Genworth (NYSE:GNW) is a mortgage and long-term care insurance company. I have traded in and out of this stock over the past several years as it has been volatile and offered investors many buying and selling opportunities. This company has a prosperous mortgage insurance business, but the long-term care division has been challenging, and there have been some charges taken in order to boost reserves. In October, Genworth's shares were trading for around $5.20, but then a buyout offer was announced by China Oceanwide (OTC:HHRBF) for $5.43 per share in cash. Self-made multi-billionaire Lu Zhiqiang is the chairman of China Oceanwide, and he has made investments in financial and insurance stocks in the past. His net worth is estimated to be $4.7 billion, which is significantly more than Genworth's total market capitalization of just around $2 billion.
I believe many investors are asking themselves why did Genworth's shares drop after getting a buyout offer since a takeover deal would normally send a stock soaring. I think there are a number of reasons for this. I don't think there is anything wrong with this deal as long as it gets regulatory approval. China Oceanwide and its chairman seem to be well financed and savvy buyers of financial assets. I think the announcement of the deal at $5.43 per share "capped" the potential upside for investors, and that was a disappointment for many shareholders. After all, if Genworth was trading at $5.20 per share just before the deal, then it makes sense to sell the stock because the most you might get is another 23 cents or just around 4% upside, and that is only if you patiently wait for months and if the deal goes through. The lack of a real takeover premium also created a situation whereby it made sense for short sellers to step into this stock and that created selling pressure as well.
Most takeover deals offer a significant premium and yet still trade for a discount to the deal price just in case the deal fails to go through. However, in this case, there was really no premium and therefore the market price of Genworth's stock was quickly adjusted downward in order to provide a typical discount in the event a deal does not go through. Here is an example of another deal which has some similarities. In October 2015, Walgreens Boots Alliance (NASDAQ:WBA) announced a deal to buy Rite Aid (NYSE:RAD) for $9 per share. When that news came out, Rite Aid's shares dropped about 8% to just around $7.97 even though the buyout price was significantly higher. Clearly, some investors believed there could be some antitrust or other regulatory issues with this deal and therefore wanted some type of "risk-premium" or discount to be built into the shares in the event the deal was not approved. Now that deal approval appears to be more likely, Rite Aid's shares are trading at about $8.40 per share. I believe the deal to buy Genworth has a strong chance of going through, and that when updates are announced and regulatory hurdles are cleared, the current discount (to the buyout price of $5.43 per share) of about 35% in Genworth shares will shrink.
If the deal goes through, then Genworth's shares could rise by about 35%, but I also believe that if the deal falls through, the shares will rise as well. That is because investors will again have more potential upside if they buy Genworth's shares. Right now, tax loss selling and some uncertainty as to whether the deal will go though are holding the stock back. Here is how I see it. If the deal goes through, that will bring about the certainty of shareholders receiving $5.43 per share in cash, and if the deal collapses, it will create the certainty of knowing Genworth can benefit from rising rates and the stock no longer has a cap on it.
I recently started buying Genworth shares again because at just $4 per share, I see a "win-win" situation for shareholders. If the deal goes through, I will see gains of about 35%, and if it does not go through, I could see even bigger gains especially in the long run, as Genworth appears to have probably better options to create shareholder value. For example, the rising interest rate environment has sent many financial stocks soaring recently, but this deal seems to have capped it for Genworth. Since the election, other mortgage insurance stocks like Radian Group (NYSE:RDN) have surged about 50%, and MGIC's (NYSE:MTG) shares are up about 30%. Based on recent statements from the Federal Reserve, many analysts now believe we could see four rate hikes in 2017 and 3.5% yields on 10-Year Treasury bonds. That rate environment would be hugely beneficial for Genworth, and yet none of this appears to be priced in as it has been left out of the major rally in financial stocks due to the deal capping the upside at $5.43 per share.
Besides the fact that the end of tax loss selling could help push Genworth's shares higher, here are a couple of other positives to consider. Genworth Australia (GMA.AX) and Genworth Canada (MIC.TO) are trading near 52-week highs right now. These are very valuable and liquid assets, and Genworth owns stakes of about 50% in each of these publicly-traded companies. Genworth Australia has a current market cap of about $1.62 billion, and Genworth Canada has a market cap of $3.14 billion. That means Genworth's stakes in these companies are valued at about $2.4 billion, which is actually more than the current market cap of the company itself, which is about $2 billion. That shows a lot of potential value that could eventually be unlocked, especially if GNW succeeds in turning the long-term care division into the consistently profitable business that it once was. Genworth has been asking for and receiving major policy premium increases, and that, combined with mortality rates, should get this division back on track.
According to an RBC Capital Markets analyst, Genworth is a "Trump stock" as it should benefit from lower corporate taxes and rising rates. When searching for "Trump" stocks, the analyst looked for companies with a low price-to-earnings multiple, a domestic orientation, superior operating leverage, high corporate taxes, and greater volatility. The list of "Trump" stocks has 40 small- and mid-cap stocks in it. According to shortsqueeze.com, there are nearly 15 million shares short, and with an average trading volume of about 5 million shares traded daily, this represents about three days worth of trading volume. This is not enough to cause a short squeeze, but it could add to the potential buying pressure in early 2017, as tax loss selling ends and as investors look for solid value in the New Year.
I think Genworth could get more for its shareholders without the deal, but let's assume it goes through, in which case, shareholders get $5.43 per share in cash. This would be a gain of roughly 35%. That is too large of a discount, especially for a stock that could be better off if the deal is not completed. Because of this and the other positive factors surrounding this stock, like rising rates and the potential for significant corporate tax cuts and deregulation by a Trump Administration, I believe the discount to the deal offer of $5.43 per share will narrow significantly. I think the combination of these factors along with the end of tax loss selling and some short covering will push Genworth's shares back above $4.50 in January, which offers investors a potential gain of about 10% in just a short time, and yet, even at about $4.50, still would offer additional upside of more than 20%, if the buyout deal goes through.
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