The GE Spin-Off You Never Heard Of

Genworth is a leading insurer, but its numbers are too low. Will investors bite?

It has a big-name parent in General Electric (GE ) and more than 10 times the earnings of Google, yet few are clamoring to get a piece of Genworth Financial Inc. when it goes public. In fact, the expected spin-off of 30% of GE's life and mortgage insurance business, now set for early in the week of May 24, may qualify as both one of the largest and quietest stock deals of the year. The $9.8 billion operation, which has more than 15 million customers and $100 billion in assets, could raise about $3.34 billion in the market.

The Connecticut conglomerate plans to start promoting Genworth in a series of print and broadcast ads next month boasting that it's "built on GE heritage." But if that heritage is so strong, potential investors may wonder why it's being kicked out of the GE family. With interest rates rising and CEO Jeffrey R. Immelt promising to sell off another big chunk of GE's Genworth stake within the next three years, they may also worry about the health of their investment.

Yet GE's reason for unloading the bulk of its insurance business has less to do with the quality of its offspring than with its own financial needs. For one, Immelt wants to improve the transparency of GE's own debt structure. More important, he aims to cut back on the capital GE has invested in slower-growth segments and put the money to work in more sprightly businesses instead. While Genworth is a hot property as far as insurers go -- with $935 million in net profits for 2003, it's a leading player in several key sectors -- that performance simply isn't good enough for GE.

Indeed, because of the need for hefty reserves to back up policies, insurance tends to offer a lower return on equity than other financial businesses. So Immelt wants to free up the capital locked in the somewhat staid unit. As Immelt has said, "it's going to give us, as we go through 2004 and 2005, even more firepower to spend on growing the company." The bulk of GE's financial-services business will now be in faster-growth segments such as commercial and consumer finance. Both generate double-digit returns, well above Genworth's. Annuities and term life clearly don't light up Immelt's eyes the way that, say, wind power and medical technology do.

Moreover, Genworth eats up a large proportion of the so-called parent-supported debt that GE carries on its own books. That reflects the guarantees that GE provides for its financial businesses, which allows them to issue debt at AAA ratings. To give investors a clearer picture of where the capital is actually used, GE has pledged by the end of next year to eliminate that support, which now stands at less than $8 billion. In its place, GE is beefing up the equity in the financial businesses instead.

The strategy of shifting focus to higher-growth industries is not without challenges. As Standard & Poor's (MHP ) equity analyst Robert Friedman notes, it's fine to seek higher returns, but "in doing so, they're also going higher out on the risk curve."

MORTGAGE WORRIES. Investors may wonder if Genworth itself is too big a risk. As a major player in term life policies, long-term care protection, and mortgage insurance, it's clearly affected by rising interest rates. Certainly, the market for mortgage insurance -- which makes up almost 40% of Genworth's earnings -- could turn down once the home-buying binge starts to ebb. And rising rates could mean more defaults. But analysts such as Suneet Kamath of Sanford C. Bernstein & Co. (AC ) argue that higher interest rates may help life insurers because low rates have made it tough for them to earn strong enough returns on their invested premiums.

Much will depend on Genworth's ability to forge an identity and woo an investment community independent of its powerful parent. Shareholders may worry that its shares could get hurt when GE reduces its stake further, but analysts say that eventuality is already reflected in the price range of $21 to $23 a share. CEO-designate Michael D. Fraizer, the current chief of GE Insurance, Financial, will also be able to focus on building the company and tapping new markets, without worrying about where Genworth fits in the larger GE puzzle. But first he has to stage a debut in a tough climate.

By Diane Brady in New York

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