will cause a number of investors to avoid the stock or hold a smaller position size.

Some industry headwinds:

  • Sales of life insurance products in the Netherlands have been declining since 2008
  • The Netherlands, like many other mature markets, is facing the economic consequences of an ageing population. To address this issue, the government extended the retirement age for occupational pensions to 67 in 2014, and linked it to life expectancy thereafter. In addition, the fiscal support for the accumulation of pension benefits has been reduced. The changes in pension regulations require insurers to modify their existing product portfolio and administrative systems, which can be costly. The decrease of the tax deductibility of premiums is expected to negatively impact premium inflows for pension providers.
  • The profitability of non-life insurance has deteriorated in recent years. For example, the net combined ratio (claims and operational costs in relation to net earned premiums (excluding reinsurance)) in income protection increased from 85% in 2008 to 118% in 2012. This increase was driven by increased frequency and duration of reported illness and disability of employees and self
  • NN's business, revenues, results of operations, financial condition and prospects are materially affected by the condition of global financial markets and economic conditions generally

Litigation: NN is involved in litigation and arbitration proceedings in the Netherlands and in a number of foreign jurisdictions, involving claims by and against NN which arise in the ordinary course of its business, including in connection with its activities as insurer, lender, broker-dealer, underwriter, issuer of securities and investor and its position as employer and taxpayer. In certain of such proceedings, very large or indeterminate amounts are sought, including punitive and other damages. While it is not feasible to predict or determine the ultimate outcome of all pending or threatened legal and regulatory proceedings, the Company believes that some of the proceedings (including the Dutch unit-linked products, Woekerpolis.nl & related litigation) may have, or have in the recent past had, a significant effect on the financial condition, profitability or reputation of the Company or NN.

Conclusion

ING's need to exit the last of its non-banking businesses to meet regulatory mandates has forced it to sell NN Group at a very attractive price. Further, the timing of the IPO has been dictated by regulatory deadlines and not on optimal market dynamics. A summer-time sale of shares worth EUR 1.5 billion is difficult. Additionally, timing it during one of the least active periods in the US markets (the curtailed July 4th week) has provided investors with the opportunity to buy a high quality insurance business with leading market shares at an incredibly attractive price. 60+% upside. Minimal downside: price to tangible book of 0.57x; price to estimated 2014 earnings ratio of 9.3x; free cash flow yield of 6.1%, dividend yield of 6.3%.

Disclosure: The author is long VOYA, NNGPF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: KL Investment Partners is long NN Group (which trades in Amsterdam, the Netherlands). KL Investment Partners may change or exit its position (buy or sell shares) without updating this article and without informing the Seeking Alpha community. KL's articles, blogs and comments are not an offer to sell or a solicitation of offers to buy any securities. Securities of the Fund are offered to selected investors only by means of a complete offering memorandum and related subscription materials. There is the possibility of loss and all investment involves risk including the loss of principal.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Source: NN Group: Forced Sale Of A Leading Insurance Company: 60+% Upside; Minimal Downside