Shares of Reliance Capital Ltd jumped 9.7% on Monday as investors cheered Nippon Life Insurance Co.’s 26% stake buy in the local firm’s life insurance unit. Nippon’s deal valued Reliance Life Insurance Co. Ltd, in which Reliance Capital has a 100% economic interest, at Rs11,500 crore, about 60% more than various Street estimates.
By that count, Nippon has paid a handsome premium for a business facing medium-term regulatory hurdles. In September, the Insurance Regulatory and Development Authority capped charges on the popular unit-linked insurance plans, asked insurers to increase life cover to 10 times of annual premium paid, and guarantee a 4.5% return on pension plans.
Consequently, Reliance Life’s premium collected fell 9.7% to Rs1,447 crore for the quarter ended December. The annual premium equivalent earned also fell 53% from a year ago.
New business achieved profit (NBAP) during the quarter also fell 28.7% from a year ago, according to Espirito Santo Securities’ calculation. This measure is the present value of all future profits for shareholders from new business.
Moreover, Reliance Life also suffers from a low 13-month persistency ratio of 54%. This means that only 54 of every 100 policyholders renew their policies the second year instead of cancelling them.
True, the firm has managed to cut costs and maintain its NBAP margin at 18% for the December quarter. Besides, increasing share of the traditional business (term insurance), which is more profitable, will help keep the margin at more than the 16% level, according to the company management.
Traditionally, insurance firms are valued by the appraisal method, which means adding embedded value (EV) and a multiple of NBAP. Reliance Capital does not disclose its EV, which is arrived by adding the adjusted net asset value and the present value of future profits of a firm.
But consider the average of the two EV numbers used by two brokerages, which declined to be named, at Rs3,300 crore and 2011-12 estimated NBAP of Rs620 crore. Then, Nippon values the company at its EV-plus 13.2 times the 2011-12 NBAP.
As Espirito Santo’s analyst Santosh Singh pointed out, deals in some Asian markets have happened at higher levels such as the sale of Axa SA’s Asian unit at EV-plus 20 times NBAP. Even Prudential Plc’s offer to American International Group Inc.’s Asian unit was EV-plus 22 times NBAP.
Nevertheless, the consensus is that India, being an under-penetrated market, will be a gold mine for insurance firms.
However, Apurva Shah, vice-president at brokerage Prabhudas Lilladher Pvt. Ltd, said strategic investors always pay a premium because of regulatory hurdles and minority investors should not assume the same valuation.
“Based on the similar transactions in the sector, we reckon the actual implied value for minority shareholders is actually about 70-75% of value accorded by the foreign investor,” he wrote in a note to investors.
The life insurance business typically makes for half the value of Reliance Capital, according to broker valuations. Given that the stock has plunged 36% since January 2010 compared with a 2% gain for the BSE-500 Index of the Bombay Stock Exchange, it’s no wonder that investors acted exuberantly.
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