Genworth MI upcoming quarterly report

There is a strong possibility that Genworth MI (TSX: MIC) will make some sort of announcement this month, specifically with respect to what they are going to be doing with their excess capital.

A chart of MIC shows that it has gone nowhere over the past month, but this has been since quite a run-up since last August when it traded all the way down to about $16/share.

mic

At the beginning of January 2013, MIC had about 210% of the minimum capital test that is required and the company has an internal target of 190%, which means that they had about $287 million in excess capital available. This does not include the additional capital that has accumulated in the first quarter of 2013.

Having this extra capital (noting that $337.87 million was in very low-yielding cash and short-term equivalents at the end of 2012) is lowering the return on equity, reducing portfolio yield and is producing a drag on performance. The cash can be safely returned into the hands of investors.

There are four options available, noting that it is unlikely that acquisition is a possibility given the very narrowly-defined scope of the industry the company is in:

1. Buy back shares: Likely through a dutch auction tender and at a higher level than existing market value. They have done this two times in the past.

On July 15, 2010, they announced a $325 million buyback between $24 to $28/share and on August 24, 2010 they announced that $26.40 would be the tender price. The stock closed on July 15, 2010 at $23.07/share and the day after it opened trading at $24.25. The market price on August 24, 2010 was $25.79/share. Genworth Financial proportionately tendered its shares to keep its 57.5% ownership stake in MIC.

On May 5, 2011, they announced a $160 million buyback between $26 to $29/share. The market value was $25.25 on the day of the announcement, and the stock opened at $25.55 the day after. On June 27, 2011, they announced that $26 was the price and the closing market value that day was at $25.77/share. Notably after this buyback, the market value fell in the subsequent months.

Given the current market value of the company, if they were to proceed with a similar tender, it would be almost on similar terms as the previous one, with perhaps a tender range between $26 to $29/share. This would be close to book value and this would achieve about a 10% reduction in share count and subsequent 11% increase in earnings per share.

2. Give a special dividend: A special dividend of $287 million would be equivalent to a $2.90/share dividend. The only special dividend declared to date was announced on November 3, 2011 of a $0.50 dividend, payable on December 1, 2011.

3. Some combination of the two;

4. No decision, keep the cash, and wait for less stormy days later.

Influential in this decision will be the needs of the parent company, Genworth (NYSE: GNW), whom is looking much more financially stable than it was back in 2010 and has no pressing need for an infusion of capital either way.

My guess at present is that Genworth MI will launch a tender for its own shares this month. They are still trading under my own estimate of its fair value.

As readers are aware, I have been long on Genworth MI since last July.

Bitcoins

Bitcoins have been making some media headlines as of late because their chart recently went exponential:

Bitcoin

I wrote about Bitcoins quite some time ago and my analysis today is still the same – ultimately a currency is only as good as the confidence that people have in it, and digital currency has a drawback of counterfeit-style currencies (e.g. why not take the open source of Bitcoin and then create your own new type of virtual currency?). Again, Bitcoin has the first-mover advantage, but who wants to subscribe to using Bitcoins when essentially the scheme has a pyramid scheme style element where the initial players in the market have a huge economic edge on those that start on it today?

My suggestion for those that are genuinely scared of their purchasing power of their money is to invest it in something that will continually be in demand. Whether this is in equities, gold, guns, or fine scotch is another matter – each of the four categories goes through its periods of high and low price variations.

Divested Rosetta Stone

My quarterly report will come out sometime after the end of March, but I have divested myself out of my position in Rosetta Stone (NYSE: RST). My average in was around 8.50, while my average out was around 13.40. I had written about them in the past on this site, albeit not in any comprehensive detail. I’ll give a little bit of my research here.

The reason for this sale is because although at current valuations the company appears to be cheap (2012 revenues at $273 million, cash at $148 million, no real debt, decent free-cash flow, diluted market cap of $316 million), and operationally they seem to be successfully executing their original plan which was to reduce the sales and marketing “bite” per dollar of revenue, my perception is that their revenue generation ability in absolute dollars-and-cents has flat-lined and that their initial attempts to get costs down are successful, they will be running up against incrementally more difficult decisions with respect to getting the expense side of their ledger under control.

For example, examine this chart (S&M = Sales and Marketing, R&D = Research and Development, G&A = General and Administrative):

  Total Revs Bookings S&M S&M / Revs R&D G&A
31-Mar-09  $ 50,284  $        –  $   23,612 47.0%  $     4,843  $      9,887
30-Jun-09  $ 56,460  $        –  $   27,147 48.1%  $   10,101  $     23,167
30-Sep-09  $ 67,216  $        –  $   32,263 48.0%  $     6,125  $     11,914
31-Dec-09  $ 78,311  $        –  $   31,876 40.7%  $     5,170  $     12,207
 2009:  $252,271  $ 114,898 45.5%  $   26,239  $     57,175
31-Mar-10  $ 63,014  $ 60,768  $   28,361 45.0%  $     5,470  $     13,643
30-Jun-10  $ 60,648  $ 64,033  $   29,441 48.5%  $     6,100  $     12,416
30-Sep-10  $ 60,926  $ 73,305  $   34,093 56.0%  $     6,030  $     12,048
31-Dec-10  $ 74,280  $ 81,814  $   38,984 52.5%  $     5,837  $     14,548
 2010:  $258,868  $279,920  $ 130,879 50.6%  $   23,437  $     52,655
31-Mar-11  $ 56,978  $ 55,580  $   37,820 66.4%  $     6,484  $     14,808
30-Jun-11  $ 66,743  $ 66,711  $   40,535 60.7%  $     6,354  $     13,809
30-Sep-11  $ 64,202  $ 66,062  $   39,821 62.0%  $     4,991  $     14,115
31-Dec-11  $ 80,526  $ 84,834  $   43,316 53.8%  $     6,389  $     19,300
 2011:  $268,449  $273,187  $ 161,492 60.2%  $   24,218  $     62,032
31-Mar-12  $ 69,449  $ 65,267  $   38,404 55.3%  $     6,273  $     13,657
30-Jun-12  $ 60,812  $ 63,043  $   35,125 57.8%  $     6,493  $     12,919
30-Sep-12  $ 64,279  $ 72,125  $   37,113 57.7%  $     5,177  $     14,474
31-Dec-12  $ 78,701  $ 84,327  $   41,005 52.1%  $     5,510  $     14,211
 2012:  $273,241  $284,762  $ 151,647 55.5%  $   23,453  $     55,261

Management has expressed its intentions of having revenues grow to about $400 million in the year 2015 and “low double digit EBITDA margin”. If they can actually achieve this (which would represent about 14% revenue growth compounded over the three years) then yes, they are grossly undervalued.

I just don’t think they will realize this. In particular, they have already trimmed a good portion of the “empty calorie revenues”, as they like to call it, and indeed they have: in 2011 they spent 60.2% of revenues in sales and marketing, while in 2012 they spent 55.5%, so they have made fairly good progress in this. They should be able to get this down to somewhere close to 50% before they run into real difficulty. In their seasonally-low (with respect to their sales and marketing to revenue ratio) 4th quarter, this went to 52.1%.

Assuming no revenue growth and roughly equivalent profitability, if they did manage to find another 5% in cost savings, leaves the company with an extra $13.66 million pre-tax and applying a 30% tax rate, a $9.56 million post-tax increase to the bottom line in relation to their 2012 results. Pro-forma, applied to their 2012 results (which you have to adjust to account for their tax accounting decisions) would leave a $7.8 million pre-tax profit, or about $5.5 million after-tax, or about 25 cents per share.

Management has done a good job to this point getting the company in a position where they can actually make profits again. I just don’t think they will be able to get to the point where they can generate huge profits because they are locked into a very discretionary part of the software market and other factors.

Another positive is because they are shifting from traditional to subscription-based software, they have the benefit of racking up plenty of deferred revenues on the balance sheet, which translates into cash on the asset side (and the deferred revenues get converted into revenues as subscriptions continue). In this respect, they have done a masterful job of piling on cash from 2011 to 2012, with about $32 million extra packed onto the balance sheet.

Management does scare me when it openly talks about wanting to make strategic acquisitions and anybody in the software industry will tell you that integration of software is a pain in the rear end operationally. It takes a lot longer than top level executives usually appreciate.

This is a type of company that really should be private, but because they have already gone through the private-then-public route, I doubt there is much appetite within their insiders to go through the whole transformation again. Any strategic acquirer would be a consumer-oriented software provider.

Management has performed well under the circumstances. Valuations (especially the $168 million enterprise value) still look relatively cheap. I have just unsubscribed from my original investment reason that the company will be able to generate excessive profits through further cost cutting. It looks like the market has already priced most of this in with the 2014 analyst estimates of 28 cents per share.

I could be wrong with my rather flat revenue projections for RST, but whoever bought the shares from me will be their risk and reward if they believe in the growth story.

Cyprus and another wall of worry

Remember the phrase “fiscal cliff”? Whatever happened to that?

My answer to anybody that asks is that we already fell off of it, so there’s no more cliff anymore.

The financial press is always trying to find the next crisis and today’s is the calamity hitting the EU regarding Cyprus’ confiscation of people’s savings accounts.

I wonder if you had an active line of credit whether they’d pare that back, but I digress.

The point of this post is that there will always be some new crisis in the news and the question of the investor is whether these are relevant to decision-making with more localized securities.

While I believe the fiscal situation of the US government is quite frightening in the medium and long-term, in the short term, if it is out of sight, it is out of mind. Until it comes back in sight again – that time is impossible to tell.

In the meantime, we continue to get this:

spx

A quick read of George Soros’ theory of reflexivity applies in this case – the broad market will keep going up until it stops going up. I know this sounds like very lame analysis, but sadly in the market context, it is the only real explanation of what is going on (in addition to all of the financial asset inflation being promoted by most of the world’s central banks).

There is very little to mention in terms of trading on my side other than that due to the release of a quarterly report, I have started to pare one of my positions. The quarterly report itself was roughly in expectations, but my fair value adjustment has been downgraded to what the market value is currently. If the share price goes higher my position will be exited and I will subsequently report this. I am not looking to redeploy the proceeds because of the existing margin position.

Ideally, market valuations will rise to the point where the decision to deleverage will be somewhat easier to make. My present degree of uncomfort is actually quite good in this respect – usually the markets work such that easy decisions are punished.