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Tuesday, 3 June 2014

Why you should (not) buy stock in the NN Group NV: my analysis with respect to the IPO of this ‘subsidiary-turning-independent’ of Dutch bank/insurer ING Group NV Pt I

Introduction

Nationale Nederlanden or NN Group – as it will be called after its IPO is currently in the top 3 of largest insurers in The Netherlands. 

It is a Dutch, but internationally oriented insurance company, active in 17 European countries and Japan, which focuses on the target areas: 
  • retirement services; 
  • life insurances; 
  • general indemnity insurances; 
  • investment management; 
  • banking (i.e. mortgages and savings).  

Together with the Dutch banks ‘Postbank’ and ‘NMB Bank’, Nationale Nederlanden formed the corner stone of the Dutch bank/insurer ING Group NV, which was established in 1991.

In 2008, the ING Group was struck very hard by the credit crisis, as a consequence of fierce financial/economic headwinds, reinforced by the circumstance that the bank/insurer had an unweighed capital ratio of only 1.27% at the time. This left no leeway to endure any financial shock at all.

The nearly unprecedented and dangerous leverage was the direct consequence of a radical stock buy-back program, which had been performed by ING Group in the years before 2008 and of which the enormous risks had been overseen by the Dutch national bank DNB

During roughly the same period, the ING branch ‘ING Direct USA’ had hoarded €24 billion in Alt-A (i.e. less than prime quality) loans, due to US regulations, which forced the bank/insurer to invest savings and deposits from Americans within their domestic market. 

These so-called Alt-A Residential Mortgage Backed Securities (RMBS) became utterly illiquid (i.e. impossible to sell) overnight, after the implosion of the market for non-prime (‘prime’ as in ‘most reliable’) securitized mortgage loans; this implosion was both cause for and effect of Lehman Brothers’ demise in 2008.

These nearly fatal side-effects of the credit crisis forced the Dutch state to hand out a €10 bln emergency loan to ING Group, in combination with the takeover of this very package of €24 bln in Alt-A loans from ING Direct USA. 

Although the European Commission recognized the need for the Dutch State to keep ING Group NV afloat (as it was ‘too big to fail’), the bank/insurer was nevertheless punished fiercely for this state support. 

ING was not allowed to: 
  • perform strategic acquisitions and mergers;
  • hand out favourable interest rates at savers and borrowers
  • aim at price-leadership within the domestic market
All these measures would remain in place until the Dutch government loan had been paid back in full, with - on top of it - a penalty of about 60% of the initial state aid.

Besides these measures, the EC ordered a split up within the company. The consequences of this split-up were that (a.o.) the bank parts (ING Bank) had to be separated from the insurance parts (Nationale-Nederlanden) and that overseas parts of the company had to be sold to third parties. The forthcoming IPO of NN Group in 2014 is the direct result of these EC measures.

Although you could justifiably call this initial stock offering of NN Group a ‘shotgun IPO’, the insurance company itself is very mature and experienced, financially healthy and it has already been quite independent during the last five years.

During the past few years ING Group NV and (now) NN Group have been involved in the full split-up process of both companies, which included the split up of the group management, the (joint) human resources, the whole consolidated bookkeeping within the group and especially the vast (joint) ICT and accountancy infrastructure. Today, this long and complicated process is (nearly) finished. In my opinion, there is nothing anymore which could stop the self-dependancing of NN Group.

For the near future, I see one considerable risk for this soon independent insurance company: the 'Woekerpolis’ (i.e. Usurious Profit Policies) affair which still lingers on in The Netherlands.

This affair  handling about insurance policies, which charged such high expenses to the owners, that it was nearly impossible to achieve the goals for which the insurance policy had been deployed – has sent shockwaves through the Dutch Insurance industry during the last decade. Even today, the affair is still far from being ‘a wrap’.

Hence, there is a considerable risk that new damage claims will emerge during the next decade. Even a kind of class action by harmed customers could take place in the coming years, which could hit the NN Group full on the chin.

Nevertheless, in my opinion there is no reason to believe that NN Group is much more involved in this Woekerpolis affair than other insurance companies in The Netherlands, other than for its sheer size and large number of clients. 

In my opinion, this affair is a substantial, but nevertheless containable risk.


Balance sheet (2013) of NN Group
Data courtesy of : NN Group / ING Group NV
Click to enlarge
The first thing that strikes one about the 2013 balance sheet of NN Group, is the strongly decreased size of it (-/- €195 billion between 2012 and 2013).

At the Asset side of the balance sheet, this unwinding is (a.o.) caused by the sale of ING USA (-/- €78 bln) and the strongly reduced exposure to Sovereign bonds ( -/- €6 bln), Corporate bonds (-/- €37 bln) and Financial Institution bonds (-/- €5 bln), as well as the nearly nullified exposure to RMBS (-/- €11 bln) and the nullification of the assets held for sale (-/- €60 bln).  

The enclosure of the Japanese operation (life insurances) within the NN Group added €16 billion to the financial assets.

At the Liabilities side of the balance sheet, the strong reduction in equity (-/- €12 bln), the strongly dimished number of insurance and investment contracts (-/- €112 bln) and the diminished number of liabilities held for sale (-/- €55 bln) all stand out.

It becomes clear from this balance sheet and the accompanying explanation that the company has abolished a lot of its past assets and that it is only half the size today, in comparison with 2012. 

In my opinion, there is a limited chance for strong autonomous, risk-free growth in the near future. 

Both the company and its current holding ING Group seem to have learned their lessons from the past developments at the sovereign (Greece) and corporate bond markets, as well as the market for Residential Mortgage Backed Securities and they have strongly diminished their exposure to these investments.

The company has, however, good chances for autonomous growth in the still small East-European markets, Greece and Turkey. Especially in the latter, the average amount of income spent on insurances is still very, very small (see the paragraph Operational Environment), which leaves room for improvement of which NN Group could profit.

The markets in the Western European countries are more mature, however, and in 2014 the spendings per capita on insurances are probably back at the level of 2011, which was almost equal to the pre-crisis level [unfortunately, the data coming from the OECD on insurances per capita, which I used for my statistics, is not more recent than 2011 - EL]This diminishes the chances for substantial autonomous growth in these West-European countries and Japan.

All in all, NN Group has a healthy leverage of about 10% currently and I expect that this will remain about the same in years to come. 

At this very moment, ING has already sold a package of €150 mln in stock and €1.125 bln in subordinated bonds to three Asian investors (see the following press release), The latter are sold with the purpose of future conversion to common NN Group stock.

In the forthcoming IPO, NN Group’s intentions are to deploy 25% of the existing shares in possession of ING Group, as the first of four / five packages. Their aim is to receive approximately €2 billion for this first package. This would bring the intended value for NN Group to €8 billion + the €1.275 billion, which have already been sold in shares (€150 mln) and subordinated, convertible bonds (€1.125 bln).

Profits and Losses overview (2013) of NN Group
Data courtesy of : NN Group / ING Group NV
Click to enlarge
When we look at the profits and losses table, we notice that NN Group made hardly any profit in 2013. Besides that, the company only paid dividend in 2013, while skipping dividend in 2012 and 2011.

In the Beursonline.nl article behind the last mentioned link, you can read (using Google Translate) that the NN Group stock is intended to be a dividend stock and not a growth stock. 

If this is indeed true, the chances for higher future profits and larger dividend payments in the future will remain reduced.

In that case, a P/E ratio of 1: 7 – 11 (based upon the past profits in 2012 and 2011) is quite high, in my opinion, taking into account that the future success of the stock depends on the stable payment of dividends in the future.

With virtually no profit made in 2013, the latter does not look to good, especially when we take into consideration that the ‘Woekerpolis affair’ could still lead to future damage claims and (consequently) losses.

Cash Flow overview (2013) of NN Group
Data courtesy of : NN Group / ING Group NV
Click to enlarge
Worrisome in this year's cash flow position of NN Group is the substantial negative cash flow of €8 billion, coming from the operational activities in 2013.

At the other hand, the investment activities have yielded a positive cash flow of €8 billion in 2013, probably due to the very favourable circumstances at the international stock exchanges. 

However, this is also a risk: when the circumstances at the stock exchanges deteriorate (for instance due to the coming end of QE III, this would definitely have a negative influence on the investment results of NN Group)

Corporate Strategy (Mission, Strategy and Market Developments )

ING Mission:

To set the standard in helping our customers manage their financial future. ING aims to deliver financial products and services in the way our customers want them: with exemplary service, convenience and at competitive prices.

ING's strategy: 
ING Group's strategic priorities up to 2013 have been: strenghening our financial position, restructuring, repaying the remaining state aid and building both stronger and sustainable banking and insurance / investment management businesses (IM)

NN Group's focus is on service to customers, generating capital, growing profitability and improving efficiency. Its strategy is about offering appealing and easy to understand products and services, multi-access distribution and efficient and effective operations in the 18 countries in which it is active.

The aforementioned mission and strategy of ING and NN Group are sound, but not very ambitious for the future. Consequently, this seems not to be a stock that you put in your portfolio, in order to “hit ‘em and quit ‘em”. As stated before, the success of this stock for your 'buy and hold strategy' depends on the steady payments of dividends in the future.

In my opinion, this remains a bit of a longshot: investors get seldomly rich from financial stocks and I guess that the NN Group stock will not be an exception, based upon the intended yields of €8 billion, coming from this IPO and future stock sales between now and the end of 2016.

Agreement with European Commission:

In November, ING and the Dutch State reached an agreement with the European Commission on a revised timeline for the divestment of the European and Japanese businesses. Under this revised agreement, it was announced that Japan Life would be included in the base case IPO.

As such, the timeline to divest more than 50% of Japan Life has effectively been extended by two years to year-end 2015. This is the agreed timeline to divest more than 50% of ING's European insurance and investment management businesses. Also as part of the revised EC agreement, ING will accelerate the time to complete the 100% divestment of its insurance and investment management activities in Europe and Japan by two years, to year-end 2016.

If I understand this agreement right, this statement confirms the agreement that NN Group will a. become the majority owner of Japan Life before the end of 2015 and b. become fully independent from ING Group before the end of 2016.

Operational Environment

As I stated earlier, the chances for strong autonomous growth of NN Group in the near future are generally limited, although some of their operational markets offer better chances than others:

Expenditure per capita on insurances
in the countries where NN Group is active
Data courtesy of : the OECD database
Click to enlarge

The percentage of the net income spent on insurances
in the countries where NN Group is active
Data courtesy of : the OECD database
Click to enlarge
  • The markets in especially Turkey, Greece and the former Eastern Block countries offer good chances for solid growth, after the credit crisis has finished. The spendings on insurances, as well as the average percentage of net income spent on insurances are both quite low in these countries.
  • In 2011 (unfortunately, there was no more recent data available), the spendings on insurances in the Western European countries and Japan had almost returned to pre-crisis levels. However, it was in 2011 that the euro-crisis seriously kicked in in the western European countries. In my opinion, this must have had influence on the general spendings on insurances in these countries. 
    Nevertheless, as today the Euro-crisis seems almost finished in the Western European countries, I guess that the average spendings on insurances are back at 2011 levels in these countries. This will mean that there is little room for extra growth in these mature countries, as an average spending of 15% of net income on insurances seems about the maximum percentage 
    achievable.

In practice, this will probably mean that the chances for general growth in especially the Western European countries will be dim. Market share must be gained at the expense of competitive insurance companies. This will put pressure on prices and yields.


A sound strategy for NN Group would be to increase its visibility in the Eastern European countries, Greece and Turkey, as the biggest chances for autonomous growth are there.

Tomorrow, the second part of this analysis will be printed

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