Saturday, February 28, 2015

(No.283) "Manulife, due diligence & core earnings"

"Manulife's approach to due diligence and core earnings"

by Alastair Rickard

After the announcement in the second half of 2014 of Manulife's purchase of Standard Life of Edinburgh's Montreal-headquartered Canadian subsidiary (the oldest life operation in Canada dating from 1833) I commented, inter alia, that at $4 billion Manu was overpaying once again, as it had done in 2003 buying John Hancock in Boston.

I also referred to the disinclination Manu has demonstrated over the years to conducting adequate due diligence involving such investments of its funds. I cited the example of Hancock's heavily promoted and sold but woefully under-priced book of Long Term Care business.

Now at hand is the official closing of the Manu deal to buy Standard's Canadian business. Given my comments last Sept. I was most interested to read the comments post- deal closing by Marianne Harrison, general manager of Manu's Canadian operation.  They were in a Globe and Mail Report on Business piece, typical of its tradition of articles giving disproportionate coverage to Manulife and its activities in comparison with other large Canadian life insurance companies like Great-West and Sun Life (ROB Feb.3,2015).

Ms Harrison declared that "one of Manulife's first orders of business will be looking at the collection of wealth and insurance products both companies sell to make sure they are priced consistently and not competing with each other."

As a former executive who had a good seat from which to observe other Canadian life insurance company acquisitions ( especially Mutual Life's purchase of the Canadian operations of Pru of England and Met Life) I would have thought that prudent due diligence by Manulife would have covered these and other such matters involving Standard before the deal closed.

Apparently not. Ms Harrison now says that "we want to get in there and really understand those [Standard] products and the pricing behind these products [sic] and be able to put those on our shelves as well. ... I think we have a lot of work ahead of us in terms of achieving our synergies we're committed to in the Canadian division. And I don't think it's a slam dunk."

Given Manu's record in terms of careful due diligence before the fact, I don't think it's "a slam dunk" either. Far from it. Three cents a Manu share for each of the next three years predicted to arise from the Standard acquisition by Manu may well turn out to be a pipe dream even allowing for the industry reality of any life company's ability to 'adjust' its results by playing with numbers and related assumptions.

The financial media have long tended to be too uncritically accepting of Manulife's spin on its own results. An excellent example of this is Manu's continuing effort to have media focus not on its actual corporate results but rather on what are termed its "core earnings".

These, the ROB explains by parroting the Manulife spin, "separate Manulife's underlying business from the direct impact of interest rates and unsteady equity markets as well as some other material and one-time items [emphasis added]."(ROB Feb.13,2015). To paraphrase Thomas Carlyle it is an attempt to wrap reality in the gossamer gauze provided by corporate public relations.

When your 4th quarter net profit year over year falls from $1.3 billion to $640 million as Manu's has, it is easy to understand why its senior management is fond of a "core earnings" focus. In terms of meaningful analysis "core earnings" so defined have all the utility and staying power of farts in a hurricane.

Think of it this way using a sports analogy: the NHL coach who wants sports writers to emphasize even strength goals while ignoring goals his team gave up while they were playing short-handed.

As I have argued on several occasions in these columns one of the problems with much of the 'expert' analysis and reporting of life insurance companies and the industry itself arises from a lack of understanding of the realities of the business, including a failure to really understand the fundamental importance to a company's financial results of its mix and quality of new and inforce individual insurance business of product design, pricing and effective distribution.

Active retail life insurance companies are in the business of selling stuff -- and stuff that carries profitable margins. However, like the common cold incomplete analysis of the life insurance industry which fails to understand its realities will be around for the long haul.

[For a lengthy commentary on Manulife, Standard Life and the deal see "Manulife buys Standard Life's Canadian operation: some comments about obsequious insincerity and other matters", a RickardsRead column (No. 273) posted on Sept.30, 2014]




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