With the ongoing pandemic, the workplace is changing as more and more people are now working from home (WFH). This trend, however, is set to continue even after everything comes back to normal as several companies such as Facebook and Google want WFH to be more than just a temporary experiment. WFH is not only going to change the workplace but also cities. It is expected that many people are going to move from cities, where rent has been skyrocketing in recent decades. These people moving moving to the suburbs or to rural regions will need to buy a house taking advantage of record low mortgage rates. Taking a mortgage for most people requires Mortgage Insurance.
There are 8 main providers of Mortgage insurance (MI) in the US, two government agencies, the Federal Housing Administration (FHA) and the Veteran Affairs (VA) and six Private Mortgage Insurers (PMI). The largest of these PMIs is Genworth Financials $GNW.
Genworth Financial has three main business segments: US Life Insurance, US Mortgage Insurance, and Australia Mortgage Insurance. In 2019, the total revenues of Genworth was $8.0 billion with US Life insurance contributing to 80% of them. US MI and Australia MI accounted for 12% and 4% of revenues respectively. However, most of the profits of the company comes from US MI.
US PMI business is now again profitable after undergoing a severed depression, following the 2008-2009 housing bubble crash, and they are slowly taking market share away from the government agencies. Genworth is set to profit from that as the company is currently generating more free cash flow per year than current market cap. But there is a catch.
China Oceanwide, a Chinese insurance company, entered into an agreement to acquire Genworth for $2.7 billion in cash or $5.43 per share in October 2016. It has been nearly four years since this deal has been finalized but it did not go through yet as the Trade War between the US and China and the inability of China Oceanwide to raise capital for the acquisition has complicated things. Nevertheless, both parties are still confident that the deal will go through and they set the date for September 30th 2020. Right now, the shares of Genworth are $3.46, representing a 56.9% spread from the acquisition price. Therefore, we can also look at Genworth as a special situation investment and a merger arbitrage opportunity. The possibility of Genworth Mortgage Insurance spinoff is something that the management is thinking of is the deal doesn’t go through. Since the PMI business is much more profitable than the Life insurance business, it could be a good idea.
Right now, we need to look at two scenarios: The deal going through and the deal not going through. If the deal goes through, then it is a good investment. If the deal with China Oceanwide fails, it is likely that the stock price of Genworth Financial will fall. Then, it will be a real bargain as a pure value play. Right now, the stock price is capped at $5.43, which is well below its book value per share of $28.94. If the deal doesn’t go through, we’re likely to see a higher stock price if the PMI business keeps generating cash flow. The company may even buy back shares and pay a dividend. If the company chooses to have a spinoff for the PMI business, it might be more attractive for investors long-term as the Life Insurance Business will always be a drag on growth.
Genworth is not the best of the PMIs but it is certainly the cheapest and there is a real growth opportunity in the PMI industry. My advice is to be cautious. Investing today can potentially lead to a 50% profit in less than a month but at the same time, if the deal doesn’t go through, we may find ourselves with an even higher return on investment. The margin of safety in this investment is more on timing than on price.
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