Transcript Valuation of a P&C Company Presented at CAS Spring Meeting June 16, 2008 – Quebec City Sean C.

Valuation of a P&C Company
Presented at CAS Spring Meeting
June 16, 2008 – Quebec City
Sean C. Martin, CFA
Vice President
Financial Institutions Group
Investment Banking
TD Securities, Inc.
Acquisition Valuation Process
of a P/C Insurer
Strategic Analysis




Actuarial/Financial Analysis





Product Diversification
Geographical Expansion
Broaden Distribution
Pricing Power with Scale
Synergies
Pro Forma Growth
Underwriting Results
Leverage
Tax
Valuation Model
Reconsideration of
Strategic Assumptions
Output
The valuation of a P&C company is often an iterative process.
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With content from: Acquisition Valuation of P&C Insurance Companies, Jaroslav Danhel, Peter Sosik (University of Economics in Prague).
Inputs to Valuation Process
Actuarial
Company/Bankers/
Accountants
Premium Growth by Business Line
Loss & ALAE Ratios by Business Line
ULAE
Payout Patterns
Expenses
Reserve Adjustments
Investment Yield
Tax
Capital Structure/Requirements
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Valuation Methods
1. Book Value Approach
Value = value of assets – value of liabilities
 Accounting focused
 Retrospective
 Future value of business not considered
2. Stock Market Approach
Value = # of shares X share price
 Efficient market hypothesis
 No control premium
 Future value of business may not be considered
3. Discounted Cash Flow Approach (DCF)
T
Value = ∑ (1-r)
t=1
 Valuation of future profit
 Sensitive to assumptions
 Validate other methods
CFt
t
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With content from: Acquisition Valuation of P&C Insurance Companies, Jaroslav Danhel, Peter Sosik (University of Economics in Prague).
Valuation Methods (cont’d)
4. Relative Valuation
 Comparison to prices of:
a. Precedent Transactions
b. Public Companies
Price to Earnings (P/E) Multiple
P/E =
Price per Share
Earnings of Target
Earnings per Share




Last-Twelve-Months (LTM)
Forward (2008E)
Normalized
Post-Synergies
Price-to-Book Multiple
P/BV =
Price per Share
Book Value of Target
Book Value per Share




Current
Tangible (excludes Goodwill)
Adjusted (reserve adjustments)
1.0x value to excess capital
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Valuation “Football Field” - Example
Preliminary Value Range (C$ per share)
$18
52 Week High - Low
$22
$26
$28.00
$20.00
Current
Price: $20.00
Analyst Target Prices (1)
Historical Average Trading Multiples
(2)
Comparable Companies
$30
$24.00
$27.50
$23.00
$28.00
$20.00
$25.00
Comparable Companies plus Control Premium
$25.00
$28.50
Precedent Transactions
Canada
$24.00
U.S.
$27.00
$23.00
Implied Price / Book Value
1.2x
1.5x
Source: Bloomberg and Thomson.
(1) Based on target prices from four of the seven companies covering XYZ.
(2) Range is from average P/E to average P/BV from January 1, 2005 to January 1, 2007.
$27.00
1.7x
2.0x
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Comparable Companies - Example
Price ($)
28-Apr-08
Canadian P&C Companies (C$)
Market
Cap (1)
(2)
EPS CAGR
Price / EPS
2007A 2008E (3) 2009E (3)
07-'09E
Price /
Book
ROE
(LTM)
Debt /
Total
Capital
Div. Yield
(LQA)
(C$millions)
ING Canada
$39.50
$4,917
9.8 x
10.3 x
9.3 x
2.8%
1.55 x
15.4%
0.0%
3.1%
Northbridge
$34.48
$1,717
5.9 x
9.5 x
11.3 x
-27.5%
1.21 x
22.8%
0.0%
1.9%
Kingsway Financial
$13.44
$680
nmf
6.9 x
6.6 x
nmf
0.80 x
0.4%
33.8%
2.2%
EGI Financial
$11.50
$115
8.0 x
7.8 x
7.3 x
4.4%
1.13 x
16.1%
16.1%
2.1%
7.9 x
8.6 x
8.6 x
-6.8%
1.17 x
13.7%
12.5%
2.3%
Canadian P&C Average
U.S. P&C Companies (US$)
Allstate Corp
$50.16
$28,301
8.3x
8.6 x
8.2 x
0.3%
1.39 x
16.4%
21.7%
3.3%
Progressive Corp
$18.79
$12,860
13.5x
16.0 x
14.6 x
-8.5%
2.71 x
16.7%
31.4%
3.1%
Safeco Corp
Mercury General Corp
$45.23
$4,059
6.5x
7.6 x
7.7 x
-8.2%
1.20 x
19.4%
17.2%
3.5%
$49.35
$2,704
12.1x
12.3 x
12.4 x
-1.5%
1.45 x
12.5%
6.9%
4.7%
The Hanover Insurance Group
$44.50
$2,708
11.6x
10.4 x
10.2 x
-2.9%
1.17 x
10.6%
18.2%
0.9%
Selective Insurance Group
$21.94
$2,107
(4)
U.S. P&C Average
10.6x
10.4 x
9.7 x
1.6%
2.01 x
11.1%
21.5%
2.4%
10.4x
10.9 x
10.5 x
-3.2%
1.66 x
14.4%
19.5%
3.0%
(1) Market Capitalization is on a diluted basis and includes in-the-money exercisable options outstanding.
(2) GAAP EPS is used for Canadian companies. Operating EPS is used for U.S. companies and excludes after-tax realized gains and losses.
(3) Based on Bloomberg estimates.
(4) Multiples are calculated based on the closing price a day prior to the acquisition announcement by Liberty Mutual.
(1)
Market Capitalization is on a diluted basis and includes in-the-money exercisable options outstanding.
(2)
GAAP EPS is used for Canadian companies. Operating EPS is used for U.S companies and excludes tax realized gains and losses.
(3)
Based on Bloomberg estimates.
(4)
Multiples are calculated based on the closing price a day prior to the acquisition announcement by Liberty Mutual.
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Precedent Transactions - Example
Canada
Date Announced
Acquiror
Target
Royal & SunAlliance Canada (1)
Axa Canada
Teacher's Private Capital
La Capitale Assurances Générales
Canadian Northern Shield Insurance Company
Price
(C$mm)
Price /
LTM EPS
Price /
Book
75
31.7x
1.4x
4.4%
10.4x
10.0x
7.2x
7.1x
15.9x
n/a
1.5x
1.5x
1.6x
1.1x
1.3x
n/a
14.8%
15.0%
21.9%
15.5%
7.9%
n/a
n/a
1.0x
n/a
ROE
(in C$ millions)
18-Oct-07
30-Nov-05
03-Oct-05
03-Nov-04
07-Oct-04
02-Mar-04
20-Jan-04
30-Jun-03
22-Nov-01
ING Canada (2)
Canadian Western Bank
Meloche Monnex
Torquest Partners, Newport
Partners, CIBC Capital Partners
ING Canada (3)
Citadel (Winterthur Canadian Operations)
310
GCAN Insurance Co.
150
L'Unique Compagnie d'Assurances Générales
48
Allianz Canada
370
HSBC Canadian Direct Insurance
25
Liberty Mutual's Canadian Personal Lines Business 130 - 140
Gerling Canada Insurance Company
80
Zurich Canada Group P&C
714
n/a
1.4x
n/a
13.7x
1.3x
13.2%
Price
(US$mm)
Price /
LTM EPS
Price /
Book
ROE
2,360
1,304
294
563
2,725
712
639
432
287
10.2x
15.0x
20.0x
14.8x
16.3x
15.5x
14.6x
1.6x
2.1x
1.4x
2.5x
1.8x
1.9x
1.9x
1.7x
1.7x
16.1%
14.2%
6.9%
17.0%
14.0%
12.1%
11.7%
11.3%
12.0%
14.8x
2.1x
12.8%
Average
United States
Date Announced
Acquiror
Target
Mapfre SA
Muenchener Rueckversicherungs
The Doctors Co
DE Shaw & Co LP
Liberty Mutual Group
Zurich Financial Services
American Insurance Group (AIG)
Texas Pacific Group
Delek Capital Ltd
Commerce Group Inc
The Midland Co
SCPIE Holdings Inc
James River Group Inc
Ohio Casualty
Bristol West Holdings
(in US$ millions)
31-Oct-07
17-Oct-07
16-Oct-07
11-Jun-07
07-May-07
02-Mar-07
24-Jan-07
05-Dec-06
04-Aug-06
21st Century Insurance Group
Direct General Corporation
Republic Cos Group Inc
Average
12.5x
16.4x
Source: Bloomberg, SDC, MSA Researcher and various news services
(1)
Price/Earnings value calculated using 1H 2007 annualized net income.
(2)
Price/Book value based on TD Newcrest estimate of adjusted book value.
(3)
1.4x transaction multiple estimated by TD Newcrest Analyst Doug Young and calculated as a percent of premiums, not book value.
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Simplified Acquisition Model - Example
Sources and Uses
Deal Assumptions
Share Price
Shares Outstanding
Market Capitalization
Premium Paid
Acquisition Price
Acquisition Price per Share
2008 Earnings
P/E (2008)
Acquisition P/E
Buy Co.
$10.00
300
$3,000
$300
10.0x
Sell Co.
$20.00
100
$2,000
20%
$2,400
$24.00
$150
13.3x
16.0x
Sources
Cash
Debt
Equity
Total Sources
Uses
Purchase of Equity
Debt Refinanced
Transaction Fees
Total Sources
$175
$1,150
$1,325
$2,650
7%
43%
50%
100%
$2,400
$200
$50
$2,650
91%
8%
2%
100%
Other Assumptions
Book Value
P/Book
Acquisition P/BV
$2,000
1.5x
$1,500
1.3x
1.6x
Buy Co. New Shares Issued
Cost of Debt
Interest Cost of New Debt
After Tax Cost of Debt
Synergies (after-tax)
Total Adjust. to Net Income
132.5
5%
-$58
-$37
$30
-$7
 20% Premium, 16.0x Price/Earnings, 1.6x Price/Book
 50% Equity Consideration (132.5 shares delivered to existing shareholders of Sell Co.)
 $37 million after-tax cost of debt
 $30 million after-tax synergies
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Source: Company reports and Bloomberg IBES estimates.
Simplified Acquisition Model – Example
Capital Structure
Cash
Total Assets
Debt
Other Liabilities
Equity
Total Assets & Liab.
Debt/Capital
Buy Co.
$75
$5,400
Sell Co.
$100
$3,700
Adjust
-$175
$0
Pro Forma
$0
$9,100
$400
$3,000
$2,000
$5,400
$200
$2,000
$1,500
$3,700
$1,150
$0
-$175
$1,750
$5,000
$3,325
$10,075
17%
12%
Buy Co.
$300
300
$1.00
Sell Co.
$150
34%
EPS Accretion (2008)
Earnings
Shares Outstanding
Earnings per Share (EPS)
Adjust
-$7
132.5
Pro Forma
$443
432.5
$1.02
Accretion/(Dilution)
2%
 $1,150 of additional debt; 34% debt/capital ratio
 $1,325 new equity issued; equity of Sell Co. eliminated
 2% EPS accretive after new shares issued, cost of debt and synergies
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Source: Company reports and Bloomberg IBES estimates.
Simplified Acquisition Model - Example
Sensitivity Analysis (2008 Earnings Accretion)
Synergies 2%
$0
$15
$30
$45
Purchase Price Premium
0%
10%
20%
2%
-2%
-5%
5%
2%
-1%
9%
6%
2%
13%
9%
6%
30%
-7%
-4%
-1%
3%
Purchase Price Premium
Equity Consideration
2%
70%
60%
50%
40%
0%
1%
5%
9%
13%
-2%
2%
6%
10%
20%
-5%
-2%
2%
7%
30%
-8%
-5%
-1%
4%
 Sensitivity analysis highlights the impact on accretion of key deal assumptions
 Additional equity reduces accretion as additional shares are issued
 Cost of equity is greater than the cost of debt
 Sell Co. acquired at a P/E ratio greater than Buy Co.
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Source: Company reports and Bloomberg IBES estimates.
Simplified Acquisition Model - Example
Pro Forma Regulatory Capital
Required Capital
Available Capital
Capital Ratio
Minimum Target Ratio
Excess Capital
Buy Co.
$1,100
$2,000
182%
175%
$75
Sell Co.
$800
$1,500
188%
175%
$100
Adjust
$0
-$175
Pro Forma
$1,900
$3,325
175%
175%
$0
Adjusted Book Value of Sell Co.
Capital at 175%
Excess Capital
Total
Book
Value
$1,400
$100
$1,500
Book Value
Multiple
1.60x
1.00x
1.56x
Equity
Value
$2,240
$100
$2,340
Base Case
$1,500
1.60x
$2,400
 Excess capital of Buyer and Seller can be used to fund transaction
 The optimally capitalized portion of the Sell Co. business is valued at a full acquisition multiple
 Excess Capital may not be valued at a full price/book multiple
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Source: Company reports and Bloomberg IBES estimates.
Closing Thoughts
 Actuaries are an integral part of a P&C valuation process by providing forecasts for loss
ratios, payout patterns, reserve development, and premium growth
 The valuation of a P&C company is often an iterative process where the forecasts
provided by actuaries can reflect the biases of the acquiring company
• for example, a purchaser may have a pessimistic view on projected loss ratios
 Actuaries can provide value to all aspects of a transaction when they are aware of the
strategic objectives of their client (while maintaining an objective viewpoint)
 It is important for all deal team members to have an understanding of the financial
model and how their analysis is being inputted into the model
 Not all members of a deal team will be experts in P&C insurance. Actuaries are often
invaluable teachers who are able to provide simplified explanations of insurance
concepts
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Source: Company reports and Bloomberg IBES estimates.