NN Group NV – “Hands off” IPO or interesting special situation ?

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.

10 comments

    • #martin,

      as I mentioned, NN is an ugly duck. With regard to litigation: I think this is a common risk for all financal institutions. Personally I would be more concerned if this would have been UK or US.

      The bigget risk for NN in my opinion for NN is that interest rates stay low, anything else is in my opinion “run of the mill”.

      mmi

  • I see there are quite some interest in this IPO from value investors seemingly because of the forced sale. This also attracted my attention. I agree with many points you made but however, there are two points I need to clarify:

    1) On page 20 of the prospectus footnote, the co record a $3b+ write down of assets due to higher interest rates. Given book at $14b and an implied market cap of $7b, how do you see the book gets erode going forward?

    2) On a related issue, how do you see the underwriting standards of the company?

    I have not finish the lengthy prospectus but these are generally my concerns thus far. Hope you can share your thoughts on these.

    Scott

    http://thevaluereport.wordpress.com/

    • Hi Scott,

      thanks for the comment. Regarding your questions:

      1) This is not a “write down” but a fair value adjustment, so if interest rates go down again (which they did) this will reverse. Insurance accounting is a little bit strange here because interest rate sensitive liabilites are always booked at cost.
      2) In general, I would place ING in the “above average” category for “underwriting”. In the Netherlands, liability matching of portfolios has a much longer tradition than elsewhere in Europe beause the pension system is to a large extent private.

      Hope that helps,

      MMI

      • Hi again, thank you for your feedback, I appreciate it.

        Yes, correct, it is a fair value adjustment.

        I agree with you that if interest rates go lower, the adjustment will reverse. However, isn’t it striking that the slight bump in interest rate had caused a $3bn fair value downwards?

        What I am concerned is that, where long term interest rates had always been at 6% thereabouts, and that the current interest rates are influenced by monetary policies, wouldn’t interest rates be higher not lower going forward?

        And if that’s the case, wouldn’t buying 50 cents on a dollar seem imprudent since the whole investment thesis rests on the bond portfolio fair valuation?

        Given higher rates in normalized scenario and short of any crucial information on the bond portfolio, wouldn’t it just mean margin of safety unknowable or even non-existent?

        How then should you view these?

        Scott

        http://thevaluereport.wordpress.com/

        • #Scott,

          I think the major point that you are missing here is the accounting side.NN has long term liabilities which are booked at cost. If interest would go up, those liabilities would econonomically decrease, However under current accounting rules this is not shown in the balance sheet. This will change in a few years under iFRS but for now we have to live with that. For a life insurance company, you should be much more worried if there would be no movement on the asset side as this would mean that they do not match their liabilities.

          By the way, I do not believe that long term in Europe or the US (that’s where NN is operating) will reach 6% at any time. Both, for Europe and Japan, 6% would be abnormally high.

          In any case, high interest rates would be good for life insurers, making heir products more attractive for new customers.
          mmi

        • I see. I understand your argument.

          In that case wouldn’t the argument be circular? If you say that should rates be up, liabilities are going to decrease, that will also means assets will economically decline yes? And that the inverse should be true when rates go down?

          Then it all totally boils down to, given whatever rates scenario, it is only the mismatch of assets v liabilities that matters? And that a 50% margin of safety affords a good measure?

          However, I find it problematic in the idea of liabilities economically decreasing when rates are higher. Theoretically, it is true. However, given the lines of business (P&C, Life, Investment management), how is that practical? Say in the coming year on higher interest rates and that a claim is due under the P&C line, your assets are economically lower (and have to be recognized to meet the claims), and your liabilities have not decreased given a fixed contractual payout. Wouldn’t it mean a recognition of the mismatch?

          I understand the P&C line is smaller so the issue may not be big. So for the last point, are we saying that although there may be risks to the mismatch in assets/liabilities in view of higher rates, ultimately we do have a $7b buffer for us?

          Scott

          http://thevaluereport.wordpress.com/

        • #Scott,

          no, there is no real “buffer”. For me, NN is a relative investment case. I am not a big fan of Life insurers at current interest levels but NN is in my opinion above average quality at a below average price.

          The best case for all insreuers would be a gradual rising interest rate level. A very rapid increase could lead to some distortion, the main risk would be that Life policy holders cancel their policies. The P&C side is pretty isolated as claims are ussually paid out of the prmiums collected in each year and not from investments.

          mmi

  • Good analysis and I totally agree – I too bought a starter position with a similar rationale to yours. A few thoughts from me on the IPO in mid-June http://financialorbit.blogspot.com/2014/06/voya-mark-2-nn-ipo.html and just before trading started earlier this week http://financialorbit.blogspot.com/2014/07/nn-group-ipo-today-few-thoughts-pre.html

    Really enjoy your insights, keep them coming!

    Chris

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