Paulson To Hartford Financial – Spin Or Else?

Listening to (or reading) company conference calls are a necessary but often painful part of investing. Calls are usually filled with a bunch of numbers, some CEO speak and suck-up analysts (if the company is doing well) so anything out of the ordinary or even somewhat controversial becomes noteworthy. Throw in ‘legendary’ fund manager John Paulson and now you have a real recipe for buzz.

In case you missed it – Mr. Paulson unexpectedly hopped onto Hartford Financial Services Group’s (HIG) Q4 call last week during the Q&A and went after the CEO. Paulson just happens to be the company’s largest shareholder, owning ~9% of the shares, and was likely disappointed with the company’s (or really the stock’s) dismal performance. So…he decided to let CEO Liam McGee know just how he felt (it’s not Eisman-esque, but still enjoyable):

Operator: Your next question comes from the line of Lawrence Farley with Paulson & Company.

John Alfred Paulson: Good morning. This is John Paulson speaking.

Liam E. McGee: Hello, John.

John Alfred Paulson: Liam, I want to go back to the slide 17 talking about the potential separating the Life and P&C business. And the – I know you’re doing a strategic review but there’s no slide talking what about what the potential would be, just that there’s challenges. Goldman Sachs came out with, I think, a very good analysis a few months ago where they showed this – they estimate the upside to doing a tax free spin-off of P&C could be over 70% of what the current stock price is trading at. Now, I agree that there’s going be challenges but isn’t your job to really overcome those challenges to achieve the maximum value for shareholders? Now, I would say that Hartford needs to do something drastic because the stock is the lowest valuation relative to book value of any major insurance company. Last year Hartford stock was down 38% while the P&C stocks were up 14% and even declined much more than the Life index which was down 21%. So what I’d like to see you do is not merely come back and say yes, we’re looking at strategic options but there’s challenges to achieving them but what – first of all, do you agree that you could create as much as 70% value for your shareholders by spinning off – separating P&C? And secondly, is  (52:10) incentive to overcome the challenges that it’s going to take to spin this off and how long do we have to wait to hear if there’s going be a positive recommendation to separate these two businesses?

Liam E. McGee: Thanks John for the question. First of all, the analysis and the intent of the comments was to acknowledge that the challenges are significant, not to say that they could not beovercome. Second of all, our analysis, including the frictional costs, if you will, that are in that third category would suggest that a split would not create the kind of shareholder value that that particularreport suggested. And third, in addition I think your sense of urgency about realizing greater value for shareholders is shared by me and by this team. And so I hope I answered your questions distinctly and directly…

John Alfred Paulson: Partially, Liam, but if you share the interest all shareholders have in increasing shareholder value I’m surprised that as part of the discussion you don’t talk about how much value could be created by separating the P&C business from the Life business. And not the only slide you devote to it talking about that there’s some obstacles to overcome and not talking about the upside in weighing the upside of the separation against what the obstacles are.

Liam E. McGee: John…

John Alfred Paulson: And better yet, not just listing those obstacles but what I’d like to see is how you will overcome those obstacles to result in a more fair valuation for Hartford. Not that there’sobstacles but how you’re going to overcome those obstacles. That’s what I as a shareholder look for you as the management to do.

Liam E. McGee: Thank you, John. And I – that is our mindset. Our purpose in the slide was to identify the hurdles. You can – if you heard our language we did not say they were not surmountable, number one. We said there were significant costs to surmount them in a number of areas, so we felt we owed shareholders that disclosure. Number two, we do not believe that splitting them in the current environment for the reasons that we cited will create shareholder value. And third, again I’ll reiterate, we have an incredible sense of urgency on looking at all ideas to create shareholder value.

John Alfred Paulson: Well, I think you need to do a much better job of explaining that because Goldman’s report is a very good report on a path to separate the business and create what theyestimate as a 70% increase in shareholder value. And then you merely say there’s some obstacles and you don’t equate what the costs are to the benefit and what value do you think could be created. Because right now with the stock performing as poorly as it has relative to both P&C and life companies, I think you need a better explanation of what you’re going to do to enhance shareholder value. Merely that you’re working hard and you’re committed but there’s obstacles. What we need you to do is overcome the obstacles to enhance the valuation for your shareholders. Not merely point out that there’s obstacles.

Liam E. McGee: Okay, John. Thank you. I hear you loud and clear.

John Alfred Paulson: I hope so.

You know, a part of me really questions the sincerity of Mr. McGee’s ‘Thank You’ at the end. While a fun read, the reason of mentioning it on this blog is obviously the potential spinoff of the life insurance business from the company’s P&C insurance. The inclusion of the infamous ‘slide 17’ in its earning presentation shows the company was already feeling some pressure to spin. Some of the obstacles to a spin mentioned include maintaining competitive credit ratings for both companies, obtaining regulatory approval, a potential writeoff of tax assets and a few other items.

The drama didn’t end there though and earlier this week, Paulson took his spinoff demands one step further by formally filing a 13D with the SEC outlining the case for a breakup of the company. In the letter, Paulson & Co states that a spinoff is by far the best choice for the company to maximize shareholder value and that the move could increase value by as much as 60% alone. No small potatoes. According to Paulson, a 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

The filing then goes on to detail those claims and also highlights the fact that many other large insurance companies such as Travelers (TRV) previously separated these businesses. The section on ‘complexity’ and sell side coverage issue is also interesting and the filing notes that “only 3 of 19 P&C analysts cover Hartford” and that only three of the 15 life-insurance analysts that cover Hartford also follow P&C companies. The fund isn’t too impressed by the supposed obstacles to a breakup and believes that those challenges “are both over-rated and readily manageable.”

While Goldman and other sell side shops may also agree that the company should make a move (I haven’t seen those reports), apparently not everyone is convinced. The stock recorded a nice pop after the conference call and again after the filing of the 13D (that should make Mr. Paulson happy) so it seems that the market supports the move. While the outcome remains to be seen, I am sure the CEO is really feeling the heat. ‘Unlocking’ that much value is certainly enticing to investors and tough to argue against. We will keep you updated as this story progresses.

Disclosure: Author holds no position in any stock mentioned.