Among life insurers, MetLife (NYSE:MET) has one of the most diversified business line-up. The company has a strong position in the U.S. variable annuity business and one of the largest exposures to rapidly growing life insurance markets such as Eastern Europe and Latin America. Despite its recent strong performance and the status of being one of the few truly global U.S. insurance companies, it is trading at a discount compared to peers. MET is also in a strong position to benefit from the rise in interest rates because it has built billions in reserves. Should interest rates rise further, the company can release some of these reserves into earnings.
The company recently announced that it is considering a separation of portions of its U.S. retail life / annuity segments from its other businesses through an IPO, a spin-off, or a sale. The decision is not only strategic but there is also regulatory consideration to it. The company is responding to the economic realities of the day, where low interest rates have pressured spreads and other areas of the business. However, the regulatory environment, where the company has been named one of three non-bank insurance SIFI, is also a factor in the break-up announcement.
A Historic Decision
Individual life insurance policies and individual annuities are two of the company's oldest and best known businesses, and the announcement means that MET would essentially exit both. This is not just another strategic decision by the insurance giant. In fact it is a historic decision. As a recently published (January 13, 2016) noted, Met has been in the variable annuity business for decades and in the individual life insurance business literally since the company was founded in 1869. Met's use over the last 40 years of the Peanuts comic-strip characters led by Snoopy in connection with these products has helped to make Met's name virtually synonymous with the marketing of individual life insurance and variable annuities.
For Met, therefore, to be seeking to exit these businesses is nothing short of extraordinary. It is the life insurance equivalent of, say, General Electric (NYSE:GE) exiting the home-appliance business.
Bold and Shareholder Friendly
Met's decision to separate into two companies is bold and shareholder friendly. The separation could result in lower capital requirements, if the old company and the new company can exit SIFI status. The strategic decision is also consistent with management's objectives of de-risking, improving free cash flows, and lowering the company's cost of capital. The separation also reduces downside SIFI risk for businesses seemingly viewed unfavorably by the Fed and could have positive capital implications. This sale, spin-off, or IPO, when completed, will provide a compelling basis to argue for the removal of the non-bank SIFI designation.
Timing A Surprise
While many expected the company to take some sort of action to get out from potentially onerous non-bank SIFI capital requirements, the timing surprised most of the investors. It is because the company is already involved in litigation to try to rescind its non-bank SIFI designation. Moreover, the capital requirements for non-bank SIFI companies are yet to be determined. Nevertheless, MET has made it clear in recent years that it would not stand idly by in the face of potentially higher capital requirements as a non-bank SIFI, and would pursue all avenues to unlock value.
For the past couple of years, the company has been talking about improving free cash flow generation and this announcement is consistent with that goal. The separation is going to take some time. However, it is worth mentioning here that both the new company and the remaining MetLife will still be very substantial companies once the split is completed.
The remaining MET will be much more focused on traditional insurance products where mortality and morbidity experience will matter a whole lot more, and considerations such as S&P volatility will mean a whole lot less. Without question, free cash flow generation should improve in terms of both percentage of operating earnings and predictability.
Post separation, the remaining company will be simpler, less market sensitive, and will generate higher free cash flow conversion. While it is unclear yet, it is also possible that MET will target a lower holdco liquidity buffer than the current $5.5 billion. As I said earlier, MET is trading at a discount compared to peers. It has a current P/E of 8.2 vs. industry average of 10.2 and the company's own 5-year average of 18.6. It has a price/book ratio of 0.7, compared to industry average of 1.1. Finally, it has a forward P/E of 6.7, compared to 17.2 of S&P 500.
All the positives that I mentioned earlier, should translate into a higher current P/E than the current 8.2 for remaining MET.
MET's bold decision to pursue the separation of a portion of its U.S. retail segment is not entirely surprising. From the time that MET announced its intention to appeal its SIFI designation, investors had assumed that a contingency plan may include a break-up of the company. So the decision was not entirely surprising but the announcement came earlier than many had expected, as the ruling from the court case over the SIFI designation has not yet been decided.
While the path to proposed restructuring is still unclear, it is the right short-term and long-term direction for the company. Moreover, is meaningfully positive for the valuation of the stock, especially at the current levels. The announcement also raises the bar for American International Group (NYSE:AIG) and Prudential Financial (NYSE:PRU) to take action in the face of regulatory/capital uncertainty.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.