Athene: A Solid Under The Radar Financial
Summary
- Athene has a solid track record and expansive investment portfolio.
- Q1 2020 was marred by some earnings volatility but the core business remains intact.
- Good valuation offset by some governance and clarity issues makes Athene a buy.
Introduction
Athene (NYSE:ATH) is a unique financial that focuses mostly on annuities and related projects. Unlike many insurance companies that also do annuities, they appear to lack any long-term traditional life insurance products, but do operate in a few unique areas like pension re-insurance and other pension risk transfer strategies.
2019 Results
2019 was a good year for Athene, but it is hard to compare apples to apples versus any previous year because the company has been expanding rapidly, mostly through inorganic means. They have acquired large blocks of annuities and other products in recent years.
Book value per share increased from $46 per share to $76. Net income doubled to $2 billion. Helping this, however, was a very large investment gain to the tune of $5.39 per share. Absent this, net income growth would be flat.
Source:2019 Annual Report
The large increase in assets and policies was funded mostly by preferred equity, resulting in the balance sheet remaining very underleveraged and the per share count actually falling year over year thanks to a pickup in buyback activity.
Debt was only about 10% of the capitalization structure at the end of 2019.
Source:2019 Annual Report
The company continues to generate strong cash flow and has been spending most of the excess on stock buybacks. The company repurchased $832 million in 2019 after a few years of almost no buybacks. It will be interesting to see if buyback activity falls off as the company finds more opportunities to buy assets at attractive prices during this economic downturn.
Financial companies of all stripes are difficult to analyze because so much depends on unknowns for the outside investor. While a company may look attractive trading under book value, with a strong record, poor risk management and underwriting of acquisitions can have long-term disastrous consequences that are not readily apparent.
Athene freely admits that being formed after the great recession in 08-09, they have not experienced anything of the sort that we might be in the middle of currently. This will be a big test for the company.
Q1 2020
Athene reported earnings on May 8, 2020, with some very interesting results and commentary about the future given how past results are becoming less relevant as the economy quickly changes.
The company actually posted a large net loss for the quarter of $1.1 billion, or $5.81 per share. Book value per share fell to $51.28, a large decrease from what we showed above in the 2019 Annual Report. The earnings release claims it was only a 2% decrease year over year, which is incredibly misleading as quarter over quarter the decline is much larger.
Source: Q1 2020 Earnings Release
Interestingly, when it comes to deposit growth or lack thereof, the comparison changes to show that quarter over quarter they were up 8%, but down 17% year over year.
The company attributes this to disciplined underwriting in the face of low interest rates and slow demand. This highlights the risk part I mentioned earlier. When analyzing financial companies, new business and policy growth is not necessarily accretive no matter what. If a company continually grows its insurance policies but does so by making exceptions and widening its underwriting criteria, then in reality it is going in reverse.
The negative net income sort of ruins any other horizontal comparisons as return on equity and other measures are now negative.
Let's get to the cause of the negative net income. The company had a negative $1.1 billion investment loss for the quarter. Athene is an insurance type company that takes premiums and other payments it receives and then invests them in order to earn income and lower the overall cost of paying out benefits for its annuities and other products.
This system of float is a tried and true business model, but it can cause some complicated financial results. Accounting rules constantly change, but this loss is driven by certain investments that are impaired or are short term in nature such that they need to be held at market value on the balance sheet.
Think of a normal stock or a short-term treasury bond or bond fund. These assets are liquid, can be sold at any time, and have a readily available market price. Athene owns a smattering of different assets across private equity, fixed income, and other asset classes.
Source: Q1 2020 Earnings Release
So when the market hit a bump in Q1, these assets lost value and created this large income statement item.
Source: Q1 2020 Earnings Release
This is unfortunately part of the nature of investing in this type of company-- the accounting and financials can be incredibly complex, while traditional operating income only being one component of net income is different than many other companies.
Behind the scenes, Athene's core business and new policies did suffer a slowdown with the uncertainty and low interest rates, but it was not too drastic. With a month of Q2 left to go, I expect that the income statement might well swing the other way with some large investment gains when the company reports.
Source: Q1 2020 Earnings Release
Apollo Deal
Athene recently completed a restructuring of their relationship with Apollo. The goal was to remove the super voting and multiple common share classes that used to exist which will allow the company to appeal to more investors, primarily by being included in indexes. Many indexes and some exchanges have rules about super voting shares and other corporate governance items designed to protect investors.
The downside is that despite this transaction Apollo still has significant economic, voting, and contractual leverage and interests in Athene. As an outside minority investor, this is a clear downside. I think this leads to a high degree of potential for obfuscation, conflicts of interest, and bad deals being made. The company continues to tout this as an advantage in terms of accessing Apollo's investment expertise and other strengths outside of possible index inclusion, but I think those are tenuous.
Interest Rate Impacts
Interest rates have a large impact on Athene's results, but analyzing that impact is tricking. Athene invests its deposits in fixed and variable rate securities and also has liabilities that are variable and fixed. It has tried to focus on fixed annuities as much as possible. The annual report cites a transaction a few years ago where it partnered with Apollo and others to buy Voya's book of annuities, but was able to keep only the fixed portion for themselves while others took the variable annuities.
In general, however, the company believes a rise in interest rates would benefit it. This would occur from investing new deposits at a higher, fixed rate, and also capturing more spread on new annuity products. They also claim demand would increase along with interest rates.
Super low interest rates hurt the company because most of their policies have certain minimums that consumers receive, which hurts the credit spread between that and what they are earning on their various investments.
Predicting increasing interest rates as a catalyst is a tough sell. That has been a common rallying cry to invest in banks for a decade now and didn't really come true. Regardless, the pandemic has brought global interest rates back down to zero just as they started going up.
Valuation
Athene's valuation is very compelling, even given the long-term low valuations we have seen for all financials as low interest rates seemed to drag on and on after the last recession. It trades at $33 per share as I write this against a book value of $56. The P/E is around 8 to 9 times which is probably overstated and includes the Q1 2020 loss.
The valuation could only be justified if the company continues to suffer investment losses and slow new business growth, which would likely be driven by a deep recession and lower or negative interest rates.
Data by YCharts
Conclusion
Athene has complicated financials and a less than straightforward way of making money, which I think might scare off some newer investors. But for diving into the madness that is Athene, I think investors are well rewarded with a cheap company whose core business is relatively unaffected by the pandemic, even if their portfolio of investments will experience some losses and volatility in the short term.
There are a couple of issues that prevent Athene from being a screaming buy such as the Apollo relationship and a high concentration of non-fixed income assets for this type of company, but I think the strengths and valuation shift the risk/reward towards buy.
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