<font color=red>Merrill Lynch - financial stability is less of an issue.
10:12am EDT 3-Oct-00 Merrill Lynch (E.Spehar (1) 212 449-4245) CNC
CONSECO INC.:Less Risk, but No Earnings Visibility
ML++ML++ML Merrill Lynch Global Securities Research ML++ML++ML
CONSECO INC. (CNC/NYSE)
Less Risk, but No Earnings Visibility
Edward Spehar (1) 212 449-4245
NEUTRAL* Long Term: NEUTRAL
Reason for Report: Company Update
Investment Highlights:
o We remain cautious about the prospects for Conseco, as it is difficult to
assess normalized earnings power.
o However, recent developments suggest that financial stability is less of
an issue.
o We are maintaining our Neutral (3) rating.
Fundamental Highlights:
o Conseco successfully renegotiated its bank credit agreement, averting a
potential liquidity crisis.
o The company has established a detailed plan for meeting both bank and
public debt obligations over the next two years.
o To improve cash flow, the company will slow the growth of the finance
operation.
o The discontinuation of the company's major medical business is not a
surprise given the lack of strategic fit and unacceptable loss ratios.
Price: $7.625
Estimates (Dec) 1999A 2000E 2001E
EPS: $2.12 $0.50 $1.00
P/E: 3.6x 15.3x 7.6x
EPS Change (YoY): -76.4% 100.0%
Consensus EPS: $0.64 $1.03
(First Call: 22-Sep-2000)
Q3 EPS (Sep): $0.83 $0.20
Cash Flow/Share: NA NA NA
Price/Cash Flow: NM NM NM
Dividend Rate: $0.58 $0.15 $0.00
Dividend Yield: 7.6% 2.0% 0.0%
Opinion & Financial Data
Investment Opinion: D-3-3-9
Mkt. Value / Shares Outstanding (mn): $2,501 / 328
Book Value/Share (Jun-2000): $17.60
Price/Book Ratio: 0.4x
ROE 2000E Average: 3.0%
LT Liability % of Capital: 45.3%
Est. 5 Year EPS Growth: 10.0%
Stock Data
52-Week Range: $24.88-$4.50
Symbol / Exchange: CNC / NYSE
Options: Chicago
Institutional Ownership-Spectrum: 38.4%
Brokers Covering (First Call): 6
*Intermediate term opinion last changed on 20-Apr-2000.
For full investment opinion definitions, see footnotes.
"A number of purported class action lawsuits have been filed in federal court
in Indianapolis, Indiana against Conseco and certain other defendants alleging
violations of the federal securities laws in connection with a series of Trust
Originated Preferred Securities (TOPrS) issued in August 1998 by Conseco
Financing Trust V (Trust V), TOPrS issued in October 1998 by Conseco Financing
Trust VI (Trust VI) and TOPrS issued in August 1999 by Conseco Financing Trust
VII (Trust VII). These lawsuits name as defendants Conseco, certain of its
officers and directors, the lead and co-managing underwriters, including
Merrill Lynch, and Trust V, Trust VI and Trust VII, respectively."
More Data Points
Last week we attended a small analyst meeting with Gary Wendt and Tom Hagerty
to discuss the progress of the company's ongoing restructuring effort. We came
away with the following conclusions:
1) Immediate liquidity-related stress has been alleviated. Conseco paid
$650 million of the $1.2 billion in bank debt on September 22, restructuring
the repayment schedule for the balance. A de-leveraging plan has been designed
with the goal of reducing debt to total capitalization to less than 25%
sometime in 2003.
2) Management is evaluating the entire company. The common dividend has
been suspended, the model under which Conseco Finance will operate going
forward has been changed, and businesses that do not have positive fundamentals
will be exited.
3) Earnings visibility still remains unclear. We continue to have a
relatively low level of confidence in our $1.00 earnings per share estimate for
2001.
Matching Sources with Uses
Conseco averted a liquidity crisis by renegotiating the terms of its existing
bank credit facilities. Specifically, in return for additional structure (e.g.
increased borrowing rate, more financial covenants), Conseco has delayed
repayment of approximately $550 million to the banks. The company, however,
has not modified the repayment schedule for its bond indentures, of which
approximately $800 million is due between now and the end of '01. Management
has created three tranches of debt repayment, with the first taking place last
Friday.
In addition to the $650 million payment made last week, Conseco provided $50
million as additional collateral against the directors and officers guarantees
($570 million in loans at 6/30/00). The next step is to provide $800 million
by the end of '00 to pay the banks $100 million, create a reserve fund of $600
million for public debt payments, as well as build a $100 million cushion for
corporate liquidity. Finally, additional assets have been earmarked for '01
sale to provide cash to pay $200 million in public debt and $475 million to the
banks. We view the identification of specific assets favorably, but believe
that a cautious view is appropriate until sales are completed.
Downshifting at Conseco Finance
In an effort to improve the finance company's cash flow, management is adopting
a slower growth strategy (which is something we have always considered
desirable). Specifically, the target is $7.5 billion in retained originations
on an annual basis or less than half the 1999 level of $16.6 billion. The more
modest growth strategy has required downsizing of the organization. Management
has already implemented a headcount reduction (2,000 employees) and closed
branch offices (46) which will reduce annual finance company expenses by $150
million. Although growth will not be the focus as it once was, the goal is to
maintain the company's market position. To this end, Conseco Finance will
utilize the whole-loan market in order to originate above the targeted level of
business retained. Finally, Conseco Finance has historically retained the low-
rated tranches of securitizations because it was not considered economic to
sell these pieces (i.e. coupons above Conseco's borrowing cost). As a result,
during the past two years the company has retained over $1 billion of this
paper, which has added risk to the balance sheet. In the future, these
tranches will be sold.
Exiting Major Medical Business
We have questioned the strategic rationale for Conseco's position in the major
medical business, and therefore were not surprised by the decision to exit the
market. Loss ratios deteriorated dramatically in late 1999 and remain high.
The latest efforts were to move the focus away from the group market toward
individual major medical, however the group market continued to contribute a
meaningful amount of total premium. This business represented 29% of total
health premiums in the 2Q and approximately 6% of total pretax insurance
income.
Earnings Outlook Still Unclear
Despite the incremental information, earnings continue to be a source of
substantial risk, in our view. Therefore, we have limited confidence in our
2001 estimate of $1.00 per share. Perhaps the greatest risk in the core
insurance business relates to the company's financial strength ratings.
Conseco acknowledges some negative impact from ratings downgrades, but suggests
that business activity has bottomed. We are not willing to make this
assumption. It is clear, however, that a sense of urgency surrounds the
initiatives to improve ratings and some components of the newly negotiated bank
agreement depend on a rating upgrade by 3/31/01. For the finance company,
impairment charges have almost completely eliminated earnings for the past two
and a half years, so determining a normalized return on assets is a
challenge. |
