Tue, Mar 24, 2020
India’s finance minister Nirmala Sitharaman, recently made a groundbreaking announcement proposing the listing of the Life Insurance Corporation of India (LIC) through an Initial Public Offering (IPO). LIC is the country's largest insurer, controlling more than 70.0 per cent of the market share in terms of the number of policies sold and first year premiums. Based on media reports, the stake sale is unlikely to be more than 10.0% which itself could be divested in multiple tranches considering the expected size. The proposed listing could prove to be one of the largest IPOs in the Asia Pacific region; it could be keenly followed not only in India, but also globally from an industry and investor perspective. Since LIC is an unlisted company currently with no publicly available value indication, the value of divestment is poised to attract significant attention.
Companies, typically, are valued in two ways: first, using an income approach which is basically the present value of future cash flows expected to be generated from business operations, or second, using a market approach which provides an indication of value by relating the equity or invested capital of comparable companies to various financial metrics such as earnings, cash flow, and book value and various operating metrics such as covered lives; these multiples are then applied to the subject entity’s corresponding metrics.
Similar methods are applied to value an insurance company. However, what differs is the nature and computation of underlying cash flows (income approach) or metrics to arrive at multiples (market approach) which are industry specific. Here in this article, we discuss commonly used multiples that can be used to value the Indian insurance behemoth. We will also discuss various factors that should be considered to adjust those multiples to account for differences in size, profitability, risk profile and growth.
We can look at the Market Capitalization to Embedded Value ratio (“MCap/EV”) for the three biggest listed players in India – HDFC Life, ICICI Prudential Life and SBI Life. The multiples range from 3x to 6x which appear significantly higher than their Asian insurance counterparts, valued at under 2x. Such rich valuations underline the growth opportunity in the underpenetrated Indian market and the confidence of the market in the sector.
Similarly, another approach that can be considered includes a ratio derived from the assets under management (AUM) of the insurance provider. For the above three companies, MCap/AUM ratio ranges from ~40.0% to ~90.0%. As of September 2019,the total AUM of LIC is more than INR 30 lakh crores.
The raw multiples arrived at using the above approaches should be further adjusted as discussed in the next section.
Once the comparable companies’ multiples are derived, the next step should be to adjust the multiples based on characteristics of the subject company (LIC). Simply applying the peer group multiple will lead to an erroneous conclusion since LIC is starkly different from its comparable peers in terms of size, profitability, ownership and growth profile. The valuation should account for the following factors:
Indicative VNB Margin Ranges of Life Insurance Products
Having said that LIC’s valuation metrics could be at a discount to the listed private insurers in India, the quantum of discount could be reduced if not eliminated if the Government can give assurance to the investors that the management would get a free hand in taking investment decisions without any social and political agenda. LIC IPO will be a historic event in the history of capital markets due to sheer size and scale. It is expected to unlock massive value and help the government to tackle the rising fiscal deficit.
Sources
1 Edelweiss: Bridging the gap – Perspectives on the Indian Insurance sector, December 2019
2 Livemint: Has LIC become the lender of last resort? June 2016
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