With a market capitalization of $58 million, GWG Holdings Inc. (GWGH, Financial) flies under the radar of most investors. But at 0.6 of book, the stock looks appealing on a simple value screen, and it looks to be just the sort of deeply discounted insurer Warren Buffett (Trades, Portfolio) would buy, but is it?
Dissecting the business
GWG is the parent company of GWG Life, a financial services company focused on transforming the life insurance industry via a new suite of options for the life insurance secondary market called LifeCare Xchange. The idea behind this product is simple; it provides seniors with the exchange value of their life insurance policies they can apply to long-term care and other post-retirement needs.
Revenue growth over the past six years has been explosive with the company achieving a compound annual revenue growth rate of 31% since 2011. Nonetheless, profits have remained elusive during this period.
On the face of it, the lack of profitability might be an issue for some investors, but this is hiding the real value. GWG is not just an exchange (facilitating transactions and taking a cut); as its descriptions infer, the company buys life insurance policies from those seeking to get out and then manages the policies itself. Looking through the latest 10-Q, right now, the company is still building its portfolio, and there are only 72 policies, with a fair value of around $82 million maturing (based on life expectancy) in 2018 and 2019.
After 2020, policy maturity ramps up with 96 maturing in 2020 alone with a fair value of $92 million. In the following years the company is set to see around 80 to 90 policies mature per year. In the meantime, GWG has to cover the interest on the debt used to buy these policies. For the second quarter ending June 30, gain on life insurance policies booked was $11.3 million, with interest expenses of $12.2 million. For the six months to June 30, the figures were $30.7 million and $25.5 million, although other costs of $15.7 million forced the company into a first-half pretax loss of $9.5 million.
Improving profits
GWG has a fixed cost base so as more policies mature, profits should flow. For example, in the six months to June 30, 2016, the company earned $38.2 million from maturing policies, paid $18.9 million in interest. Fixed costs of around $13 million saw the company report a pretax profit of $7 million.
As GWG manages these policies to maturity, reinvests the proceeds and reduces debt, the company should be able to increase shareholder equity steadily. At the end of the second quarter shareholder equity was $114 million, up from $18.1 million in the first quarter of 2016.
That being said, there are plenty of risks to the business of buying life insurance policies. GWG has borrowed heavily to buy these policies; if the former owners end up living longer than intended, the company may find itself running into difficulty. What’s more, if the insured ends up living past the estimated date of death, GWG may find itself in the position where the policy is worth less than the amount paid.
Time to buy?
So is GWG worth buying as a value play? Even though the company is trading at a deep discount to book value, I’d like to see a more predictable income stream and less debt on the balance sheet before investing.
It’s interesting to note that CEO and Chairman Jon R. Sabes owns around 22% of the business, and Executive Vice President, Director and Secretary Steven F. Sabes owns 18% of the business so there’s plenty of management skin in the game. This is important because as noted above, trading life policies can be risky, and if management has a significant stake on the line, the chances of taking on too much risk or overinflating policy values are substantially reduced.
All in all, GWG is an interesting value play although until the balance sheet improves, it’s not for me, and Buffett might have the same opinion.
Disclosure: The author owns no share mentioned.
