NWLI
sells a broad portfolio of individual whole life, universal life and term
insurance plans, and annuities. In May 2011, I began buying NWLI around $160
per share which was around 47% of the then current book value. The stock was
fairly stagnant and I continued buying as it fell to $150, building a modest
position. For reasons I discuss below I decided to sell in early 2012 at $136
for a 15% loss. Meanwhile, over this short period, the business continued its
slow and steady performance. This post is to reflect on my reasoning, and
hopefully learn from the situation. Which decision (to buy or sell) was a
mistake? My opinion obviously is the purchase, but only time will tell.
The
Abridged Bull Thesis
Preliminary
notes:
·
The stock is a split class, with the Class B
(200,000 outstanding) electing two thirds of the board with the Class A (3,434,766 outstanding) electing the remainder. On a per
share basis, Class B effectively has half the interest in earnings as Class A.
Robert Moody Sr, the Chairman and CEO, owns 99% of
the Class B and 34% of the Class A shares. In the rest of the post, I refer
only to Class A shares.
·
An interesting bit of history about the Moody
Family can be found in this book. Be sure
to visit their pyramids
if you’re in Galveston.
The
bull thesis for NWLI is quite compelling. The business is boring, has been in
business since 1956, and is not covered by the sell-side (plusses in my book). NWLI’s
performance over the last decade has been steady:
·
typically earning around 6-8% on equity
·
book value and statutory capital have grown 9%
and 8.5% compounded annually
At
the time I began purchasing NWLI (May 2011) it was selling for around 47% of
book value and 66% of statutory capital and surplus (statutory accounting
principles are meant to present financials conservatively – almost on a
liquidation basis – whereas US GAAP book value presents things on a
going concern basis). This is as opposed to the 12 year historic average 68%
and 95% respectively.
The
company’s assets are apparently managed conservatively with most of the
insurance float invested in high quality bonds to match liabilities (see latest
SEC filings for details of their asset mix/quality). Because the company seeks
to match assets and liabilities, interest rate risk is reduced, however the
company remains exposed to rapid (‘80s-esque) increases in interest rates – a
scenario that could result in policy surrenders (as policyholders seek higher
returns elsewhere, before crediting rates are increased) requiring the sale of
fixed-income positions that have fallen in value (so called “disintermediation”
risk). The company manages this risk with life and annuity policy features
discouraging surrender (e.g., market value adjustments and surrender charges).
Their fixed-index annuity products (by far their biggest annuity product) are
hedged with OTC options (exposing them to counterparty
non-performance risk managed partly by diversification and collateral
arrangements).
So
far so good, the company:
·
is consistently profitable and significantly
cash flow positive
·
conservatively manages its assets
·
has no long-term debt
·
is selling at a huge discount to book value
My
Actions
My
actions with respect to this stock were amateurish at best. I purchased NWLI in
May – Aug 2011, at prices between $150-160 – which I was very excited about. I
held my shares for a short period, selling in Feb 2012 at $136.
My
change in opinion centered on corporate governance and concerns about
management. Below is the list of items that I grew too uncomfortable with in
aggregate to continue holding shares. To varying degrees, I was aware of these
items prior to investing, however at the time I was not overly concerned. I
think the reason for this was the large discount to book and statutory figures
combined with consistent reported profitability.
1.
Poor capital allocation
o
NWLI trades at an incredibly low price in
relation to every conceivable valuation metric. So it’s hard to imagine a
better use of capital for this company than to repurchase a reasonable amount
of its own shares – even if it had to forego writing marginally profitable
business in the short term to free up capital.
o
Management has paid lip service to this idea,
however has not acted and seems content not to regardless of how large the
discount (i.e., attractiveness) becomes.
o
Management’s arguments against this course of
action (balance sheet strength) are insufficient in my opinion. To me it seems
like management is focused on empire building and other self-serving activities.
But size does not equate to adequate shareholder returns.
2.
Incestuous board with questionable
qualifications
o
4 immediate Moody Family members and 1 in-law
on the board
o
Compensated between 70k-115k
o
Multiple have backgrounds that do not appear
particularly relevant to the insurance business (e.g., trustee/staff of the
Moody Foundation, or manager of the retirement homes owned by the company)
3.
Conflicts of interest and related-party
transactions
o
Mr. Moody is also the Chairman and CEO of ANAT.
ANAT and NWLI sell similar life and annuity products and therefore compete.
Which company gets the best ideas and attention?
o
The list of related party transactions is not
short, and includes payments of $3.6m, $2.9, $2.7m, $2.3m, and $1.4m and
receipts of $1.5m, $1.3m, $1.3m, $1.2m, and $0 for the last 5 years; it is not
clear to me that these recurring transactions are being executed at arms-length
terms
4.
Highly questionable auditor independence
o
KPMG (either Dallas or Austin office) has
audited NWLI 16 of the last 19 years (couldn’t find data prior to this); 2011
audit fees of $692k; a 3 year interlude with Deloitte
o
ANAT is also audited by KPMG; 2011 audit fees
of $3.2m and tax fees of $936k
o
The Moody Foundation controlled by Mr. Moody is
also audited by KPMG; fees not disclosed
In
short, I am not on the same page with management on a variety of levels, most
importantly with respect to attitudes towards shareholders and economic
objectives. To me it seems management places its interest ahead of shareholders,
and favors size over returns on capital. Further, neither the board nor the
auditors seem capable of questioning management on behalf of shareholders. And
although the company has no long-term debt, it is still a highly leveraged
financial institution with an opaque balance sheet. To remain a shareholder of
such a company, I would need to strongly believe in the skills and integrity of
management, and be in tune with their economic philosophy. I could not
confidently make these assertions. So I sold at $136 for a 15% loss, believing
that the market has appropriately discounted their assets.
