Stock Review

AMP: Setting up for failure?

10/03/2011

  • Company: AMP (AMP)
  • Recommendation: Sell
  • Price at Review: $5.47
  • Current Price: $5.62
  • Fundamental risk: 3
  • Share price risk: 3.5
  • Category: BLUE CHIP INDUSTRIAL

Do AMP’s ambitions exceed its capabilities? History suggests they may. It's time to get out. Greg Hoffman explains why.

AMP’s acquisition of AXA’s Australian and New Zealand assets is now a done deal, with approval received from shareholders and the Supreme Court of Victoria. The combination will create Australia and New Zealand’s largest ‘non-bank wealth management company’ which will be ‘the market leader in retail superannuation, individual risk insurance and financial advice’.

This all sounds great in theory and the acquisition is truly a ‘company transforming deal’. The question is whether it will transform the fortunes of AMP’s 800,000 shareholders for better or worse. Mark us down as sceptics.

Share on issue to balloon

Firstly, the deal will see AMP’s shares on issue balloon by 33% (plus the company will make almost half a billion dollars in cash payments to AXA shareholders). The final acquisition price is more than double AXA’s GFC-induced low; the comparable off-the-low gain for AMP’s own shares—the currency management is using to pay for the deal—is a lowly 55%.

Two other factors should combine with that rough indicator to set shareholders’ nerves on end. The first is general; extensive studies have repeatedly shown that large takeovers tend to destroy value for the acquiring shareholders. The second reason is specific; AMP’s form in this regard is mediocre. And that’s being kind. 

Key Points

  • Acquiring AXA’s local and NZ assets is indeed ‘transforming’ but not necessarily for the better

  • AMP’s record on corporate deals like this is, being kind, poor

  • There’s no reason to go along with the risks this deal entails

Want to know more?

See AMP: A case study in (the perils of) valuation Part I and Part II.

Since demutualisation, shareholders have suffered from ill-timed or poorly executed acquisitions (such as GIO general insurance) and a bloodbath in the UK life insurance market (something those who remember the Pearl ‘with profits’ fiasco would rather forget). So they have every right to feel unnerved by the current strategy, which involves ‘expanding into adjacent markets and new geographies’.

When it comes to another current priority, ‘renovating the core business’, it’s all been said before, too. Eight years ago shareholders were promised that management would be ‘focusing on our core businesses’ and ‘pursuing operational excellence’.

Table 1 shows the key performance measures as determined by the board over the past seven years. It isn’t a pretty picture, especially when it was painted at a time when there wasn’t the distraction of a major acquisition.

Table 1: AMP board’s five key performance measures

 

2004

2005

2006

2007

2008

2009

2010

Earnings per share (underlying) (cents)

48.0

43.0

46.6

51.2

42.9

38.3

36.7

Return on equity (underlying) (%)

 21.2

25.0

30.3

37.9

38.9

31.6

26.2

Total operating margins ($m)

502

647

752

770

737

701

686

Value of new business ($m)

286

317

348

393

360

319

278

Controllable costs ($m)

833

805

851

894

879

837

884

AMP does enjoy excellent brand awareness and product distribution. In the right hands, the stock could easily be worth more than $6, as we explained in AMP: A case study in (the perils of) Valuation. Currently, though, its ambitions appear to exceed its capabilities. And there’s plenty of scope for things to work out badly.

AMP shareholders could be giving too much of the farm away to AXA shareholders, or maybe the integration process will take longer and prove more costly than expected. The current estimate is that by spending $285m after tax (or more than $400m, assuming a 30% tax rate), $120m per year can be added to the bottom line in three years’ time.

That may occur but history suggests it’s unlikely. These projects tend to take longer, cost more and often don’t save as much as initially expected. For two former mutual organisations, each with the ‘legacy’ systems and issues you might expect from a combined 300 years of history, that’s an even stronger possibility.

AMP’s share price has risen with the market since our update on 19 Aug 10 (Hold—$5.11) but this stock will offer little, if any, downside protection in the next market downturn. If you’re looking to preserve the gains of the past few years—and your analysts most certainly are—this stock isn’t a safe warehouse for your cash.

Recommendation guide

Long Term Buy

Up to $4.00

Hold

Up to $5.00

Sell

Above $5.00

Over the next three years, though, AMP’s share price will also be influenced by whether management has paid a reasonable price for the AXA assets (a hefty takeover premium reduces the odds of that) and its ability to successfully undertake the task of integrating these vast businesses at the budgeted cost whilst delivering the anticipated ‘synergies’.

That’s a difficult enough task for a company with a first-class record in making acquisitions work (such as QBE, for example). AMP doesn’t have that. In fact, it has the reverse; a woeful record in acquisitions. With more attractively-priced, less risky and more defensive stocks on our current buy list, we recommend you now SELL.


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