Capital Crisis For AMP

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Selling its life business was critical to rebuilding AMP and, with the RBNZ finding fault with the Resolution Life deal, the company's problems are compounded.

-First half dividend scrapped and capital now seen constrained
-A significant reduction in valuation expected if the deal is resurrected
-Significant changes required to stabilise cost base and rebuild advice
 

By Eva Brocklehurst

Wealth manager AMP ((AMP)) is between the devil and the deep blue sea, as the sale of its life business to Resolution Life is now highly unlikely to proceed. This has led to the scrapping of the company's first half dividend.

The Reserve Bank of New Zealand has signalled the current terms of the sale agreement are unlikely to be approved which implies, while AMP is trying to find a way to make the transaction work, revised terms are likely to be worse. So, in the end, the life business may be retained.

Selling the life business was critical to rebuilding the company and Morgan Stanley notes three critical issues needed to be resolved to stabilise the platform. Clients must be recompensed for inappropriate advice and fees charged over the last 10 years, planner productivity issues must be addressed and separation of the life business must be successfully executed.

To salvage a sale, new terms need to be renegotiated, likely on less favourable terms for AMP. Morgan Stanley notes industry data reveals the Australian disability income market has deteriorated significantly over the past year and downgrades the company's FY20/21 life earnings by over -50%.

Any future deal is likely to be affected by valuation assumptions after changes to the Protecting Your Super legislation. Bell Potter suggests Resolution Life has been delivered a "get out of jail free card" as the valuation of the life business has significantly deteriorated in the year since the deal was announced.

The main impact that AMP has flagged is a deterioration in value of -$700m, comprised of a deterioration in best estimate assumptions of -$400m and the requirements of Protecting Your Super legislation of -$300m. This is coupled with the -$100m, Bell Potter points out, that AMP has spent separating its life and mature businesses.

Shaw and Partners believes it reasonable to conclude that the life business is on track to earn very little profit in 2019, just as it did in 2018. If the sale is rekindled on terms that are likely to be at least -$700m inferior then the cash return to AMP on sale may be less than zero, reflecting the loss in value. The broker, not one of the seven monitored daily on the database, has a $1.50 target and a Sell rating.

No Interim Dividend/Capital Constrained

Ord Minnett always believed the original deal was poor value for AMP shareholders, even taking into account expected legislative changes and claims deterioration. So, while winding back the sale may be positive for shareholders and earnings, it would leave the company constrained on capital and in need of investment.

Retention of the life business would require substantial investment in technology and, while the company may avoid a capital raising by scrapping its dividend, the outlook has not improved. Other brokers suggest meaningful changes in provisions may result in the need for an equity raising. For now, Bell Potter includes a further $250m provision in the accounts.

Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, believes confidence in the forward estimates for AMP is significantly diminished by the lack of information, which it hopes will become clearer when the company reports on August 8. Following the asset write-downs the broker reduces the target to $1.45 and retains a Sell rating.

Citi agrees there is little transparency on the earnings impact of the collapse of the sale, also noting the company's statement that cumulative earnings/losses of the businesses for sale are "not substantial". The broker also questions whether the removal of any interim dividend provides sufficient capital to meet the company's target surplus.

Citi had presumed AMP would use most of the sale proceeds to fund the transition of its advice model, which require substantial capital over time. AMP has, therefore, been left with a stark choice of either delaying the implementation of its strategy or coming to the market to raise capital.  Macquarie expects AMP to increase its advice remediation provisions, which could be the catalyst for such a capital raising.

Revised Deal Or No Deal

AMP may be in discussions in an attempt to resurrect some kind of deal but Citi strongly suspects a significant reduction in the previously proposed $3.3bn purchase price is likely. Resolution Life also appears to be the only bidder, seemingly putting it in a strong negotiating position.

Should revised terms be agreed, Macquarie would also expect a material reduction in the previously agreed consideration. Assessing legislative changes and reduced assumptions, combined with a higher capital cost of ring-fencing assets in New Zealand, the broker calculates consideration closer to $2bn. This would negate any potential capital return that had been flagged following completion of the sale.

In terms of the option to retain the life business, managing it in run-off would entail significant management distraction and UBS agrees that this could curtail the company's strategic agenda. The broker believes weighing up whether AMP is better off retaining life, rather than exploring revised terms with Resolution Life, should be balanced against delaying the transformation in the wealth business.

UBS asserts it will take one-two years to restore stability of AMP and the numerous risks and challenges cannot be quantified. Morgan Stanley agrees the company needs to stabilise the cost base and rebuild its advice proposition, while quantum of change required is significant, simply to maintain the status quo.

FNArena's database shows five Hold ratings and two Sell. The consensus target is $1.97, signalling 8.3% upside to the last share price. This compares with $2.10 ahead of the announcement. Targets range from $1.50 (Morgan Stanley) to $2.35 (Credit Suisse, yet to comment on the update). The dividend yield on 2019 forecasts is 3.0% and for 2020 forecasts, 7.5%.

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