Merger And Share Repurchase To Boost Efficiency But Facing Diminishing Margins And Legal Risks

Key Takeaways

• Merger with Assured Guaranty Inc. aims for capital efficiency and operating improvements, indicating potential for future cost savings and operational effectiveness.
  
• Strong new business generation in various sectors and a favorable ruling in the PREPA case highlight growth potential and improved future earnings.
  
• Dependence on favorable legal outcomes, market volatility, inefficient capital use, sectoral growth challenges, and merger integration risks could impact earnings and shareholder value.

Catalysts

Provides credit protection products to public finance, infrastructure, and structured finance markets in the United States and internationally.

• The merger completed between Assured Guaranty Municipal and Assured Guaranty Inc. aims to achieve more efficient utilization of combined capital and increase operating efficiencies, impacting future earnings through potential cost savings and enhanced operational effectiveness.
  
• The expanded pool of capital and claims-paying resources from the merger is intended to support each insurance company's policies more robustly and enhance diversification, potentially impacting future revenue by enabling larger or additional new business opportunities.
  
• Assured Guaranty's strong new business production in diverse areas (U.S. public finance, international infrastructure, and global structured finance) underscores its growth potential, expected to directly influence future revenue and earnings positively.
  
• The $500 million share repurchase program with a target for the year and additional authorizations signals strong capital management and shareholder returns, aiming to positively impact earnings per share (EPS) by reducing the number of outstanding shares.
  
• The favorable ruling in the Puerto Rico Electric Power Authority (PREPA) restructuring case could lead to improved recovery outcomes for Assured Guaranty, potentially impacting future earnings positively by resolving one of its non-paying exposure issues.

Assumptions

• Analysts are assuming Assured Guaranty's revenue will grow by 2.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 85.6% today to 21.6% in 3 years time.
• Analysts expect earnings to reach $191.6 million (and earnings per share of $7.25) by about September 2027, down from $714.0 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 23.8x on those 2027 earnings, up from 5.7x today. This future PE is greater than the current PE for the US Insurance industry at 13.8x.
• Analysts expect the number of shares outstanding to decline by 10.17% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.28%, as per the Simply Wall St company report.

Risks

• The reliance on favorable legal outcomes, as seen in the PREPA case, introduces risk associated with potential legal reversals or less favorable outcomes than anticipated, impacting potential loss reserves and earnings.
  
• Economic, geopolitical, and financial market volatility, as mentioned, poses risks to investment valuations and could lead to increased claims or reduced value of investments, impacting net margins and earnings.
  
• The company's significant amount of excess capital, while advantageous for share repurchase programs, may dilute return on equity (ROE) if not efficiently deployed, affecting overall shareholder value.
  
• Challenges in growth sectors like healthcare, where increased costs and pressure from COVID-19 are mentioned, could lead to higher loss expenses or reduced profitability in these lines, impacting revenue and net margins.
  
• Operational and integration risks associated with the merger of Assured Guaranty Municipal and Assured Guaranty Inc., including achieving the anticipated capital and operational efficiencies, could impact operational costs and net margins if projected benefits do not materialize as expected.

Valuation

• The analysts have a consensus price target of $99.75 for Assured Guaranty based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $113.0, and the most bearish reporting a price target of just $84.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $885.1 million, earnings will come to $191.6 million, and it would be trading on a PE ratio of 23.8x, assuming you use a discount rate of 6.3%.
• Given the current share price of $77.93, the analyst's price target of $99.75 is 21.9% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.