 Good day, fellow investors. Brighthouse Financial is David Einhorn's second portfolio position. It's trading at a price-to-book value of 0.37 and at a forward price earnings ratio of just five. That implies a 20% earnings yield in the future. That's extremely cheap and in this video we are going to discuss why it is cheap, whether it is a value trap or it's really a bargain. The market seems to disagree with Einhorn and let's see who will be right or what is the risk reward to put it in a better perspective. The company is a recent spin-off from MetLife. As you can see the spin-off was made somewhere at around 70 but since then since last year the stock has drifted to the current price of around 40. So a big big loss 40% loss there. Einhorn opened his position at around 57 so he's also significantly down on this one. What are we going to talk about? We're going to give an overview of the company, a discussion on risk, the spin-off, the current situation and the outlook. Then we're going just to shortly touch on behavioral finance, Claremont's take on profits from his book Margin of Safety, how that translates into analysts estimations at the beginning of the spin-off when the stock was starting to trade and now as the stock price has drifted lower Einhorn's bullish thesis and the market's bearish thesis and then we're going to discuss it, conclude and I'm going to give you my opinion on it and whether I'm buying this stock or not. Brighthouse Financial is a large insurance business with a well-established retail platform. They sell mostly life insurance. The best way to explain the company is just to quote the CEO. We are a domestic only life and annuity company. That's it. And I can tell you out of the marketplace that has really resonated with advisors. As a matter of fact, I've been pleasantly surprised as to how much that has resonated with them. Eric, am I getting a pure play on long-term interest rates with you? Is that why I should stay in the stock? It's certainly a play on interest rates. I would say it's more a play on equities. That's the key. What do you mean? We need equity markets to rise generally. Our base case scenario has equity markets rising. If equity markets slow down a little bit, that puts some pressure on us. So if you take a look under the hood in this 600-page form pen document that we have on, you'll see that we're really leveraged to the equity market. We make money if interest rates rise, but mostly if equities go up. We need equity markets to rise. That's the key. So this is a bet on rising equity markets. Nevertheless, Brighthouse is one of the largest US life insurance companies, as we said. The assets mostly variable annuities, fixed and index linked annuities, runoffs and life. They sell annuities with guaranteed minimum withdrawal benefits, guaranteed minimum debt benefits, guaranteed minimum accumulation benefits. So a lot of guarantees that they are selling incorporated into those annuities products. Operating revenues 55% from annuities, 14% life, runoff and corporate another 5%. 9 billion operating revenues for 2016. And there is a huge fee income from selling those annuities. If you look at their insurance ratios, those look fine. The risk-based capital looks good, and the leverage looks manageable. Their risk management framework, they have hedged exposure to down markets. They have total asset adequacy for the variable annuities. And they are well diversified, high quality investment portfolio for the general account credit risk. So they hedge their exposure to down markets with their products that give universal life guarantees with secondary guarantees, ULSG, universal life insurance with secondary guarantees. So those are the secondary guarantees that they hedge for. And that's a nice risk that we'll discuss in a second. These are the ratios. There is a new framework coming in for now. They are protected there where they don't have enough funding. They are hedged, so they think they are protected in that way. They hope to reach funding level at peak 2026 from their variable annuity block. Those hedges mitigate the risk. So a lot, a lot of moving parts. And that's something that I don't think analysts like. So on their variable annuity assets above the target funding level of the required regulations, in whatever happens, in whatever case, they will stay above thanks to their hedges. However, their amount of funding will be much higher if equity markets increase 40% and significantly lower on a 10% decline and on the 40% decline. The difference in those declines for 10% decline in markets and 40% isn't big because they offer the more sold product is a guarantee protection in case of a 10% market decline. And those hedges give good production, but hedges are costly and their price changes in relation to what goes on in the markets, especially volatility. And here we come to the key chart. In the base case that implies an equity market return of 8.25% per year over the next 10 years and a fixed interest return of 3.5%, which is for me crazy, but call me crazy, they will, the present value of lifetime cash flows does discounted future lifetime cash flows enforce on the enforce very variable annuity block they own is 9.8 billion, which is double the current market cap of 5 billion. If markets, the separated account returns fixed income stocks, equity is 9%, then they, the present value is 14.4 billion. In case of downside, where the separate accounts, equity bonds, return 4%, their present value is only 2.7 billion. That's half the current market cap and that is the risk with Brighthouse. If equity markets go up, Brighthouse makes money, if equity markets go down, they don't make that much money as expected. If there is just one shock of 21%, they have to pay for their guarantees and then they expect a 6.5 return after the shock. If that doesn't happen, then the shock, the present value might be even negative. And this is a big, big risk. So there is a big difference and that's the risk in this case. If markets don't work well for Brighthouse, then the stock won't do also fine. Further, there is no cash flows paid out now. They expect to pay cash flows in 2020 and on their company presentations they discuss distributable cash flows only after page 26. So probably all the analysts at the presentations, those of after first 5-10 pages of an insurance company, so they don't even hear about these cash flows. And that's Einhorn's strategy also. The key is that as the funding increases due to profitability, good markets, then the hedges will be less needed and less costly and there will be much more money to distribute to shareholders. If we look at the highly diversified investment portfolio, mostly bonds, 76% fixed maturities, corporate credit, a little bit of everything. And there is a very, very high quality portfolio with 95% investment grade. So they probably invest everything in investment grade and those who lose their credit ratios go below investment grade. Now the key here, with higher interest rates, a lot of those bonds that are now investment grade and if there is a change in the situation, like Italy was just downgraded, now those become less than investment grade. If that happens, the value of those bonds is lower and the management usually insurance company says we're going to hold them to maturity. But if you own lower than investment grade bonds that doesn't resonate good with the advisors that are selling the policies, the annuities, that means that you are usually forced to sell those at a loss and that's a permanent capital loss. So those insurance companies also as I look at them, while everything is good, while the SAP is going up, everything looks fine, it's a good investment. But the key question here is what happens when things changed, when things change? And for that you have to be a market timer, which we'll discuss a little bit later when concluding on Einhorn's position. However, if markets go down, Brighthouse is in deep trouble. If markets go up, Brighthouse will shine like a Brighthouse. Their focus, their guidance is on 50 to 70% of operating earnings to be paid out, to shareholders, operating EPS growth, 9% return on equity. So very, very positive. Of course, if the markets hold, if we go on the risks, the main risk as I said, what happens if something change? That's the first risk in their reports, risk report, differences between actual experience and reserving assumptions may adversely affect our financial results, capitalization and financial conditions. The key here is what happens when things are different than what they assume? Big trouble, if not on the positive, of course. And this is the main risk for insurers. Blacks wants, we know how blacks wants are much more likely to happen than what statistical models show. And that's why you have thousands of defunct insurers and banks. And that's a risk one has to keep in mind when investing in such companies. Let's continue with the risks. Certain of the variable annuity products we offer include guaranteed benefits. Guaranteed benefits, so you guarantee something, but you are under the influence of the market. The market never gives any guarantees. Haging risks, so capital market risk, if the cost, finally the cost of our hedging program might be greater than anticipated, because adverse market conditions can limit the availability and increase the cost of the derivatives. We intend to employ and such costs may not be recovered in the pricing of the underlying products we offer. So if the market gets in trouble, hedging costs explode and then Brighthouse needs to pay more to hedge for the same things that they are paying now very little due to the low volatility. 2017 everything was good and they still keep those 2017 volatility measures in their models. In August they will adjust their actuarial assumptions and I wonder whether they will adjust also the volatility from 2017 to the new level of volatility, which is a little bit higher in 2018, but can be also adjusted to the historical level, which is also higher. So another thing to keep in mind. When insurers get in trouble, they pay a commission to whoever sells their annuity and that's called the third asset cost. So that's an asset and they amortize that asset over time. However, if the value of what they sold gets lower in trouble, then they have to amortize that faster and then you see huge losses, huge capital hits and downgrades and the house of cards might really fall really really quickly with insurers as it has happened a lot of times in the past. So it's a clear balancing act here between okay, if things go wrong, what's the risk, what's the downside, if things don't go wrong, if things go right, what's the upside, what's the ups and downs. So you have to see how am I protected and in order to gain on the upside. Einhorn here is 107% long with his portfolio, 85% short. So he is long, short. And that's why this stock isn't really for retail investors, if you are not long and short. If you are long, short, okay, bright house, big upside if markets continue, but downside is very big if markets don't continue to grow up. So you have to be long, short. This has to be a long, short part of the portfolio. But that for now, I'll explain that more later. Let's dig more. Also in the base case scenario, they expect the United States treasury rate, 10 year rate to be at 4.25% over 10 years. Better invest than in the treasury probably. And then they get those targets. If interest rates go down to 1%, they have hedged a little bit, they will have a higher degree of cash flows. But remember what happened? This is a 25% shock to equities. They don't expect more than a 25% shock. And that's not a risk that I can accept 40%, 50% shock. Then we can talk about something. What happens if it is a 40% shock and it stays down? It doesn't return later at 6.5% per year. So these scenarios are really rule of thumb scenarios. If you just change those scenarios a little bit, the present value of the cash flows changes significantly. Even if in any case, it is positive. But it is in two cases, scenario 4 and 5, which are likely, if we look at what Delio thinks what will be the 10 year returns negative, then the present value of cash flows also changes here. So risky business for me. Also, when they do their accounts, assumed implied volatility is held constant with respect to market levels at December 31, 2017. Let's see now that they adjourn their actual expectations. Their guidance is, however, still very positive. Earnings per share adjusted without the hedge losses, $8.5 to $9 per share, leading to what? The price earnings ratio of almost $5.6. They announced a $200 million stock repurchase program, which will probably boost and protect the stock. Everything is good. They still expect an approximately 8% return on equity, less the things that they are adjusting for. The primary drivers of second half performance are expected to be equity market returns. So equity markets have to go up 85% in a year. That's going on. That's good for them. Lower expenses, lower claims severity in universal life with secondary guarantees and higher investment income from continued investment portfolio repositioning. So they are repositioning, they are selling their low yields for higher yields at the cost, but they will get higher income from that. And they hope that the new framework that is coming for insurers, life insurance, should pay the way for growth in ordinary dividend capacity in the years to come, as we believe changes in reserves will better align with our hedge target. So the key here, they expect dividends. They expect dividends 2020 that the more, the less they will have to pay for those hedges, the more there will be dividend available for shareholders, the more there will be capital, there will be more dividends. And that's also something Einhorn is playing. However, there shouldn't be a market crash up to 2019-2020. And from a value retail investment perspective, you have to always look, okay, is there a potential for permanent capital loss? What's the risk? If the markets crash, there is a huge risk for Brighthouse Financial too. Like if the markets crash, Brighthouse Financial will probably crash more than the markets. And that's the key here. However, let's see what Claremont has to say about spin-offs from the book, margin of safety. And this is something, this is the bullish thesis also from Einhorn. The behavior of institutional investors dictated by constraints on their behavior can sometimes cause stock prices to depart from underlying value. Institutional selling of a low-price small capitalization spin-off, for example, can cause a temporary supply-demand imbalance, resulting in a security becoming undervalued. If a company fails to declare an expected dividend, institutions restricted to owning only dividend-paying stocks may unload the shares. Institutions owning MetLife that got Brighthouse Financial that is not paying a dividend. Such phenomena as year-end tax selling, window dressing also cause market inefficiencies as value considerations are subordinated to other factors. As Benjamin Graham and David Dodd usually say, the market is not a weighing machine, the market is a voting machine and the market is voting against Brighthouse. If we look at analysts, this is very interesting. Credit Suisse started following with a neutral rating $71 target, JP Morgan $78 target, Barclays 72, Citigroup the only one sell rated at the listing at the IPO, 50 target, FBR, FBR 72, 65 target, 77 and 71. So this was a little bit more than a year ago. However, things have changed since then. Everybody has a hold, only one buy, a friend of Einhorn's perhaps, one sell and the prices, the targets have become have been completely readjusted. The average is now not 70 but 49 and the low is even 35. So see how also analysts change their targets in relation to what the market is voting for. Let's look at Einhorn's thesis, nothing much has changed. He initiated the position at an average of $57.92, no capital return and this result in a low valuation of just 56% of book value, now we are at 37% book value, 6.4, now we are at 5, 2018 EPS. So he says that analysts are laser focused on the downside from a bear market but not on the upside from favorable markets. With the shares trading at 40-50% discount to similar companies, he expects normalization. However, in the last letter, BHF reported mediocre but not terrible year end results driven by slightly higher than expected mortality loss and slightly higher expenses. First quarter announced great terrific results but the stock finished the quarter at 40.07. They have seen bearish analysis that include concerns about long-term care blocks of business that cite the low price at which VOIA financials sold its variability etc etc that has more liabilities than assets. All told, we really don't understand why the stock is performing so badly. Yes, BHF would suffer in large equity sell-off but so would almost every stock in the market. Now, here I want to discuss Einhorn, Einhorn's position. I think that there is a large risk with BHF and that retail investors shouldn't own BHF as see Einhorn, he has 20 what percent, 14-15% in it and then put 15% of your portfolio in it because he is hedged with 96% of his portfolio. So I think he can be afford to belong, hopefully I don't know, with his hedges. So I wouldn't say that BHF is a good stock for retail investors because the risk of permanent loss especially in adverse market conditions is very very big. So that's the key where Einhorn is playing. If you think the markets will continue to go on for two, three years like there are and like there is a big possibility as Trump is doing whatever he can to push the markets higher, even lowering the capital gain tax, then this might be revalued, there might be dividends and that might change the situation. However, that's the risk reward here. There is a big reward, let's say 100% up, this could trade at 80 like Einhorn is saying, but also there is 50-100% down in case of a market crash where I think Brighthouse Financial is more susceptible to crashes, it has higher beta than the market. And here I think Einhorn is hedged. The second point what I want to discuss is compared to Pabrai. I recently made a video about Pabrai and he said that he doesn't find any value in the US market anymore and he has switched a few years ago to India. And I think that Einhorn with his hedge fund based in New York probably only American clients is forced to do whatever he does in the United States. He cannot do what Pabrai did and simply take his portfolio movie to India. I think the clients would kill him. So that's a big constrain to a value investor when he can only invest in top notch famous US markets and stocks because those are usually overvalued or when there is value like in GM or Brighthouse, then there is also big risk. GM we have said, we have discussed it also in another video, link in the description below how GM is risky due to recession, late-party economic cycle, same thing for Brighthouse in case of a market crash. So to conclude I have only one stock in the US but I'm always looking. If I find value I'm not afraid of buying value but the risk of permanent capital loss has to be minimal. In this case with Einhorn stock the risk of long-term permanent capital loss is significant for me and therefore I say pass. If you have a long short position Brighthouse might be something interesting for you. Thank you for watching. If you like this analysis, if we like how we approach investing from a value investing perspective or from a risk reward perspective where if we take such a big risk we expect much bigger upside than what Brighthouse financial is delivering has or potentially will deliver, please subscribe to the channel, like the page, comment down side, share your thoughts and I'll see you in the next video.