Hedge-fund manager John Paulson’s newest pet project is splitting Hartford Financial (HIG) into separate property-and-casualty and life insurance companies. But the idea could face tough going because of cash-flow issues in the life-insurance business, according to Bernstein Research’s Suneet Kamath.
Of particular interest is how debtholders are likely to react — something that’s gotten less attention than what Paulson has argued is the huge store of shareholder value that’s unlockable by a split, Kamath says:
One clear challenge relates to the fact that the life businesses at HIG are unlikely to pay dividends to HIG’s parent company in 2012 due to capital strain from hedging programs, weak earnings from Group Benefits and the impact of low interest rates, among other issues. While management has indicated the business could dividend “several hundred million” in 2013, we argue this is likely predicated on an improving macro environment, which is not a foregone conclusion. As such, we would argue that holders of debt that would be allocated to the life business would understandably want to see some level of sustainable free cash flow generation from HIG Life before agreeing to take on this exposure. While market commentary in support of a separation has largely focused on the potentialupside for equity holders, which may be significant, we do not feel there has been enough attention placed on the downside protection for the firm’s debt holders, which we feel will be an important consideration for management and the company’s board.