Phoenix still rising

Phoenix might well be the biggest company you've never heard of. It is the UK's largest player in the closed-life fund business, and like many companies of this ilk, its main attraction is a generous dividend yield backed up by prodigious cash flow.

The group has been around in various guises for quite some time, but it was only in November 2009 that it obtained a secondary listing in its current form in London - its main listing is on NYSE Euronext. The group was actually formed after Liberty Acquisition Holdings acquired closed life specialist, Pearl, which had earlier bought the business assets of Resolution, but not the name. Phoenix operates to ensure the successful and profitable run-off of life insurance policies - it currently has over 6m policies on its book - and also operates Ignis Asset Management which, like its parent, isn't particularly well known in the UK.

But unlike open life businesses, Phoenix does not allocate significant amounts of capital to support the writing and distribution of new insurance products, so capital requirements for the operating business decline as policies mature. This boosts cash flow by releasing excess capital. Of course, without fresh acquisitions, business would eventually cease as the last insurance policy matured, so the excess capital provides a source of funds to finance continuing acquisitions.

Phoenix has certainly made impressive progress in freeing up capital. At the start of this year, the cash generation target for the full-year was £750m-£850m, but during the first four months of the current financial year the group has already generated over £300m. Moreover, Phoenix reckons that in the four years to 2014 it will generate £3bn of free cash. This is especially important because, when creating Phoenix, management also took on a hefty £2.7bn of previously generated debt. Normally, this wouldn't be particularly arduous, representing gearing of a little over 50 per cent. But the loans carry certain covenant restraints that place a cap on some of the group's objectives, such as the pace of dividend growth.

Negotiations are ongoing to restructure that debt pile on a less restrictive basis, but the current terms include favourable interest rates and are tax efficient. So if these advantages cannot be retained, then the debt will be paid down using organic cashflow and gearing is already on target to fall below 50 per cent in the current year. Furthermore, Phoenix looks well placed to return cash to shareholders and the current attractive dividend yield would probably increase still further once the debt restructuring issue is resolved.

Phoenix is also required to maintain a certain level of reserve assets, and the group is well placed here, too - excess capital under the insurance group directive minimum requirements totals £2.9bn. Stress testing provides some indication of how strong Phoenix is. Managers say that even if there were a combined 25 per cent fall in equity markets, a 20 per cent decline in property values, rising yields and wider credit spreads, the group would still have £1.8bn of excess capital.

Assets under management at the end of March totalled £67bn, down slightly from £67.5bn at the year-end, driven by the run-off of the closed life book. But management is always on the look-out to snap up some of the billions of pounds tied-up in closed life funds. Some current operators will inevitably elect to free up cash by selling on closed-life books, although Phoenix can expect to face stiff competition for these assets from rival operators like Chesnara. Still, the attraction of further acquisitions remains, because integrating fresh purchases into the group's low-cost operating platform means that day-to-day costs don't have to rise.

Last year, the group made an operating profit of £373m on an IFRS basis, of which Ignis contributed £46m. The asset manager's primary function is to manage the assets held by Phoenix, and normally assets under management decline as the size of the closed-life book runs off. However, Ignis has reduced this to a trickle as a result of solid investment growth and through attracting a net £1.3bn of third-party sales.