2023-12-23 05:07:05 ET
Summary
- Vericity, a life insurer targeting middle-income Americans, will merge with iA American Holdings in the first half of 2024.
- Shareholders will receive $11.43 per share in cash if the merger closes as expected.
- Investors must weigh the opportunity cost of holding their shares until the merger, against potential alternative investments.
Thesis
In the next six months, life insurer Vericity, Inc. (VERY) will merge and become part of a larger entity. Shareholders need to determine whether it is worthwhile waiting for the closing or to sell now (or sooner). By my calculations, many will come out slightly ahead by holding and waiting for the closing.
About Vericity
This life insurance company differentiates itself in part by targeting middle-income Americans, which it characterizes as domestic households with annual incomes ranging between $50,000 and $125,000.
According to the third-quarter 2023 10-Q , it operates through two subsidiaries, Fidelity Life, an insurance carrier, and eFinancial, a call center-based agency. The latter sells Fidelity life products, as well as the policies of unaffiliated carriers.
The current iteration of Vericity was created in 2019, when it went through a demutualization and became publicly traded. At the time of the IPO, the stock was valued at $10.00.
Merger
On October 3, 2023, the company announced that it would merge with iA American Holdings, Inc., a subsidiary of the Canadian insurer, iA Financial Corporation ( IAG:CA ). The parent company traditionally has been known as Industrial Alliance, hence the iA name.
A press release announcing the merger reported that the all-cash deal was worth $170 million and was expected to close sometime in the first half of 2024. The transaction had been approved by a majority of shareholders and the board of Vericity.
Assuming the merger closes as expected, each share will be converted into $11.43 in cash; the closing price on Thursday, December 21 was $11.14. When closure occurs, Vericity will be delisted and deregistered.
iA noted in the 10-Q that closing conditions included a waiting period as dictated by legislation, receipt of regulatory approvals, and compliance by Vericity to its covenants.
The company going forward will be iA American, which is no surprise given the difference in size. The parent iA company has a market cap of $9.05 billion, while Vericity has a cap of $165.86 million.
Vericity financials
This consolidated returns income statement from the 10-Q indicates why Vericity might have wanted or needed the merger:
Getting more granular, Vericity had total revenues of $175 million on a TTM basis, up from $163.9 million in 2022 and down from $176.6 million in 2021.
Total operating expenses were $190.6 million, leaving a $15.6 million TTM loss in operating income. That compares to losses of $22.6 million in 2022, $17.0 million in 2021
EPS is similarly disappointing, with a TTM diluted EIPS of minus $1.03 (basic EPS was -$1.02). And, EPS has been negative for the previous four years, ranging from $1.68 in 2020 to $1.30 in 2019.
There is little on the financial side that would attract investors.
Operations
Vericity's distinguishing strategy is to target what it calls the middle American market. In its 10-K for 2022 , the company wrote,
"We strive to deliver to this market affordable, easy to understand term and whole life insurance products through a consumer-friendly and efficient sales process. Through innovation in product design and distribution that provides access to the Middle Market, including call center and web-enabled sales and underwriting processes, quick issuance of policies and an emphasis on products not medically underwritten at the time of sale, we believe we are well positioned to make life insurance more affordable and accessible to the Middle Market."
Note that the tactics involved in this strategy are, or can be, inherently contradictory. That is, the company aims to provide affordable products, while 'emphasizing' products that are not medically underwritten. The point is that non-medically underwritten insureds are likely to die sooner, thus generating fewer premiums before death occurs. In the long-run, that makes policies less affordable.
While I'm not sure if that is strictly the case at Vericity, I see in its Q3-2023 income statement that net insurance premiums were $23.43 million, while claim benefits totaled $22.58 million. Claims gobbled up more than 96% of the net premiums.
Many firms with low-price strategies do well; high-profile operators such as Walmart Inc. ( WMT ) and Costco Wholesale Corporation ( COST ) have become legends. But what they have accomplished, and Vericity has not, is to build volume. Thin margins require high volumes.
Vericity's total premium and annuity revenues were $100.6 million in 2019-on a TTM basis, they were $101.8 million. Statistically, that's a meaningless difference after nearly four years. Even more concerning, though, is that premium and annuity revenues rose to $113 million in 2020 and $114.3 million in 2021 before slumping to $104.5 million in 2022.
Essentially, the company is losing volume, rather than gaining it, and some sort of change is needed. Selling to a company with greater resources and perhaps management expertise is one, and perhaps the only, feasible solution.
Valuation
Normally, the challenge is to determine what might be a fair value for a stock. In this case, that's not an issue because we know that there is a high probability stockholders will receive $11.43 a share sometime in the first half of 2024.
That's assuming the deal goes through, which I expect it will. Vericity is a relatively small company in a huge, fragmented industry, so this merger will not affect competition or industry stability. There are other wildcard possibilities, including Vericity not meeting its covenants, but none that seem likely to block the deal.
Since we know what price stockholders will receive in the next six months and the current price, this becomes an arbitrage case. If the merger closes in January, then investors may wish to hold to pick up an extra 30 or 40 cents. On the other hand, if the merger doesn't close until the end of June, then investors may be better off selling now.
For the longer term, there could be an opportunity cost for holding. Staying for X months ties up funds that could be invested elsewhere, for greater returns (in principle, at least).
To some extent, this will involve the size of each individual's holding. If you own a hundred shares, then your upside for holding is only $30 or $40. For 1,000 shares, the upside is $300 to $400.
Working on the basis of 1,000 shares and three months until closing, we can quantify that opportunity cost or its opposite.
Hold until closing:
- 1,000 shares @ $11.14 = $11,140.00
- Hold shares until closing @ $11.43 = $11,430.00
- Gain = $290.00
Sell now:
- Receive $11,140.00 in cash (transaction costs not included)
- Buy shares yielding a 7.00% annual return
- $11,140.00 x 7% = $779.80 / 4 = $194.95 for three months
On 1,000 shares and three months, investors would be $95.05 better off by holding than by selling now, assuming they invest in a conservative alternative. But, having bought into a micro-cap, perhaps you're looking for something more aggressive. In that case, your risk/reward profile would shift, and the calculations might favor selling rather than holding.
Conclusion
In Vericity's somewhat unique case, the future price of shares is known, while the time until that price is realized is unknown.
Each investor must develop their own opportunity assessment, one that reflects the number of shares he or she owns and when they expect the merger to close.
For the example shown above, the best strategy would be to hold, but given the modest amounts involved, some investors will logically reach other conclusions.
For further details see:
Shareholders Face Decision: Hold Or Sell Vericity Stock Ahead Of Merger