Two Insurance Stocks vs. Tangible Book Value

By Dave Zaegel - May 30, 2012 | Tickers: AIG, HUM, UAM | 0 Comments

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By simple definition, Tangible Book Value ("TBV") is calculated as Total Assets minus Total Liabilities minus Intangible Assets and Goodwill.  This calculation essentially shows what the company would be worth if the business ceased to exist and its net assets were sold at their book value.  Calculating a TBV per share is important because it provides a frame of reference to compare against the stock's price.  In theory, a company's share price should never be lower than its TBV per share because the company could be liquidated and you would have more per share than the current price.  Such a dynamic would only exist if the company's operations were expected to cause a decrease in TBV in the near-term.  Said differently, if a stock trades at its Tangible Book Value, the market is placing zero value on its ability to produce future earnings.

Let's look at two insurance companies to see how they compare to their Tangible Book Value: AIG and Universal American.

AIG (NYSE: AIG)

AIG is obviously the better known of these two entities and has a market cap of $52 billion.  Unfortunately for AIG, it became synonymous with the market meltdown back in 2008 when the US Treasury stepped-in to keep AIG solvent.  This continues to haunt AIG's share price as the US Treasury has begun selling shares, with the May offering priced at $30.50.  This selling, along with the market's general struggles in May, has driven the price down to $29.

Using their most recent quarterly report and updating the share count to be current, I calculate AIG's TBV as follows:

The two items subtracted from net assets are Deferred Tax Assets and Deferred Policy Acquisition Costs.  These assets would have no value in a liquidation scenario because they are accounting items that have value only to a continuing organization.  You can see that the TBV per share of $44.56 is clearly higher than AIG's current share price of $29. 

AIG produced roughly break-even cash-flow from operations for the most recent quarter.  Also, they had positive income from investments that was only offset by repurchases of stock, mostly from the Treasury.  Given that AIG has stabalized its business activities, it seems that AIG's share price has a sufficient valuation cushion to offset any future effects from US Treasury sales.

Universal American  (NYSE: UAM)

Universal American focuses mainly on Medicare Advantage insurance.  They have survived CMS sanctions and are now operating and growing profitably.  However, it seems that the perception of the company has yet to rebound from the CMS sanctions that were lifted last fall.  For Universal American, TBV is calculated as follows: 

Universal American currently sells for $10.  By contrast to AIG, Universal American does NOT trade at a discount to tangible book value, but does trade at a discount to its book value per share of $12.47.  This shows than UAM may be cheap because it trades below book value per share, but not so absurdly cheap because it does not trade below tangible book value.

To validate a cheap valuation, we need to look at some other metrics.  For example, Universal American has a forward P/E of 13.  However, that's nothing special when you consider that a competitor such as Humana (NYSE: HUM) has a forward P/E of 8.9.  What I prefer to focus on right now is the company's buy-out potential.  There have been numerous acquisitions in the Medicare Advantage space with the most notible purchases being Cigna (CI) buying HealthSpring and Humana buying Arcadian.  Even if Universal American were only able to fetch $7,500 per Medicare Advantage member (certainly possible given what HealthSpring and Arcadian sold for), they would sell for over $1 billion or $12.24 per share, making it very undervalued from a buy-out perspective.

From a more qualitative perspective, the market also underappreciates the opportunities that Universal American is developing from its acquistion of APS Healthcare.  This acquisition will allow them to better address the Dual Eligible population, meaning those that are eligible for both Medicare and Medicaid.  The opportunity in addressing this population stems from Medicare being a federal program and Medicare being a state program.  Both government agencies provide reimbursement for the expenses they cover seperately.  The opportunity for Universal American lies in being able to receive reimbursement from both programs and coordinating care for that patient who is dual eligible.  This provides a higher margin for UAM and likely a better experience and health outcome for the member.

Conclusion

Both AIG and Universal American are inexpensive stocks that can be held long-term.  For AIG, it's a simple matter of trading below liquidation value /  Tangible Book Value.  For UAM, the Book Value calculation still shows that it may be relatively cheap, but the acquisition price and opportunities for dual eligible members provide additional value that the market is currently ignoring.

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