Presentation on theme: "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."— Presentation transcript:
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.
2 Acquisition Valuation Process of a P/C Insurer With content from: Acquisition Valuation of P&C Insurance Companies, Jaroslav Danhel, Peter Sosik (University of Economics in Prague). Strategic AnalysisActuarial/Financial Analysis Product Diversification Geographical Expansion Broaden Distribution Pricing Power with Scale Synergies Pro Forma Growth Underwriting Results Leverage Tax Valuation Model Output Reconsideration of Strategic Assumptions The valuation of a P&C company is often an iterative process.
3 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
4 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) Value = Valuation of future profit Sensitive to assumptions Validate other methods T t=1 CF t (1-r) t With content from: Acquisition Valuation of P&C Insurance Companies, Jaroslav Danhel, Peter Sosik (University of Economics in Prague).
5 Valuation Methods (contd) 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 per Share Earnings of Target Last-Twelve-Months (LTM) Forward (2008E) Normalized Post-Synergies Price-to-Book Multiple P/BV = Price per Share Book Value per Share Book Value of Target Current Tangible (excludes Goodwill) Adjusted (reserve adjustments) 1.0x value to excess capital
6 Valuation Football Field - Example Preliminary Value Range (C$ per share) Comparable Companies plus Control Premium Precedent Transactions Comparable Companies Analyst Target Prices (1) 52 Week High - Low Historical Average Trading Multiples (2) Canada U.S. Implied Price / Book Value $22 1.5x $26 1.7x $30 2.0x $18 1.2x $27.50 $20.00$25.00 $28.50 $27.00 $28.00 $27.00 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. $28.00 $20.00 Current Price: $20.00 $24.00 $23.00 $24.00 $25.00
7 Comparable Companies - Example (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.
8 Precedent Transactions - Example 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. United States Canada
9 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 Simplified Acquisition Model - Example Source: Company reports and Bloomberg IBES estimates. Deal Assumptions Buy Co.Sell Co. Share Price$10.00$20.00 Shares Outstanding300100 Market Capitalization$3,000$2,000 Premium Paid20% Acquisition Price$2,400 Acquisition Price per Share$24.00 2008 Earnings$300$150 P/E (2008)10.0x13.3x Acquisition P/E16.0x Book Value$2,000$1,500 P/Book1.5x1.3x Acquisition P/BV1.6x Sources and Uses Sources Cash$1757% Debt$1,15043% Equity$1,32550% Total Sources$2,650100% Uses Purchase of Equity$2,40091% Debt Refinanced$2008% Transaction Fees$502% Total Sources$2,650100% Other Assumptions Buy Co. New Shares Issued132.5 Cost of Debt5% Interest Cost of New Debt-$58 After Tax Cost of Debt-$37 Synergies (after-tax)$30 Total Adjust. to Net Income-$7
10 $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 Simplified Acquisition Model – Example Source: Company reports and Bloomberg IBES estimates. Capital Structure Buy Co.Sell Co.AdjustPro 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/Capital17%12%34% EPS Accretion (2008) Buy Co.Sell Co.AdjustPro Forma Earnings$300$150-$7 $443 Shares Outstanding300132.5 432.5 Earnings per Share (EPS)$1.00 $1.02 Accretion/(Dilution)2%
11 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. Simplified Acquisition Model - Example Source: Company reports and Bloomberg IBES estimates.
12 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 Simplified Acquisition Model - Example Source: Company reports and Bloomberg IBES estimates. Pro Forma Regulatory Capital Buy Co.Sell Co.AdjustPro Forma Required Capital$1,100$800$0$1,900 Available Capital$2,000$1,500-$175$3,325 Capital Ratio182%188%175% Minimum Target Ratio175% Excess Capital$75$100$0 Adjusted Book Value of Sell Co. Book Value Book Value Multiple Equity Value Capital at 175%$1,4001.60x$2,240 Excess Capital$1001.00x$100 Total$1,5001.56x$2,340 Base Case$1,5001.60x$2,400
13 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 Closing Thoughts Source: Company reports and Bloomberg IBES estimates.