HDFC Life-Max Life deal: Positive but for the non-compete fee
HDFC Life has gained size, paid mostly with shares to acquire a public company such as Max Life and is also getting listed in the process—all in a single shot
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A non-compete fee is always galling for minority shareholders. The HDFC Life Insurance Ltd and Max Life Ltd transaction is no exception. The deal envisages a payout of Rs.850 crore to the Analjit Singh-led Max group. Why a non-compete, in a merger transaction? A non-compete is usually paid to compensate a person for exiting a business and for promising not to re-enter it for a period, four years in this case.
The first takeaway is this: HDFC Life has acquired Max Life through the structure of a merger. Although Max Group gets a stake in the merged entity, it will sit with the minority. HDFC Life has gained size, paid mostly with shares to acquire a public company and is also getting listed in the process, all in one shot.
Max Financial Services Ltd, with a market cap of Rs.14,481 crore, is the holding company of Max Life with a 69.55% stake. That yields a valuation of Rs.20,820 crore for Max Life, ignoring the residual value of Max Financial’s non-life business. That works out to a per share value of Rs.534. Take the swap ratio of 2.33 shares of HDFC Life for 1 share of Max Life, and you get a value of Rs.229 affixed to the HDFC Life share.
The valuation of the merged entity (HDFC Life + Max Life) comes to Rs.66,508 crore, matching the 69:31 relative valuation disclosed. Embedded value is a metric used in the valuation of insurance companies. HDFC Life uses the market consistent embedded value measure, which is defined as the present value of shareholders’ interests in the business.
The transaction values HDFC Life at 4.5 times its FY16 embedded value and Max Life is valued at 3.7 times. The actual valuations would have been done based on projections for the next few years. Thus, HDFC Life has secured a higher valuation.
Max Financial’s minority shareholders may not mind this, as they become part of a much larger entity, and if the merger does result in lower operating costs, then profitability and valuations can improve further. The sticking point will be the non-compete fee being paid.
This sum of Rs.850 crore will be paid by the merged entity. Normally, one would think a non-compete fee is paid by the incoming acquirer. Since the merged entity is paying, minority shareholders of Max Financial will be indirectly paying part of the fee. After all, they too will be shareholders in the merged entity. The amount works to around Rs.45 a share of the merged entity, or 20% of its merger valuation. That’s a substantial premium being paid to them. But shareholders can have a say in whether this is paid to them or not, so it is open to them to vote it down.
The final piece in this acquisition jigsaw is what valuations the merged entity will trade at. If it remains at current valuations, then the gains to the Max Financial shareholders are not much. However, shareholders will be hoping that it trades at a premium. That is the only thing that can soothe the hurt caused by the proposed non-compete fee. Max Financial’s shares closed down 1.61% on Tuesday.