MERGER DAYS ARE HERE AGAIN !

Mergers and Acquisitions (M&A) activity is broadly driven by larger economic themes as companies reconfigure their strategic initiatives to match macro events and adjust to externalities that change the dynamics of their value chain or competitive landscape. The practice of mergers and acquisitions has attained considerable significance in the contemporary corporate scenario which is broadly used for reorganizing the business entities.

 

Indian industries were exposed to plethora of challenges both nationally and internationally, since the introduction of Indian economic reform in 1991. The cut-throat competition in international market compelled the Indian firms to opt for mergers and acquisitions strategies, making it a vital premeditated option. Insurance is one of many industries that enthusiastically embraced M&A as a way to boost revenue growth, enter new markets, and improve operating efficiencies.

 

Currently merger and acquisition activity is gathering momentum in insurance. The Indian insurance sector has, of late, been witnessing a spate of mergers and acquisitions (M&As) with many joint venture partners expressing their intent to look for new partners. Over the past 18 months, there have been at least six instances of stakeholders in insurance ventures expressing their desire to exit.

 

These included Exide Life Insurance, Future Generali India, Life Insurance and DHFL Pramerica Life. One reason why companies want to exit insurance is that leveraging is not happening in the sector. When companies get into this business, especially those from the non-financial sectors, and realise there is no leveraging, they start rethinking of their decision after few years. If the company’s new business and trail business (renewal) is almost the same as the industry average, then there is no cause for worry.

 

M&A activity in insurance began to be noted from January 2013, after Exide Industries, India’s largest producer of automotive and industrial batteries, decided to acquire ING Group’s stake in ING Vysya Life Insurance. Exide Life, which had a 50 per cent of the equity capital of ING Vysya Life Insurance, decided to acquire the remaining stake in the insurance firm.

 

This saw ING Group exit its insurance business in India. Later, in May 2014, ING Vysya Life Insurance Company Ltd was renamed Exide Life Insurance Company. Similarly the case of insurance joint venture, DLF Pramerica Life Insurance, to Dewan Housing Finance Limited (DHFL). DLF had then said this transaction was in line with its ongoing strategy to divest non-core businesses/ assets.

 

In July 2013, realty major DLF signed an agreement to sell its 74 per cent stake in its life. In December 2013, the deal was completed and the company was re-named DHFL Pramerica Life Insurance. Some companies have also made decisions to divest a part of their stake to an external partner. In March 2013, Pantaloon Retail (now called Future Retail) decided to sell 22.5 per cent of its stake in Future Generali India Life Insurance to Industrial Investment Trust Limited (IITL).

 

In December 2013, Future Retail informed the stock exchanges that it has received the necessary regulatory and government approvals for the deal. Now, Future Retail holds three per cent in the insurance venture, while 49 per cent is held by Sprint Advisory Services and 22.5 per cent by IITL. The trend of more stringent regulation continues and insurance companies should take note of several regulatory developments that may impact their M&A planning.

 

Despite the challenges, insurance industry appetite in India has not dissipated. Insurance M&A pursuits will proliferate as large insurance companies and third-party capital chase regional expansion opportunities. It is increasingly challenging to find value proposition targets and with demands not abating anytime soon, upward price pressures will continue.

Merger deals being called off

There are various factors that facilitate mergers and acquisitions in India. Government policies, resilience in economy, liquidity in the corporate sector, and vigorous attitudes of the Indian businessmen are the key factors behind the fluctuating trends of mergers and acquisitions in India.

 

Alliances in Industry

1. Maximum mergers and acquisitions in the insurance sector have taken place in the USA followed by UK.

2. From 1990 to 2003 – 666 M&A’s took place in US alone followed by UK at 217.

3. In EU – After the 3rd Directive i.e. during 1990 to 2002 – 2,595 M&As involving European insurance companies all over the world.

 

A prospective deal between a global reinsurer and an Indian corporate to begin a health insurance business was put on the back-burner due to delay in necessary approvals. There has also been a case of a merger deal being called off. More than a year after Larsen & Toubro (L&T) General Insurance and Future Generali India Insurance announced a joint venture combining both the companies’ businesses; L&T in April 2014 said the parties had decided to call off the venture.

 

This was due to valuation issues around the new venture. In March 2013, L&T, Future Group and Generali Group signed a non-binding term sheet for the merger of L&T General Insurance and Future Generali India Insurance. This was the first-of-its-kind merger that was proposed in the insurance sector.

 

Were the merger to happen, L&T would have held a 51 per cent stake, Generali Group 26 per cent stake and 23 per cent was to be held by Future Group in the merged entity. This deal was to be approved by the Insurance Regulatory and Development Authority (IRDA) and needed to have a nod from the court as well as the Competition Commission of India. While some exits have happened and some more may be on the anvil, unlocking has not happened in the industry.

In the life insurance sector, there have been reports of some foreign companies operating in the financial services sector and having presence in India through joint venture agreements in insurance, have been planning to exit. However, these exits haven’t happened owing to valuation issues and disagreement with partners. Similarly, some non-financial sector companies that are partners in insurance companies had earlier made a re-think on their decision to continue in the venture.

 

The gestation period in insurance is quite long. Players need to invest at least 8-10 years in a venture for it to become profitable. Making profits in a short duration is not a possibility. Hence, cases of exit intentions are more. Especially for foreign partners when the FDI incentive is not present, there is no major reward to stay invested if they are not cash-rich. Jammu & Kashmir Bank and Religare Enterprises recently expressed their intent to exit from their respective life insurance investments.

 

In June 2014, J&K Bank informed the exchanges of its decision to sell out the entire stock of equity shares (five per cent) in PNB Metlife India Insurance, subject to the satisfactory valuations.

 

Similarly, Religare Enterprises expressed its desire to exit the joint venture AEGON Religare Life Insurance. Religare and Aegon have agreed that Religare will exit once a replacement shareholder is identified and is approved by the regulatory authorities.

 

M&A deals in insurance

 2011: Nippon Life buys 26 per cent stake in Reliance Life Insurance at an aggregate value of Rs 3,062 crore.

April 2012: Japan’s Mitsui Sumitomo (a unit of MS&AD Insurance Group Holdings) announces buying of 26 per cent stake in Max New York Life for Rs 2,731 crore. The life insurer re-branded Max Life Insurance Company, as the US-based New York Life exited the joint venture after nearly 10 years.

 

July 2012: Tata AIG rechristened AIA following the exit of American International Group from Hong Kong-based insurer AIA Group.

 

September 2012: IRDA approves the 30 per cent stake purchase by Punjab National Bank in MetLife India Insurance (now PNB MetLife Insurance).

January 2013: Exide Industries decides to acquire remaining 50 per cent stake in ING Vysya Life Insurance for Rs 550 crore, subject to regulatory approvals. ING exits venture, which was later re-named Exide Life Insurance.

 

March 2013: Pantaloon Retail inks an agreement with Industrial Investment Trust Limited to sell 22.5 per cent of its stake in Future General India Life Insurance.

 

March 2013: L&T, Future Group and Generali Group signs a non-binding term sheet for the merger of L&T General Insurance and Future Generali India Insurance. Deal later called off in April 2014.

July 2013: DLF says it is selling its stake in DLF Pramerica Life Insurance to Dewan Housing Finance. Later re-named DHFL Pramerica Life Insurance.

June 2014: Jammu & Kashmir Bank looks to exit PNB MetLife Insurance by selling its five per cent stake. Deal has not yet been completed.

 

September 2014: Religare Enterprises says it intends to exit AEGON Religare Life Insurance.

 

M&A guidelines:

Till now, the Insurance Act provided for the M&As only for life insurance companies. Insurance regulator IRDAI had notified the merger and acquisition guidelines for general insurance companies thereby paving way for consolidation in the sector. With more than 10 years after opening up of the insurance sector, the regulations would pave way for M&As between 23 private sector players, most of who have foreign investment that is capped at 26%.

 

The Regulation – Insurance Regulatory and development Authority (Scheme of Amalgamation and Transfer of General Insurance Business) Regulations, 2011 – would apply to all private general insurance companies with immediate effect. Following this, the general insurers would now have to file the draft agreement of the proposed merger with the IRDAI and also the respective balance sheet while seeking approval from the regulator.

 

The regulator has retained with itself the power to veto the valuations arrived at by the companies involved in M&As, saying that the Authority would carry out an independent valuation of the insurance business of the transacting parties to arrive at the valuation. In order to safeguard the policyholders’ interest, the IRDAI has mandated the insurers to inform their respective customers about the deal.

 

Besides IRDAI, an acquirer would need to have approvals from the Reserve Bank and the finance ministry, in case it has foreign direct investment. It also needs to have clearance of the Sebi and the Competition Commission of India (CCI). Most of the private sector general insurance companies require fresh infusion of capital which may come from foreign partners, post enhancement of the FDI cap. The general insurance business has remained loss making for want of capital, which is constrained due cap on foreign capital infusion.

 

Foreign Players in Non-Life Sector

1.Royal Sun Alliance, UK

2.Millea Asia Pte. Ltd., Japan

3.American International Assurance Co., USA

 

4.Allianz, Germany

5.Mitsui Sumitomo, Japan

6.Fairfax through its affiliates, Canada

 

7.ERGO, Germany

8.Individual Promoters, UAE

9.Apollo Hospital Enterprises Ltd.; Apollo Energy Company Ltd.; PCR Investment Ltd. & DKV, Germany (August 3, 2007)

10.Pantaloon Retail Ltd.; Shendra Infrastructure Development Ltd. (SIDL); Participatie Maatschapij Graafsschap Holland NV, Netherlands (“Generali”)

11.Sompo, Japan

12.Santam, South Africa

13.AXA Holdings, France

14.QBE, Australia

 

Begining of Consolidation ERA:

Insurance sector currently has 24 life insurance companies and 29 general insurance companies including five standalone health insurers. A likely era of consolidation begins in the insurance sector with board approval for merger of Max Financial Services and Max Life with HDFC Life. The second such deal this month; earlier, it was announced that L&T General would merge into HDFC ERGO General Insurance (a Rs 551 crore deal).

 

Till now, not a single merger or acquisition has been completed. Some talks were conducted in the past for possible deals but weren’t fruitful. For instance, in March 2013, L&T, Kishore Biyani’s Future Group and Generali Group had signed a non-binding term sheet for the merger of L&T General Insurance and Future Generali India Insurance. This was a first-of-a-kind proposed. L&T was to hold 51 per cent stake, Generali 26 per cent and Future 23 per cent.

 

However, in April 2014, L&T General and Future Generali India called off the venture, due to ‘inordinate delay’ in finalising a transaction. To reach the next phase of growth, apart from mergers and acquisitions, listing on the stock exchanges would be the next logical step. Sector officials said the regulator feels those completing 10 years should do so. However, only HDFC Life and ICICI Prudential Life have announced intent to list.

 

While the Indian insurance market has been through several cycles in a relatively short time, the expenses are still to reduce to international levels and scale is not increasing exponentially any more. Logically, one will see consolidation, which can come out of desire to have larger scale and ability to address different clientele, and better synergy in expenses, leading to higher value for customer and shareholder. Housing Development Finance Corporation (HDFC) would sell up to 10 per cent stake in HDFC Standard Life, through an Offer for Sale.

 

The latter is a joint venture (JV) between HDFC and Standard Life Plc, a provider of financial services in the UK. Standard Life (Mauritius Holdings) Ltd holds 35 per cent stake in the JV. Earlier, HDFC had sold a nine per cent stake in HDFC Life to Standard Life, for Rs 1,705 crore, valuing the firm at Rs 18,951 crore. This could open the way for more. The first private life insurance company to be granted a licence, HDFC Life was launched in 2000.

 

It was also the first insurer to clearly state it was planning an Initial Public Offer (IPO) of equity, though the company was waiting for market conditions to improve and also for foreign direct investment (FDI) norms to be eased. This was enabled in February 2015, when the law was changed to allow FDI up to 49 per cent, from 26 per cent.

Max Financial Services and Max Life have entered into an agreement for a merger with HDFC Life. In a statement to the stock exchanges, Max Financial Services and Housing Development Finance Corporation (HDFC) confirmed that their respective boards have approved entering into a confidentiality, exclusivity and standstill agreement to evaluate a potential combination through a merger.

 

The agreement provides for a mutually agreed exclusivity period for due diligence and discussions between the parties in relation to a proposed transaction.

 

However, it has not been mentioned as to how much stake the foreign partner of Max Life will hold post the merger. No timeline has been given for the merger. The combined entity would be the largest private sector insurer, both in terms of assets under management and new business premiums. Assets under management of the combined entity would touch Rs 1.10 lakh crore and new premiums would almost touch Rs 9400 crore. HDFC Life is a joint venture between HDFC and Standard Life Plc, a provider of financial services in the UK. While HDFC holds 61.65 per cent in it, the foreign partner holds 35 per cent. Max Life Insurance is a joint venture between Max Financial Services Ltd. and Mitsui Sumitomo Insurance Co. Ltd. The foreign partner holds 25 per cent in the insurer. Max Financial Services is already listed on the stock exchanges and is the holding company of Max Life Insurance.

 

Great Ambitions:

This consolidation in the private (life insurance) sector would enable the creation of large companies which can then drive economies of scale, thereby servicing customer interests better at constantly declining structures. The strong distribution network of Max Life, the combined entity would be able to achieve double- digit annual growth.

 

The combined entity will become the country’s largest private sector insurer, both in terms of assets under management and new business premiums. Assets under management of the combined entity will touch Rs 1.10 lakh crore and new premiums will touch Rs 9,400 crore. This will be the second merger announced by HDFC.

 

While the companies are yet to work out the deal valuations and swap ratios, according recent brokerage reports, the value of HDFC Life is about Rs 24,000 crore while that of Max Life is pegged at Rs 16,000 crore based on analysts’ estimates for FY17. These are only indicating purposes. While HDFC Life is unlisted, Max Financial Services’ market capitalisation stood at Rs 11,480 crore, a day prior to the merger announcement.

 

The stock gained 10.3 per cent following the announcement to close at Rs 472.80. Given that it is debt free and that it holds 68 per cent stake in Max Life, the market was valuing the insurance business at Rs 16,880 crore, which is a little over what analysts have pegged the value at. If this is the basis of valuations, the shareholding in the merged entity will be 60 per cent for HDFC Life shareholders and 40 per cent for Max Life shareholders. Given that public shareholders held 69.55 per cent stake in Max Financial Services as on 30 March 2016, they will hold approximately 28 per cent stake in the combined listed entity. Since the minimum public shareholding is mandated at 25 per cent, the new entity will be compliant on that front.

 

Recent insurance regulatory reforms in countries, such as China, Indonesia and India, have created newfound M&A opportunities. Since June 1, 2014, Chinese-based foreign insurers, as well as domestic insurers, have had the ability to acquire shares in more than one company operating in competing lines of business. The recent landmark insurance law enacted in India allows foreign insurers to invest up to 49 percent in a local Indian insurance company.

 

The outlook is for a much anticipated active M&A market, driven by insurance companies hungry to get a slice of the growing Indian insurance pie. Private life insurers depending on individual agents for business are suffering from low productivity and higher fixed costs. The more the variable costs, the better for the company but it is not so in the Indian life insurance space. Performance has been affected by regulatory changes. Previously, insurers enjoyed handsome surrender profits, but with changed regulations, the surrender profits have largely vanished whereas the policy persistency ratio has declined, insurance executives complained. For life insurers to make a profit, the continued renewal of policies by policyholders is a must as the cost of acquisition is mostly met upfront.

 

Life insurance space will see consolidation. In the next 12-18 months, insurance can see 3-5 such deals between small and medium sized companies. At present, there are 24 life insurance companies in India and most of them have foreign partners. Most of the companies are struggling to grow their presence and have a market share of less than 1%. Many foreign investors have raised their equity to 49% after foreign direct investment limit was raised from 26%.

 

The HDFC-Max merger, the first of its kind in the Indian life insurance market will open the floodgates for more deals in the segment. Logically, one will see consolidation, which can come out of a desire to have larger scale and ability to address different clienteles, and better synergy in expenses, leading to higher value for customer and shareholder. There is a big mismatch between acquisition costs and margins.

 

The cost of distribution is very high. While bank-promoted life insurers are reaping the benefits of a wide distribution network, those which do not have bancassurance partners, or those non-bank promoted life insurers that have bancassurance partners, are suffering from high distribution costs. Non-bank promoted life insurers have to shell out huge sign-up bonuses to a bank to act as their corporate agent which even over a long period does not work out economically, note industry players. LIC, the only state-owned life insurer, has a market share of about 70%.

 

There are 23 private life insurance players in India. Four of them control around 20% of the life insurance market while 19 of them share the remaining 10%. More mergers and acquisitions are to be expected. For more than 10 years, companies individually have not been able to gain significant market share. The private life insurance companies are not able to shake the strong position of Life Insurance Corporation of India. Market conditions are appropriate for consolidation not only for life insurers but also for non-life insurers.

 

References:

1. https://www.irda.gov.in
2. http://www.business-standard.com/article/finance/hdfc-max-to-merge-life-insurance-arms-116061800054_1.html
3. IRDA Annual Report 2014-15
4. http://business.mapsofindia.com/finance/mergers-acquisitions/mergers-and-acquisitions.html
5. http://www.ironshore.com/blog/insurance-industry-merger-and-acquisition-appetite-in-the-asian-region