Hedge fund manager John Paulson — who currently holds a 8.4 percent stake in The Hartford — filed a letter yesterday to the board of The Hartford with the Securities and Exchange Commission. In the letter, the billionaire investor made his case that splitting up The Hartford’s life insurance and P/C businesses would boost the company’s sagging stock price.
The Hartford’s stock price declined 38 percent in 2011, while its P/C peers were up 14 percent and life peers were down 23 percent, according to Paulson.
Paulson’s spokesperson said there would be no other public comment at the moment beyond the letter to The Hartford board filed with the SEC. The Hartford was not immediately available to comment.
Paulson, who is currently the biggest stakeholder in The Hartford, confronted CEO Liam McGee last week during the company’s fourth-quarter earnings call — demanding that McGee split up the company to boost the share price.
And yesterday, Paulson — who made his billions in 2007 when he bet against the subprime housing market — filed a letter to The Hartford’s board. (The entire letter can be viewed on the SEC website. )
‘Create Two Pure Play Insurance Companies’
In the letter, addressed to the board’s chairman and CEO McGee, Paulson says the spin-off would:
• Create two pure play insurance companies – one in life and one in P/C – whose management is focused solely on each companies’ own strategies, distribution channels and capital requirements.
• Enable each of the respective companies to achieve a multiple consistent with its industry, which, for the property casualty business, would mean a multiple of approximately 1.1x book value versus Hartford’s current multiple of 0.4x — the lowest of any major US insurance company.
• Reduce complexity, which limits sell-side coverage and investor interest.
“Given the extremely poor performance of Hartford’s stock and the fact that Hartford trades at lower valuation multiples than any of its US insurance peers, addressing these issues should be Hartford’s highest priority,” Paulson said in the letter.
“That is why we were disappointed that management, on the Feb. 8th earnings call, only addressed the potential ‘challenges’ of a separation. Not only do we believe that you underestimate the potential value that would be created by a spin, the ‘challenges’ you describe are both over-rated and readily manageable.”
If P/C and life were separately traded, Paulson argued, “we believe the two companies would be valued at a combined $32 per share, resulting in immediate share price appreciation of more than 60 percent above the $19.12 price on Feb. 7th before Hartford’s fourth quarter earnings call.”
Paulson: Split Would Reduce Complexity
A tax-free spinoff of 100 percent of P/C would create both pure play P/C and Life companies that would be easier to understand and benchmark against their peers — it would immediately attract P/C investors and P/C analyst coverage, he said.
Currently, he said, P/C analysts shun Hartford due to its complexity, resulting in a lack of research coverage and investor interest. For example, only three of 19 P/C analysts cover Hartford while 18 of the 19 cover Travelers and Chubb and 17 cover ACE, the hedge fund manager said in his letter. And few of the life analysts who cover Hartford understand the P/C side of Hartford, he said. Of the 15 Life analysts who cover Hartford, only three also cover its P/C peers.
“Many of the largest institutional investors in Hartford’s peers are significantly underweight Hartford, which suggests, among other things, the complexity makes the company un-investable, even at the current stock price,” Paulson said.
He added that the most significant challenge to a spinoff that CEO McGee has identified seems to be how to allocate the debt to balance the company’s credit ratings objectives.
But that could be readily addressed, Paulson said in the letter to McGee.”We believe, as do others, that your analysis understates the debt servicing capabilities of Life. If debt were allocated roughly in proportion to equity, approximately 40 percent to P/C and 60 percent to Life, $2.5 billion could be allocated to P/C and the balance of $4.3 billion of debt would be allocated to Life. P/C would have a debt-to-total capital ratio of 28 percent and Life’s ratio would be 24 percent.”
Then, both would be in line with Hartford’s 25 percent ratio today and well within ‘A’ ratings leverage guidelines of 25-35 percent from S&P and 30-40 percent from Moody’s, according to Paulson.
Further, there are numerous other ways to reduce leverage, he said. For instance, there is the $1.6 billion of holding company cash. And a spinoff would likely take 8-to-12 months or more to complete, so debt ratios would be measured off forward financials. Also, the company could consider using the $400 million ear-marked for share buybacks to pay down debt instead.
The Hartford also issued a statement on Tuesday, saying that the company looks forward to “continued dialogue” with Paulson and other shareholders.
“We recognize there are potential benefits to a separation of the P/C and life companies, including those outlined by Paulson & Co. Inc.,” the company stated.
“While there are challenges to successfully executing a separation, we welcome Paulson’s views and look forward to continued dialogue with him and other shareholders. We are evaluating the company’s strategy and business portfolio with the goal of delivering shareholder value. We remain objective and pragmatic about the best ways to achieve this goal.”
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