Regular readers of my work will know I’ve been following David Einhorn (Trades, Portfolio)’s Greenlight Capital for some time. After one of its worst years on record last year, Greenlight has been on the comeback trail this year as some of its most concentrated positions have staged a strong rally.
According to Einhorn’s second-quarter letter to investors, the Greenlight Capital funds returned 5.8% for the second quarter of 2019, taking the firm’s year-to-date performance to 17.4%.
One of Einhorn’s most significant holdings is Brighthouse Financial Inc. (BHF, Financial). Since its initial public offering last year, the market has hated the business. Einhorn believes it is undervalued, and the market does not understand the opportunity. I have no position, but I’m watching this story with interest.
Einhorn versus Wall Street
Einhorn covered the stock in his first-quarter letter after it put in a strong performance during the first few months of the year. Brighthouse looked to be a winning bet back then. Since then, however, performance has been mixed. The stock is basically unchanged in the second quarter.
This seems to be a classic example of Wall Street thinking one thing and value investors thinking something else. In his letter, Einhorn attacks the comments made by analysts at both Goldman Sachs and Credit Suisse in their respective research reports. Specifically, Einhorn wrote:
“These reports contain several key flaws. First, both reports value BHF’s main business -- variable annuities -- based on the run-off value of the existing book of business. However, BHF is not in run-off; the company sells nearly $2 billion of new annuities per quarter. The bearish reports each treated the business as if it were not a going concern.
Second, both analysts significantly overestimate BHF’s sensitivity to declines in interest rates. The Goldman Sachs analyst sees the potential for a nearly $1 billion hit from today’s lower rates, yet this is contrary to BHF disclosure. In December (amidst a dire market backdrop), management noted that a loss of $1.2 billion would require “correlated stress” of both a 25% decline in equity markets and a 100 basis point move lower in the 10-year Treasury.”
Einhorn also believes the two reports make some key mistakes when evaluating the rest of the business. The differentiating views make it apparent how difficult it is to value long-tail insurance businesses like Brighthouse. Another thing to consider is the company’s age. Einhorn noted that old life insurers tend to throw off more cash than young. Brighthouse falls in the latter category.
“BHF has a younger book of business,” Einhorn wrote. “The result is that its book currently throws off less free cash flow than others.” The result is that the market believes Brighthouse deserves a lower valuation, as the business is less profitable, on a cash basis than its more mature competitors. “There is no justification for this view, which is the bedrock of their [the analysts] absurdly low price targets,” he added.Â
The value investor continues to believe Brighthouse is a cash flow machine and that the bulk of this cash flow will be returned to investors over the next several years. “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,” Einhorn wrote in his letter. “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...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.”
Based on these estimates, there’s no denying Brighthouse is cheap. However, only time will tell if Einhorn’s evaluation of the bear case is correct or if Wall Street has the upper hand. I’m going to be watching the story play out with interest over the next several years, especially as Brighthouse’s capital build reaches a conclusion and the company starts to return capital to investors.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Warren Buffett Takes His Bank of America Stake Over 10%
- Warren Buffett: The Only Reason to Sell a StockÂ
- Time Is the Enemy of Bad BusinessesÂ
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
Also check out:
