Goldman Sachs (GS) said that it will sell USI Holdings, a private equity affiliate of Goldman Sachs Capital Partners. USI Holdings is an insurance and financial products distributor that sells property and casualty insurance to small and midsized business. It has annual revenue close to $700 million. Goldman Sachs bought the company for $1.4 billion in 2007. This translates to an EBITDA multiple of 9.7 times. This also means that it paid USI shareholders $17 cash per share, a premium of 9% over the company's stock price.
According to sources, an auction has already been started. Its potential buyers include its key competitors such as Alliant Insurance Services, an insurance company under the Blackstone Group (BX), and Hub International of Morgan Stanley (MS) and Apax Partners. There are no details with regards to the price of this transaction. Its annual EBITDA is at $190 million. Assuming a 9 to 10 times EBITDA multiple, it could sell for as much as $1.7 billion to $1.9 billion.
Goldman Sachs has written off around $485 million in equity since the time it purchased the company. USI Holdings' strength is its ability to cross-sell various financial products to its clients. However, its high financial leverage offset its strength. In addition to that, it faces economic headwinds in an uncertain macroeconomic environment.
Property & Casualty Insurers Outlook Still Uncertain
Based on Ernst & Young property and casualty and insurers outlook, uncertainties surrounding the global economy will continue to have significant impact on the insurers. The global economy remains fragile and volatility is expected throughout this year.
The low premium growth environment will continue to persist for the year. This will adversely affect insurers' profitability and potentially result in 5 consecutive years of negative performance for the industry. Loss reverses and premium adequacy are expected to decline while average investment yields will also be lower.
In terms of economic cycle, the industry has not yet recovered following big losses incurred in the previous year. There are industry experts that believe that 2012 could be a tipping point. The catalyst will be increased acquisition in the sector, marking the bottom of the industry.
Many private equity firms, including Goldman Sachs Capital Partners have made significant investments in the past years. Most of these investments were done prior to the financial crisis. The investment thesis was based on buying these insurance companies at book value and selling them at higher multiples in the future. While valuations have stayed low for a while, I have not seen multiples improving to least book value levels. For example, Safety Insurance (SAFT) trades at 0.96 times book value, while Allstate (ALL) is valued at 0.93 times. Since most private equity funds have mandatory exits, pressure is beginning to build to exit from these investments. This is precisely what Goldman did. The result is that transaction will be at fire sale prices.
Goldman Growth Drivers
Goldman Sachs' exposure in emerging markets, notably China and Brazil, will support its rapid expansion abroad. There is increasing evidence that companies from these countries have signified their intention to raise capital via the debt capital market. This will drive demand for underwriting and debt origination services. There is also a growing trend toward shifting from being a closed family business to converting into a public company.
Another key driver will be its asset management business. Goldman Sachs' growing assets will be a good catalyst for future growth. Given that new regulations have restricted its proprietary trading desk and risk taking, this business will provide higher value in the future.
Its debt trading capital stood at $210 billion at the end of 2011. There is a risk that Goldman will be forced to reduce this risky portion of its business. Trading assets will gradually decline as regulators are expected to be really tough on the banks.
No Signs of Weakness in the Financials
As I have mentioned above, the reason for the sale is not to raise funds, but to follow its mandatory exit based on its investment horizon. If you look at the financials, it is safe to say that Goldman Sachs will withstand future operating stresses.
Based on the recent financials, the company has total assets of $923 billion. These are mostly funded from long-term debt of $174 billion and deposits of $46 billion. This translates to a leverage ratio of 13 times. This is lower than its leverage ratio of 28 times in 2007. However, this appears higher to its peers. Citigroup (C) has leverage ratio of 10.56 times, although Citi's leverage has been stable at 19 times based on its historical standards. JPMorgan (JPM) has leverage ratio of 13 times, but like Citi, it has maintained its leverage ratio at 12 times even in the past.
Analysts expect Goldman Sachs to earn $10.52 this year. This translates to an earnings growth of 133% this year. For the 5 years, the company is expected to grow its earnings by 14% a year. JPMorgan is forecast to see a decline in earnings by 4% to $4.30 per share. Over the next 5 years, the company is expected to grow its earnings by 15% a year. Meanwhile, Citi is estimated to grow its earnings by 9% this year. Its 5-year earnings growth is pegged at 9% a year.
These valuations suggest that Goldman trades at 8.93 times earnings. It also carries a dividend yield of 1.96%. JPMorgan trades at 7.5 times and has a dividend yield of 3.50% Citigroup is valued at 7.30 times and carries a dividend yield of 0.20%.
Overall, the financial industry is cheap based on historical standards. Goldman Sachs has a reputation in the market as a financially strong bank. The recent crisis has tested this perception. The market has questioned the viability of its business during the crisis. The simple leverage ratio suggests that it has moved away from the high-risk and high-return days. I expect Goldman to be a bank of modest risk that could yield above-average returns. However, it could take a while before we can see improvement in the bank's valuation.