Revisiting David Einhorn's Brighthouse Financial Trade

A look at one of the value investor's top positions

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Jan 23, 2020
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One of the most significant positions in

David Einhorn (Trades, Portfolio)'s Greenlight Capital portfolio is the life insurance company Brighthouse Financial Inc (BHF, Financial).

According to the hedge fund's latest 13F filing, the firm owned around 3.6 million shares of this company at the end of the third quarter of 2019. It made up 10.4% of the long equity portfolio at around $144 million. It was the fourth-largest holding in Greenlight's $1.4 billion equity portfolio.

Unloved spin-off

Brighthouse has been a bit of a disappointing investment over the past few years. The company was spun off from its parent, MetLife, in 2017. Since then, the stock has trended downwards. It is currently about 20% below its spin-off price.

However, Einhorn believes that the stock offers value at current levels. According to his analysis, which was published in his fourth-quarter and full-year letter to investors of Greenlight Capital, the hedge fund manager believes that after recent declines, the stock is currently trading at a single digit 2020 price-earnings ratio of just 4.0. Moreover, he calculates that it is dealing at a price to book value of 0.3.

So why is the company so cheap? It appears that Einhorn thinks that Wall Street does not understand the business.

Wall Street is overlooking the value

To understand how to value Brighthouse, we need to take a look at the company's business model.

Its main business is variable annuities. Customers pay the company a lump sum, and then it manages this money to give them a steady income. It invests the money in the stock market or bond funds to produce the best returns.

Pricing and managing annuities is quite a complicated business. Because annuities guarantee a set level of income, the company managing them takes on a huge responsibility. In the worst-case scenario, customers' money is mismanaged, or stock markets don't perform as expected, and the company has to make good on these minimum guarantees.

As Einhorn writes in his 2019 letter to shareholders, "Policies written with assumptions that are too optimistic cause trouble for variable annuity writers, as was the case from 1988 to 2011 when the S&P 500 index was essentially unchanged."

The risks involved in the business mean that the annuities sector is highly regulated, and the companies involved are capitalized at all times.

All of the above seems to have scared off investors, who don't want to be exposed to the risks of the annuities business. Nevertheless, Einhorn believes there's an opportunity here because, as he says, the stock market moves both ways. While the company might suffer if markets return less than expected, it benefits substantially if they produce better returns than expected. That is exactly what has happened over the past few years.

The hedge fund calculates that the S&P 500's 31.5% return last year added "at least" $2 billion to the company's distributable cash flow over the next four years. This adds to Brighthouse's existing capital buffers, which are already substantial.

At the end of 2018, the company announced that it would be returning $1.5 billion to investors by the end of 2021. Einhorn calculates that at this rate, Brighthouse is buying back around 1% of its outstanding shares every month, increasing book value by 10% a year.

All of the above suggests the stock offers a wide margin of safety at current levels. Therefore, while Brighthouse will always be exposed to the risks of operating in the complex variable annuity sector, investors do not have to be 100% correct in their evaluation of the business to make money.

Even if the group's operating performance improves only slightly, and there's a marginal improvement in market sentiment, the stock price could increase substantially over the next few years as book value continues to expand.

Disclosure: The author owns no share mentioned.

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