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Morningstar | An Acceleration in Net Cash Outflows and Business Restructure Lead to a Reduction in AMP’s FVE

Alarming levels of cash outflows from its wealth management business in the third quarter 2019, along with the sale of its Australian and New Zealand wealth protection and mature closed life insurance business for a bargain, have prompted a reduction in our fair value estimate for narrow-moat AMP. The sale results in a major restructure of AMP, leading to lower underlying earnings and dividends. This results in a reduction in our fair value estimate to AUD 2.85 from AUD 3.40 per share. Our fair value estimate assumes that about AUD 1 billion of proceeds from the sale will be used to buy back AMP shares, on the expectation that its surplus capital needs will be reduced following the sale. However, AMP did not provide firm guidance on what it proposed to do with the proceeds. The ultimate use of these proceeds will likely depend on the Royal Commission’s final report, potential future client remediation and damages claims, and the incoming CEO’s strategy, leading to a continued high uncertainty rating. At our fair value estimate, the stock has a 2018 dividend yield of 6.3%.

The third-quarter 2018 net cash outflows were higher than we expected, which is tangible evidence of the damage inflicted by the Royal Commission. Net cash outflows of AUD 1.485 billion in the third quarter represent an acceleration from net cash outflows of AUD 873 million in first-half 2018. This compares with net cash outflows of AUD 243 million in third-quarter 2017 and cash inflows of AUD 1.023 billion in first-half 2017. We also think its life businesses are being sold on the cheap, given that the price is equivalent to 82% of the embedded value of the sold businesses and considering the negative impact to earnings in its wealth management business. On a positive note, the sale will significantly simplify AMP’s business model and materially reduce its regulatory capital requirements. It will also give incoming CEO Francesco De Ferrari more balance sheet capacity to turn the group around.

AMP is selling its Australian and New Zealand wealth protection and mature businesses to global insurer Resolution Life in a complicated deal for total cash and noncash gross proceeds of AUD 3.45 billion. This transaction is subject to regulatory approvals. Net proceeds following the repayment of the insurance business' debt, separation costs, and other capital costs total AUD 2.17 billion. The sale of AMP's wealth protection business will leave it with a wealth management business in New Zealand generating operating earnings after tax of about AUD 40 million, which it plans to spin off via an initial public offering in 2019. As part of the sale, AMP has entered into a reinsurance agreement with Swiss Re over its New Zealand wealth protection business that will release AUD 150 million of regulatory capital.

We think a reflection of the level of integration in its business model is the negative impact the sale of its insurance businesses will have on its wealth management business and group costs. The sale will unwind distribution arrangements and reduce the product offering in its wealth management business, resulting in a reduction in operating earnings in this business by AUD 80 million-AUD 90 million per year. Group costs that were previously absorbed by the insurance businesses being sold (that is, stranded costs) are also expected to total AUD 40 million per year. However, AMP Capital will continue to manage the wealth protection and mature assets, and it will be placed on Resolution Life’s global panel of preferred asset managers. AMP will also retain its interest in China Life Pension Company.

The consideration for sale includes AUD 1.9 billion cash, AUD 300 million worth of preference shares in the businesses being sold, an economic interest in the future earnings of the mature business worth AUD 600 million on a capitalised basis, and an equity interest of AUD 515 million in Resolution Life. While AMP expects to eventually monetise its noncash consideration, in the meantime the preference shares, interest in mature business, and equity interest in Resolution are expected to generate AUD 110 million in investment income per year. AMP also expects interest expense savings on lower corporate debt to amount to AUD 35 million per year.