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Valuation of a P_C Company

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					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                                                                           Synergies
   Geographical Expansion                                                                            Pro Forma Growth
   Broaden Distribution                                                                              Underwriting Results
   Pricing Power with Scale                                                                          Leverage
                                                                                                      Tax


                                                                                                                   Valuation Model


                             Reconsideration of
                                                                                                                             Output
                           Strategic Assumptions




                 The valuation of a P&C company is often an iterative process.


                                                                                                                                                                        2
                               With content from: Acquisition Valuation of P&C Insurance Companies, Jaroslav Danhel, Peter Sosik (University of Economics in Prague).
Inputs to Valuation Process
                                                  Company/Bankers/
                                      Actuarial
                                                    Accountants

Premium Growth by Business Line

Loss & ALAE Ratios by Business Line

ULAE

Payout Patterns

Expenses

Reserve Adjustments

Investment Yield

Tax

Capital Structure/Requirements


                                                                     3
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)
                 CFt
                       t
           t=1
    Valuation of future profit
    Sensitive to assumptions
    Validate other methods

                                                                                                                                                                    4
                           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

                                                                         5
  Valuation “Football Field” - Example

                              Preliminary Value Range (C$ per share)
                                                                             $18                         $22                        $26                 $30

52 Week High - Low                                                                   $20.00                                                    $28.00


                        (1)
                                                                      Current
Analyst Target Prices                                                 Price: $20.00                          $24.00                         $27.50


Historical Average Trading Multiples    (2)
                                                                                                        $23.00                               $28.00


Comparable Companies                                                                 $20.00                                $25.00


Comparable Companies plus Control Premium                                                                         $25.00                           $28.50


Precedent Transactions

Canada                                                                                                            $24.00                  $27.00


U.S.                                                                                                     $23.00                           $27.00


Implied Price / Book Value                                                  1.2x                        1.5x                    1.7x                    2.0x


                                Source: Bloomberg and Thomson.
                                                                                                                                                            6
                                (1) Based on target prices from four of the seven companies covering XY Z.
                                (2) Range is from average P/E to average P/BV from January 1, 2005 to January 1, 2007.
          Comparable Companies - Example


                                                                                                                                                                                           Debt /
                                                                                                                           (2)
                                                                Price ($)       Market               Price / EPS          EPS CAGR                            Price /           ROE         Total    Div. Yield
                                                               28-Apr-08        Cap (1)         2007A 2008E (3) 2009E (3)  07-'09E                             Book            (LTM)       Capital    (LQA)

Canadian P&C Companies (C$)                                                    (C$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%
Canadian P&C Average                                                                                7.9 x          8.6 x          8.6 x          -6.8%          1.17 x          13.7%        12.5%        2.3%

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%
                (4)
Safeco Corp                                                         $45.23         $4,059            6.5x          7.6 x          7.7 x          -8.2%          1.20 x          19.4%        17.2%        3.5%
Mercury General Corp                                                $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          10.6x         10.4 x           9.7 x           1.6%          2.01 x          11.1%        21.5%        2.4%
U.S. P&C Average                                                                                   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.
                                                                                                                                                                                                          7
                                                              (3)     Based on Bloomberg estimates.
                                                              (4)     Multiples are calculated based on the closing price a day prior to the acquisition announcement by Liberty Mutual.
   Precedent Transactions - Example
 Canada
                                                                                                                              Price          Price /          Price /
                                                                                                                                                                               ROE
Date Announced      Acquiror                            Target                                                               (C$mm)         LTM EPS           Book
(in C$ millions)

18-Oct-07           Royal & SunAlliance Canada (1)      Canadian Northern Shield Insurance Company                               75            31.7x           1.4x            4.4%
30-Nov-05           Axa Canada                          Citadel (Winterthur Canadian Operations)            310                                10.4x           1.5x           14.8%
03-Oct-05           Teacher's Private Capital           GCAN Insurance Co.                                  150                                10.0x           1.5x           15.0%
03-Nov-04           La Capitale Assurances Générales    L'Unique Compagnie d'Assurances Générales            48                                 7.2x           1.6x           21.9%
07-Oct-04           ING Canada (2)                      Allianz Canada                                      370                                 7.1x           1.1x           15.5%
02-Mar-04           Canadian Western Bank               HSBC Canadian Direct Insurance                       25                                15.9x           1.3x            7.9%
20-Jan-04           Meloche Monnex                      Liberty Mutual's Canadian Personal Lines Business 130 - 140                             n/a            n/a              n/a
                    Torquest Partners, Newport
30-Jun-03                                               Gerling Canada Insurance Company                                         80             n/a            1.0x             n/a
                    Partners, CIBC Capital Partners
22-Nov-01           ING Canada (3)                      Zurich Canada Group P&C                                                 714             n/a            1.4x             n/a
Average                                                                                                                                        13.7x           1.3x           13.2%


 United States
                                                                                                                              Price          Price /          Price /
                                                                                                                                                                               ROE
Date Announced      Acquiror                                Target                                                          (US$mm)         LTM EPS           Book
(in US$ millions)
31-Oct-07           Mapfre SA                               Commerce Group Inc                                                 2,360           10.2x           1.6x           16.1%
17-Oct-07           Muenchener Rueckversicherungs           The Midland Co                                                     1,304           15.0x           2.1x           14.2%
16-Oct-07           The Doctors Co                          SCPIE Holdings Inc                                                  294            20.0x           1.4x           6.9%
11-Jun-07           DE Shaw & Co LP                         James River Group Inc                                               563            14.8x           2.5x           17.0%
07-May-07           Liberty Mutual Group                    Ohio Casualty                                                      2,725           12.5x           1.8x           14.0%
02-Mar-07           Zurich Financial Services               Bristol West Holdings                                               712            16.4x           1.9x           12.1%
24-Jan-07           American Insurance Group (AIG)          21st Century Insurance Group                                        639            16.3x           1.9x           11.7%
05-Dec-06           Texas Pacific Group                     Direct General Corporation                                          432            15.5x           1.7x           11.3%
04-Aug-06           Delek Capital Ltd                       Republic Cos Group Inc                                              287            14.6x           1.7x           12.0%
Average                                                                                                                                        14.8x           2.1x           12.8%

                                           Source: Bloomberg, SDC, MSA Researcher and various news services
                                           (1)    Price/Earnings value calculated using 1H 2007 annualized net income.                                                                8
                                           (2)    Price/Book value based on TD Newcrest estimate of adjusted book value.
                                           (3)    1.4x transaction multiple estimated by TD Newcrest Analyst Doug Y oung and calculated as a percent of premiums, not book value .
  Simplified Acquisition Model - Example
Deal Assumptions                                                          Sources and Uses
                               Buy Co.            Sell Co.               Sources
Share Price                     $10.00             $20.00                Cash                            $175    7%
Shares Outstanding                 300                 100               Debt                          $1,150   43%
Market Capitalization           $3,000             $2,000                Equity                        $1,325    50%
Premium Paid                                         20%                 Total Sources                 $2,650   100%
Acquisition Price                                  $2,400                Uses
Acquisition Price per Share                        $24.00                Purchase of Equity            $2,400    91%
                                                                         Debt Refinanced                 $200     8%
2008 Earnings                     $300                 $150              Transaction Fees                 $50     2%
P/E (2008)                        10.0x               13.3x              Total Sources                 $2,650   100%
Acquisition P/E                                       16.0x
                                                                          Other Assumptions
Book Value                      $2,000              $1,500               Buy Co. New Shares Issued      132.5
P/Book                            1.5x                1.3x               Cost of Debt                     5%
Acquisition P/BV                                      1.6x
                                                                         Interest Cost of New Debt       -$58
                                                                         After Tax Cost of Debt          -$37
                                                                         Synergies (after-tax)            $30
                                                                         Total Adjust. to Net Income      -$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

                                                                                                                       9
                               Source: Company reports and Bloomberg IBES estimates.
Simplified Acquisition Model – Example
                     Capital Structure
                                                             Buy Co.        Sell Co.    Adjust   Pro Forma
                     Cash                                        $75           $100      -$175           $0
                     Total Assets                             $5,400         $3,700         $0       $9,100

                     Debt                                        $400           $200    $1,150      $1,750
                     Other Liabilities                         $3,000         $2,000        $0      $5,000
                     Equity                                    $2,000         $1,500     -$175      $3,325
                     Total Assets & Liab.                      $5,400         $3,700               $10,075

                     Debt/Capital                                 17%            12%                   34%



                     EPS Accretion (2008)
                                                              Buy Co.        Sell Co.   Adjust   Pro Forma
                      Earnings                                   $300           $150       -$7         $443
                      Shares Outstanding                          300                    132.5        432.5
                      Earnings per Share (EPS)                  $1.00                                 $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

                                                                                                              10
                               Source: Company reports and Bloomberg IBES estimates.
Simplified Acquisition Model - Example


                      Sensitivity Analysis (2008 Earnings Accretion)
                                                                     Purchase Price Premium
                                    Synergies 2%                  0%       10%       20%        30%
                                       $0                         2%       -2%        -5%       -7%
                                       $15                        5%        2%        -1%       -4%
                                       $30                        9%        6%         2%       -1%
                                       $45                       13%        9%         6%        3%

                                                                       Purchase Price Premium
                          Equity Consideration
                                              2%                  0%                  20%       30%
                                      70%                         1%            -2%   -5%       -8%
                                      60%                         5%             2%   -2%       -5%
                                      50%                         9%             6%    2%       -1%
                                      40%                        13%            10%    7%        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.

                                                                                                      11
                              Source: Company reports and Bloomberg IBES estimates.
Simplified Acquisition Model - Example


                        Pro Forma Regulatory Capital
                                                             Buy Co.        Sell Co.       Adjust   Pro Forma
                         Required Capital                     $1,100           $800            $0       $1,900
                         Available Capital                    $2,000         $1,500         -$175       $3,325
                         Capital Ratio                         182%           188%                       175%
                         Minimum Target Ratio                  175%           175%                       175%
                         Excess Capital                          $75           $100                         $0



                        Adjusted Book Value of Sell Co.
                                                        Book                  Book Value            Equity
                                                        Value                    Multiple            Value
                        Capital at 175%                $1,400                      1.60x            $2,240
                        Excess Capital                   $100                      1.00x              $100
                        Total                          $1,500                      1.56x            $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

                                                                                                                 12
                               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




                                                                                                13
                          Source: Company reports and Bloomberg IBES estimates.

				
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