New Long: Brighthouse Financial $BHF

[Andrew Stepner]

Feedback sought:

Brighthouse Financial $BHF is a pick from David Einhorn and Greenlight Capital. They seem to often have some standard value investors blindspots, but they are awesome at deep dive research and I really respect their ability to fundamentally value a company. And they think this one is mega cheap. My process is that I just have to make sure I don't see a potential downside that they are missing. But on this one it seems like a clean and good thesis.

Bottom line, Brighthouse seems unloved and very cheap. Catalyst will hopefully be big accelerating buybacks and maybe hedge funds buying or analyst ratings increases.

Here are my narrowed down highlights from what they have said about it. It is in chronological order and explains the big key reasons to be bullish:

1/16/18 Greenlight Einhorn Letter

1. Spin off (historically a great investment thesis in and of itself)
   
2. "BHF appears to be a traditional spin-off — an underperforming and unloved part of a larger, more successful company."
   
3. "They bought at a "valuation of just 56% of book value and 6.4x 2018 EPS estimates."
   

7/31/18 Greenlight Einhorn Letter:

1. https://www.scribd.com/document/385132733/Qlet2018-02-1
   
2. "Last year, our biggest new investment was Brighthouse Financial (BHF). It was a spin-offf rom MetLife. It had all the spin-off dynamics we like to see. The roadshow presentation was practically morbid and almost designed to discourage investing. The most off-putting was management’s plan to refrain from capital returns for three full years to allow the company to “season.”
   
3. We paid $57.92 per share or 62% of book value and less than 7x future earnings.
   
4. the company continued to build excess capital and hinted that capital return could commence sooner than expected.
   
5. the company said capital return could begin sooner than 2020 under certain circumstances.
   
6. All told, we really don’t understand why the stock is performing so badly. It now trades at about 37% of book value and less than 5x earnings. Generally, when an insurance stock trades this poorly, there is either a large capital hole or an enormous reserving problem. We don’t see evidence of either. Yes, BHF would suffer in a large equity sell-off, but so would almost every stock in the market.
   
7. Ultimately, we see capital return as an important trigger to realize value in this investment. The current absence of it, in a sector where most peers pay out 50% or more of earnings as dividends, has left BHF stock adrift without a valuation anchor in a period where financials have underperformed broadly. For now, investors are ignoring the large discount to book value and dismiss BHF as “a future story” – but the current ~20% earnings yield becomes impossible to ignore once those earnings return to shareholders in the form of cash dividends or stock buybacks."
   

10/5/18 Greenlight Einhorn Letter

1. https://www.scribd.com/document/390197639/Greenlight-2-1
   
2. "The biggest [winner of the quarter] was Brighthouse Financial (BHF), which announced a satisfactory quarter, but more importantly announced a $200million buyback, thereby commencing capital return a full 2 years sooner than projected at the spin-off road show"
   

4/12/19 Greenlight Einhorn Letter

1. https://www.scribd.com/document/406033932/Einhorn-April-2019
   
2. "BHF’s GAAP accounting is difficult for many investors to understand. Essentially, the company purchases hedges to mitigate its exposure to equity market and interest rate risks. Under GAAP accounting, the hedges get marked to market each quarter, but the liabilities they hedge do not. This creates a mismatch between how BHF’s assets and liabilities are treated in response to market moves. All else being equal, BHF benefits from rising equity markets and higher interest rates, as the economic gain from lower expected claims more than offsets the company’s losses on its hedges. However, the company’s GAAP accounting indicates the opposite; while the hedges generate mark-to-market losses, there is not a corresponding reduction in GAAP liabilities.
   
3. As a result, when markets rose in the first part of 2018, BHF’s GAAP results showed losses and book value declined. The company presents adjusted earnings that correct for the perverse accounting treatment, but we believe the GAAP losses dissuaded many investors from buying the shares last year.
   
4. If anything, the result suggests that adjusted profits are a better indicator of BHF’s performance. On that basis, BHF earned $7.44 per share in 2018 and we expect it will earn about $9 per share in 2019. BHF intends to repurchase $1.5 billion of stock by the end of 2021, which would be more than one-third of its market capitalization."
   

7/25/19 Greenlight Einhorn Letter

1. https://d2gr5kl7dt2z3t.cloudfront.net/blog/wp-content/uploads/2019/07/28201547/Greenlight-Capital-Q2-2019-Investor-Letter.pdf
   
2. "…Either way, over the next few years BHF's need to build capital will peak and the headwind will turn into a tailwind. It isn't hard to envision free cash flow doubling over the next few years as the variable annuity book matures, eventually reaching $1 billion per year or more. Even now, BHF has plans to buy back $1.5 billion of stock by the end of 2021. At today's prices, that is approximately 1% of shares outstanding per month. Today, the company's market capitalization is just over $4 billion. We've digested the bear case and we continue to think that BHF is deeply undervalued at about 30% of book value and 4x earnings."
   

10/30/19 Greenlight Einhorn Letter

1. https://www.scribd.com/document/433411984/Einhorn-Letter-Q3-2019
   
2. "As one analyst put it in his summary of the quarter, “we do not expect there to be many buyers for this name despite a seemingly cheap valuation and reasonably good earnings results.” But someone has been buying: with the stock in the doldrums, BHF continued its aggressive buyback program, repurchasing nearly 3% of outstanding shares in May and June alone, and management collectively purchased nearly $1 million worth of shares on the open market after the earnings report in August."
   

1/21/20 Greenlight Einhorn Letter

1. https://www.scribd.com/document/443770600/Greenlight-Q4-2019#download&from_embed
   
2. "Brighthouse Financial (BHF) – Long 4.0x P/E on 2020 consensus adjusted earnings, 31% of book value
   
3. "This remains one of the most perplexing investments we have ever made. Although the shares “recovered” 29% in 2019, the underlying value of the business also improved, so much so that the shares are arguably cheaper now than they were a year ago.
   
4. BHF’s annual report provides certain sensitivities showing intermediate-term cash flows from the variable annuities segment based on hypothetical capital markets scenarios. We estimate that the 31.5% gain for the S&P 500 incrementally added at least $2 billion to BHF’s distributable cash flow over the next four years. BHF’s entire market capitalization is only $4.2 billion. The company will release new sensitivity tables next month.
   
5. In 2018, the company announced that it would return $1.5 billion to shareholders by the end of 2021. At that time, management was clear that its targets were sensitive (in both directions) to capital markets. As a result, we believe there is an excellent chance BHF will exceed its capital return targets. Even at current levels, the company is buying back stock at a rate of over 1% of the company each month. Given the discount to book value, the buyback alone is causing book value per share to grow by 10% per year, in addition to the company’s earnings.
   
6. The bears’ latest bugaboo is that around 2022, BHF will be subject to a change in accounting, which could lead to a “sizable” non-cash charge and reduction of book value. We note that the shares already trade at only 31% of book value and that any write-down would actually have a positive impact on future earnings. We estimate that every $10 per share write-down will improve annual earnings by $0.65 per share. By our estimates, even with a $3 billion charge, book value per share is likely to grow at a double digit rate over the next 5 years and adjusted earnings per share is likely to grow even faster than book value per share.
   
7. BHF shares could double from here and still be absurdly cheap."
   

Those were the consolidated highlights from Greenlight's investor letters. Let me know if you want me to copy/paste/send their full comments which are maybe twice as long.

Let me know your feedback.

Stepner

[Brendan Mathews]

I thought this was the more interesting one from the letter you shared earlier. Generally, annuity business isn’t very good one. So it’s probably a low-quality business, but that might be ok if cheap enough. You’d have to look at the balance sheet to understand what they’re on the hook for with annuities. Those can be dangerous. I’d say earnings is probably a bad way to value this business. By nature of long tail insurance, earnings are based on a lot of assumptions and mostly paper based. It’s a bit disingenuous of Greenlight to focus so much on earnings. Maybe they are trying a bit to “foist” this on investors (like Larry David’s assistant). Or it could really be cheap and overlook. Certainly looks ugly situation and it would be easy for people to misclassify if they don’t do the work. Capital return (especially buybacks) if it’s cheap could be a double whammy — accretive plus signal to unlock discount. I can try to look at the balance sheet tomorrow if you want a fundamentals check against greenhorn (new nickname?!). 

Final thought (and personal bias)... it probably is a lot market cycle, but I haven’t traditionally done very well with these types of count the cash cheap stock situations (despite how much they tend to appeal to me). So I’m a little hesitant just based on the category. 

I’ve been almost exclusively been buying small lots of things that cross my desk related to venture companies — Hubspot, DocuSign, square, live oak bank — I don’t have deep insights or research on these. So mostly just starter positions. 

On Jan 27, 2020, at 1:15 AM, Andrew Stepner <andrew...@gmail.com> wrote:



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[Andrew Stepner]

Greenhorn it is! I'll still mention the real names occasionally just to make the emails more searchable.

Interesting thoughts.

Brighthouse and Greenhorn do reference "Adjusted Earnings" which at least equalizes the quarterly change in liabilities. But I take your point on EPS being a bad measure. And it's quite lumpy anyway. To me it seems like book value is the better measure since that's what Greenhorn emphasizes. I also did my back of the envelope DCF model. It uses Revenue and Net Income margin to calculate Net Income payback over time. It also looks absurdly cheap on that basis. It looks to me like the entire enterprise value will be earned back in just under 3 years if present Revenue and Net income levels are maintained. This is also seen in the P/E being ~3X. I get that earnings may not be the best measure, but would you disregard a P/E of 3 completely?

For annuities being a bad business, how do you reconcile that against the idea of insurance being a good business for Berkshire? Presumably insurance generates float for Buffett to use whereas that's not the case here. But if we take float out of the equation, does that otherwise make insurance and annuities both equally bad businesses? Or there is a reason to prefer insurance? Or am I missing something when you say annuities are a bad business? (You probably know more than I do in this regard).

Ultimately to me the book value discount coupled with potential for accelerating buybacks is the key positive dynamic. And then I just have a lot of trust I place in Greenhorn to do deep dive fundamental analysis a million times better than I could. Generally, my edge (assuming I have one) is critical thinking, and even though this is not "first principles" it seems much more effective for me apply my critical lens to Greenhorn rather than directly to Brighthouse, if that makes sense.

Stepner

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[Brendan Mathews]

I don’t like annuities mostly because it is long tail business. Long vs short tail is big difference for insurance models. Basically, it is how long until you know what you have to payout. Auto is short tail, usually under a year. Annuities are decades. And a lot of dependence on unknowable macro factors. Another problem with annuities is not usually a consumer friendly product. Or actually a risk transfer mechanism that makes much sense. 

On Jan 27, 2020, at 7:03 PM, Andrew Stepner <andrew...@gmail.com> wrote:



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[Andrew Stepner]

That's insightful, thanks.

And what did your last few words mean, "that makes much sense"?

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[Andrew Stepner]

It's more fun to follow up on ones doing good than ones doing bad so forgive the selection bias...

$BHF up ~11% on earnings report. https://www.fool.com/investing/2020/02/11/heres-why-brighthouse-financial-is-soaring-today.aspx

They also announced $500 million additional repurchase authorization which they expect to use in the next 12 months. They repurchased $570 million in the last 18 months, so if anything the pace of it is slightly increasing.

On the earnings call they discussed switching to more conservative hedging strategy for stock market risk. The analysts seemed to like that.

Stepner