Life Partners Holdings: Attractive Yet Highly Speculative

Shares of Life Insurer Life Partners Holdings (LPHI) rallied 30% on Monday after management said it expected a "substantial increase" in its first-quarter earnings compared with the year-ago period. The Waco, Texas-based insurance company said it sees per-share earnings of 49 cents for the quarter vs. 5c last year. The company also said it expects to post revenue of about $17.5 million, up from ~$6 million a year ago.

The spike in shares immediately lit up our systems, and then dawned on us that 1) no one the sell side wants to cover this name and 2) the shorts are unequivocally getting blown out of the water here. We had to dig deeper.

Business Overview

Life Partners Holdings is viatical settlement company. A viatical settlement is the sale of a life insurance policy by a person with a terminal illness to another person. The company also offers life settlements, in which life insurance policies are sold by people who are not necessarily terminally ill but do have a life expectancy of approximately 10 years. The company generates fees by facilitating the purchase of these contracts. It is the only publicly traded life settlement provider. Since its founding in 1991, Life Partners has generated a total business volume of approximately $700 million in face value of policies for its worldwide client base of over 15,000 high net worth individuals and small institutional purchases (source: latest 10K).

A viatical settlement is the sale of a life insurance policy by the policy owner before the policy matures. Such a sale, at a price discounted from the face amount of the policy but usually in excess of the premiums paid or current cash surrender value, provides the seller an immediate cash settlement. Viatical settlements catapulted to popularity in the US in the late 80s, when the AIDS epidemic first spread and AIDS victims, largely homosexual men, found themselves needing to quickly extract value from their policies (source: Wikipedia).

Although viatical settlements developed a bad reputation in the investing community (unscrupulous salesmen pining for mammoth commission rates), regulation has helped to sanitize the space and attract renewed attention. Despite the sour experience of many investors, viatical settlements continue to be an invaluable panacea to the sundry financial crises many ill people face today. In countries that exhibit towering healthcare costs, viaticals have become a pragmatic way to pay off those health insurance premiums that severely ill people face. We believe this trend is responsible for the solid top line growth Life Partners has enjoyed over the last 24 months.

Investment Highlights

There are a several salient themes we think will propel shares of Life Partners Holdings into the limelight. One, there is a growing awareness in the financial markets that life settlements could be attractive investment vehicles through which to diversify portfolios and seek alpha in non-traditional spaces. In other words, settlements, arguably immune to the business cycle, could represent the next frontier in integrated wealth management. Two, while the average life viatical has traditionally been carried out for individuals with less than 2Y to live, there is a gradual trend towards longer life expectancy customers, which we estimate will help expand LPHI’s market potential. As the figure below illustrates, LPHI’s business volume has nearly doubled over a 2Y period. Lastly, heightened regulation within the insurance industry is bolstering investor confidence in this demographically driven niche, an overlooked pocket in the financial services cosmos.

Investment Risks

The three biggest risks, we think, include: 1) the lack of information among viatical settlements companies, primarily because they are mostly privately held; 2) The insurance industry’s accelerated death benefit policy offerings are posing a threat to viatical settlements companies (although viaticals are much more flexible a tool); and 3) an acute sense of “wrongdoing”’ within the industry, brought about by the bad apples that used questionable business practices to close viatical deals and/or pay brokers.

Moreover, two brokers account for 53% of the policies LPHI purchased last year -- this concentration risk is something all potential investors must bake into their cost of equity. As an insurance company, LPHI could see its profitability deeply impacted my miscalculated future premium reserve levels (i.e underestimating average life expectancies) and climbing brokerage fees (which really hammered the company a while back and one reason we believe 4% of the float is short). Investors should also note how thinly LPHI’s shares are traded, that the agreements the company has with the brokers it does business with are not fixed (brokers can switch to rivals at any time), and that cash flows are quite volatile.

Conclusion

In the end, however, we think Life Partners Holdings could be an attractive, albeit highly speculative, way to play the Baby Boomer theme: the overall market for viatical settlements should grow at a pronounced rate over the next decade as older citizens become aware of their option to liquidate insurance policies that no longer serve any purpose. Furthermore, over a trillion dollars worth of life insurance policies either lapse or are surrendered annually and the settlement market, barely 15 years old, is expected to grow 4-6 fold over the next 5 years. It may not be your typical hip replacement or laser ablation play, but it’s a Boomer stock nonetheless. With so many life insurance policies currently outstanding, and boomers increasingly opting to take advantage of the life settlement option, LPHI could be that one Baby Boomer microcap we’ve all been waiting for. Just don’t look for us if it blows up.

Full Disclosure: Daniel A. Jacome is an MBA candidate at the Kelley School of Business, the founder of Ceviche Fund Partners LP, and an equity analyst intern on the buy side. At the time of publication, neither he nor any of the firms he is employed at held a position in any of the securities mentioned.

Comments

[DanielJacome]

Shares have more than doubled (22 -----> 50) since we posted 90 days ago -- we are being emailed frequently to see if we still think LPHI is worth holding onto -- we do and urge investors to stick to the stock until a key moving average (20 day) is breached....for those with a double on their hands, trimming down half the position to take profits would not hurt

Thx
DJ

[DanielJacome]

LPHI shares officially sliced the 50 day days after our last comment (see thread)...take it as a warning sign; volume was a bit worrisome