value and opportunity

NN Group is the name of the soon to be just IPOed Insurance subsidiary of Dutch ING Group. NN Group sounds a little bit strange but is the “traditional” name of the Dutch Insurance company, “Nationale Nederlanden”.

As a value investor, normally, IPOs are an absolute “No go”. Benjamin Graham famously said that one should never touch an IPO because almost always, the stock price is overhyped and the risk return relationship is not good. Especially now with the market reaching new highs, buying IPOs doesn’t seem a good idea.

So why could this IPO be different ? In my opinion there are some good reasons:

1. ING is obliged to sell.

ING had to be rescued in 2008 by the Dutch Government under the condition that they dispose their full insurance activities. They cannot simply spin off the business because they need the money to pay back the Dutch Government and shore up the bank balance sheet.

This is form a recent Bloomberg article what they have done so far and what they committed to:

ING, the recipient of a 10 billion-euro bailout from the Netherlands in 2008, agreed with EU regulators to complete its disposal program by the end of 2016 and to sell more than half of NN by the end of next year. ING also still owns about 43 percent of Voya and a stake of about 10 percent in Sul America SA (SULA11) in Brazil.

The company is open to selling the Sul America stake, worth about 566 million reais ($253 million) based on the Rio de Janeiro-based insurer’s market value, in a block trade, Chief Executive Officer Ralph Hamers said in an interview in Sao Paulo yesterday.

2. The company is an “ugly duck” at first sight

The remaining insurance compqny is a strange combination of Netherlands, Eastern Europe and Japan with some Investment Management thrown in. In German, one would call the business mix a “Resterampe”, so the remains of what could not be sold directly. The majority of the business is Life insurance, which itself is clearly suffering from low interest rates.

The company shows more or less zero profits for 2013, however a couple of items could be considered true “One offs” in order to look better in the future, for instance the large charge against the closed Japanese VA business. Also Q1 2014 showed a loss, this time because of a charge in relation to pensions.

So now one can accuse ING of “dressing up the bride”, rather the opposite.

3. European Insurance is one of the sectors with the lowest valuations anyhow

The Stoxx 600 has currently a P/E of 24,8 and a P/B of 1,9. Compared to this, the Insurance sector trades at a trailing p/E of 12,4 and P/B of 1,21. This is even cheaper than banks and utilities. Within the insurance sector again, the Life Insurance sector is even cheaper. There are clearly many reasons for those low valuations, especially that interest rates are so low which makes it hard for life insurers to earn their guarantees and a spread on top if this.

4. The IPO valuation looks cheap compared to the sector.

The company comes to the market at around 50% of book value. Considering that they don’t have a lot of Goodwill, this looks cheap even compared to the generally low valuations for life insurance companies. Dutch competitors Aegon and Delta Llyod trade at P/Bs of 0,7 and 1,3, the average for European Life insurers is ~1.4 including UK, and around 1 excluding UK.

5. The company looks like a target

Looking at this IPO, there seems to be a big sign on the company saying “split me up”. This strange combination of businesses is clearly not value enhancing. Splitting the company up for instance into a Dutch entity and selling down the rest could be a pretty easy exercise for an activist Hedge fund. I could also imagine that some Asian financial companies would be interested in acquiring a solid Dutch “brand”-.

6. The company is relatively solid

If one looks at the “usual suspects”, like Goodwill, pensions etc. there is not much to be found. The company had 6 bn of defined benifit liabilities in 2013 but actually got completely rid of them in early 2014 against an extra charge. I consider this as very positive and a good sign that they really cleaned up a lot of stuff befor doing this IPO. Additionally, another insurance specialty, so-called “DACs”, which are capitalized distribution costs only play a very minor role at NN compeared to other life players like AXA.

They do have some leverage but overall I would rate the balance sheet quality as “above average” for the sector.

7. The US IPO went relatively similar

There is a blue print for this transaction: Voya, the former ING US IPO. The US business was also supposed to be pretty ugly, so ING placed the first tranche very very cheap at below 0,4 times book value. Since then however the valuation seems to slowly approach those of other US life insurers and the stock almost doubled since IPO:

Other thoughts:

Management incentives
What I didn’t find out in the annual report or in the IPO prospectus was how the NN Group management is aligned with shareholders going forward.

In situations like this, a lot depends on Management, especially if they want to actually increase sahreholder value or if they want to maximise salaries which is easier in a bigger company and which would make reasonable spin-offs and disposals unlikely. So this is something to be watched.

Management has committed to a quite aggressive dividend payout ratio of 40-50%, starting with a large payout already this year in autumn. I am not a dividend investor, but this greatly reduces the risk of stupid acquisitions.

Distribution agreements with ING Bank

Life Insurance is mainly distributed via banks these days (often along with a mortgage loan). NN has an exclusive agreement with ING Bank according to the IPO porspectus until 2022. Although this is a limited time frame, this is very valuable as banks now charge high upfront fees in order to access their distribution channel.

Summary:

In my opinion this “IPO” of NN Group is much more similar to the classic “spin-off” than a “real” IPO. ING has to sell, the underlying business looks ugly at first sight and there is a lot of overall negative headline news for the sector and the specific business fields. As a result, other than with a normal IPO, the valuation is very cheap.

As I feel comfortable with the headline risks at this price level, I will invest a “half position” (2,5%) of the portfolio into NN Group at current prices (21,70 EUR). The short form investment thesis is that one gets an above average quality insurance business for a below average price.

Again, this is clearly not a “no brainer” and will need (lots of) patience, but over 2-3 years, the price of the shares could be easily 50% higher (including dividend distributions) if they reach average valuation ratios and the one-offs turn out to be real one-offs.