For AMP, it's all about the balance sheet

This changing landscape was behind AMP's decision to buy its arch rival AXA last year, its recent move into the highly fragmented and low-margin self-managed super fund segment, and the complex sale of a 15 per cent stake in its subsidiary AMP Capital to Japanese bank Mitsubishi UFJ Trust and Banking Corp (MUTB).

It also goes a long way to explaining its recent decision to relinquish its role as joint external manager of the $2.3 billion listed infrastructure fund Duet. By doing so it will get a nice one-off compensation payment of up to $50 million in cash and securities, which will boost its capital position in time for its year to December 31 profit results.

And it puts into context the rising speculation that the AMP board is considering a hybrid debt issue, similar to those issued by Tatts Group, ANZ Bank, Westpac, Tabcorp, Woolworths and Origin Energy.

For now, the market will focus on its interim results, due out on Thursday. Investors will look to two things: expenses and its capital position, or the ratio of net tangible assets (NTA) to the minimum capital requirement (MRR), which was a robust 2.1 times just before its acquisition of AXA and subsequently fell to 1.0 times.

The BBY analyst Brett Le Mesurier estimates the ratio of NTA to the minimum capital requirement will be 1.1 times at June 30. He calculates the minor improvement in its capital position came from the MUTB deal, which added $425 million to its coffers, as did a dividend reinvestment plan, which raised $160 million.

AMP provided further important detail on the MUTB deal in its notice to shareholders for its upcoming AGM, which led him to suggest that AMP has adopted an "alert but not alarmed" strategy when it comes to capital. In item five of its notice to shareholders, AMP explains that the sale of AMP Capital can be unwound at any time by either party. This means AMP has the option to buy back the 15 per cent stake at any time and MUTB has a similar option to sell back its stake in AMP Capital. If either party exercises its option AMP will issue some 3.49 per cent of new shares in AMP. The company sought approval from shareholders in the event that one of the parties wants to back out of the deal.

What is interesting about this is that under ASX Listing Rule 7.1 companies can issue up to 15 per cent more shares without shareholder approval in any 12-month period. This means without shareholder approval AMP could still have been able to raise 328 million in new shares, or $1.3 billion in fresh capital.

It suggests AMP is as nervous about its capital position as the rest of the market. The brutal reality is AMP may well have to improve its capital position in time for the introduction of tough new life and general insurance standards by the financial services regulator APRA on January 1. These standards are expected to include a higher MRR.

AMP's capital is affected by movements in investment markets, including bonds and equities, changes in asset valuations and dividend payouts. Its earnings are affected by these issues but also the net cash outflows in the Australian Financial Services business. In the first quarter this year, the net cash outflows were $292 million, which followed net cash outflows of $331 million in the last quarter of last year. The weak investment markets and the better deal the banks are offering on term deposits are weighing on AMP's ability to achieve revenue growth.

Against this backdrop, AMP is trying to position itself in an industry that is undergoing structural change. The battle has begun between the banks, AMP, which would like to be a fifth pillar, and the industry super funds, for a growing army of disenchanted customers.

AMP is positioning itself to be the company of choice. To this end it bought AXA last year to get its hands on a retail platform, improve its technology and boost its economies of scale by creating a network of 4100 financial advisers servicing 5 million retail customers across Australia and New Zealand and 350 institutional clients.

Its recent purchase of Cavendish Group, which is the largest self-managed super fund administrator, was another bet on technology and scale. While self-managed super funds is a highly fragmented, low-margin business, it is growing like topsy, and if AMP can make a small fee by doing the paperwork on behalf of accountants and entice some of these self-managed super funds into their investments or products, it will be a game changer. The latest data from APRA estimates there are 470,000 such funds, compared with 230,000 five years ago, managing $420 billion in funds under management.

It is also trying to expand overseas. But it faces a lot of challenges. It has a high-margin legacy business which is being transformed into a low-margin business. The combination of these characteristics produces a business with little growth. It is a chilling reminder of a company that once had the best position in the only industry that the government legislated for decades of high growth.

AMP listed more than 10 years ago with hopes of having a $20 share price and rising. Now shareholders would be delighted if it could get to $5, but even that may take years.