Warren Buffett Rests as John Paulson Digs In (Update 1)

Updated to reflect analyst commentary and share prices

NEW YORK ( TheStreet) -- Warren Buffett's buy and hold bank investing strategy has lost at least one follower: Hedge fund magnate John Paulson, who turned corporate raider in a proposed split of Hartford Financial Services ( HIG).

For Buffett, recent buyback and dividend boost announcements by Wells Fargo ( WFC), American Express ( AXP), U.S. Bancorp ( USB) and SunTrust ( STI) have paid off again and again. But after liquidating stakes in Bank of America ( BAC), Wells Fargo and Citigroup ( C) ahead of a 2012 share surge, Paulson's activism on a large Hartford Financial Services holding reveals his impatience with the sector and his focus on getting returns fast.

John Paulson's flagship hedge fund was reportedly down 51% in 2011

On Wednesday, Hartford Financial Services said it will look to sell pieces of its life-insurance unit and stop selling some annuity products, in a move that may appease the demands of the company's largest shareholder, struggling hedge fund magnate and gold bug John Paulson.

That sale plan was seen as a concession to Paulson and other frustrated investors, which may pave the way for an eventual split by Wells Fargo analyst John Hall in a Wednesday note. "While these actions fall short of a full split of the company's non-life and life operations, we think they will position the Hartford to better pursue a split in the future."

After taking the single largest stake in the insurance conglomerate with an over 8% holding, Paulson called for Hartford Financial Services to consider a spinoff of some businesses in a Valentines Day breakup letter, after agitating for change on the company's fourth quarter earnings call.

Instead, it appears Paulson will get a possible sale of some insurance units to help realize the company's asset values. Those businesses include the company's Individual Life, Woodbury Financial Services and Retirement Plans businesses, Hartford Financial Services said in a press release. "The actions announced today will allow us to build on our strong financial foundation by concentrating our resources on a smaller number of businesses to position The Hartford for long-term success," said The Hartford's CFO Christopher J. Swift.

"We see this as a positive development for shareholdersin that it opens up more options as it relates to deleveraging, share repurchase, or potential legal separation down the road," wrote Credit Suisse analyst Thomas Gallagher. He estimates that Hartford Financial's plan could free up as much as $4 billion in capital.

In the short term the sale plan may put a dent into Hartford's earnings per share, noted JPMorgan analyst Jimmy S. Bhullar. "While these actions are incrementally positive, they do not alter our view on the stock."

Overall, analysts give Hartford Financial Services shares a price target of $26.46, according to consensus estimates compiled by Bloomberg. Those analysts give Hartford Financial Services nine "buy" ratings, eight "holds" and one "sell."

For Paulson and Hartford Financial Services, the insurance unit sales may provide relief after a disastrous 2011.

Overall, 2011 was a brutal year for Hartford Financial Services. The insurance company's stock fell nearly 40% on waning profitability and a drop in revenue. The company's net income fell over 60%, while sales fell over 2%. In early trading, Hartford Financial shares rose over 2% to $22.19 in late afternoon trading, adding to a 33%-plus 2012 surge. Still, shares are off nearly 15% in the past 12 months.

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For Paulson, 2011 was even more missable. His flagship Advantage fund dropped 51% in 2011, according to Bloomberg reports after a bet on financials panned. By comparison, Paulson's Advantage Plus fund jumped 164% in 2007 on a timely mortgage short.

Timing may be a problem for Paulson in 2012 after he threw in the towel on his biggest bank holdings such as Bank of America, Citigroup, Wells Fargo, SunTrust and Regions Financial ( RF) in the fourth quarter of 2011. Each of those banks have added to late 2011 gains with an over 25% year-to-date stock surge, on expectations for improving earnings, lower legal liabilities and buyback and dividend increases in the wake of the Federal Reserve's stress test results.

Paulson's two largest holdings are tied to gold, however he also counts Delphi Automotive ( DLPH), Hartford Financial, Anadarko Petroleum ( APC) and Capital One Financial ( COF) as his largest corporate holdings, according to filings with the Securities and Exchange Commission compiled by Bloomberg. Overall Hartford Financial is Paulson's fifth largest investment after paring his bank holdings.

While Wednesday news signals that Paulson may start winning his Hartford Financial Services investment battle, the hedge fund investor immortalized in Michael Lewis's The Big Short for his subprime bet may be losing the investment war to Buffett's long-term investing math.

Many of Buffett's largest bank holdings surged in March after receiving Fed approval to increase capital return plans, making the value investor poised to see big bank investment returns over the long-haul even if shares falter after a 2012 rally.

In his February annual letter, Buffett detailed his math on how to gain on stock swoons and share repurchases, using his investment in IBM ( IBM) as an example. After Wells Fargo boosted its dividend 83% and indicated accelerated buybacks on the heels of stress test results, Buffett's largest bank holding may have a similar thesis, with a relevance to other Berkshire Hathaway ( BRK.A) investments in Bank of America, American Express and U.S. Bancorp.

On Wednesday, Guggenheim Partners analyst Marty Mosby maintained "buy" ratings on large Buffett bank investment like Wells Fargo, U.S. Bancorp, in addition to JPMorgan ( JPM) on capital return programs and an expected growth in corporate and mortgage lending. "WFC, JPM, and USB are high-quality large cap banks that continue to appreciate off of earnings momentum and deployment of excess capital," wrote Mosby.

If bank buyback's were to play out similar to an expected $50 billion share buyback program launched by IBM, it could be the basis for consistent earnings outperformance by Berkshire Hathaway relative to the S&P 500 Index. In 2011, Berkshire saw its book value per share grow 4.6%, outpacing a 2.1% boost to S&P 500 components that includes dividends, reversing a trend of postcrisis underperformance for Warren Buffett's financial empire.

As of 2011, Berkshire's compounded annual gain of 19.8% more than doubled the S&P 500's 9.2% gain, since the fund's inception in 1965, according to its February letter.

Will Paulson's activist investment strategy in Hartford Financial Services give him the lift he needs to make back ground on Buffett's 2012 financial sector returns? It's unlikely.

"As the largest investor in the Company for the past year, we have done exhaustive research on the challenges and opportunities of The Hartford and believe that a spinoff would produce an increase in value for Hartford shareholders of 40 -- 60%+ above the unaffected share price," wrote Paulson in his Valentine's Day letter to Hartford Financial Services Chief Executive Liam McGee.

"We would hope that a newly incentivized Life management running a pure Life company would take steps to further improve the separately traded Life's value," added Paulson, who said that other large companies like ConocoPhillips ( COP), Kraft ( KFT) and McGraw Hill ( MHP) have undertaken similar strategies recently. The possible sale of The Hartford's life insurance units instead of a shareholder spin, indicate that management didn't fully heed Paulson's advice.

Even if he were to impart his will and big stock gains on Hartford Financial Services, they likely wouldn't cover the missed opportunities on big bank stock buyback programs that Buffett's capitalized on in 2012.

>>View John Paulson's Portfolio

TheStreet Ratings gives Hartford Financial Services Group a B- grade and a $25.06 price target.

-- Written by Antoine Gara in New York

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