Reliance Capital: Gains 'insured'

The deal to sell a minority stake in the life insurance business will lead to enhanced stock valuation for the company and provide funds for future growth.

The announcement of Reliance Capital, controlled by Anil Ambani, to sell a 26 per cent stake in its life insurance subsidiary, Reliance Life Insurance, to Japan-based Nippon Life Insurance Company on Monday, has proved to be a double-edged sword. While the deal, worth $680 million (Rs 3,062 crore), values the insurance arm at $2.6 billion (Rs 11,500 crore). It has helped enhance the market value of the business and will also provide nearly Rs 2,500 crore in cash inflow to Reliance Capital, which it will use to fund the growth of its other businesses.

 

While most analysts had valued Reliance Capital’s stake in Reliance Life Insurance at Rs 285 per share, or about Rs 7,000 crore, this deal values it at Rs 468 per share of Reliance Capital, which is a huge premium (64 per cent). Not surprisingly, after the deal announcement, Reliance Capital’s stock posted gains of nearly 10 per cent on Monday. Reliance Capital’s other key businesses are also doing well, all of which put together should help the stock deliver good returns in the medium term.
 

PROFIT MIX
In Rs crore	FY10	9MFY11	% chg ^
Finance & Investments	342.6	116.6	-66.0
Asset Management	230.3	176.5	-23.3
General Insurance	-90.6	-91.1	0.6
Commercial Finance	135.0	176.5	30.7
Others	-27.4	8.0	-129.2
Figures represent profit before tax of each of the businesses  ^ change is year-on-year                                                            Source: Company

 

INCREASING PROFITABILITY
In Rs crore	FY10	FY11E	FY12E
Net Interest Income	735	891	988
% change y-o-y	3.1	21.2	10.8
Total Operating Income	4808	4988	5513
% change y-o-y	1.1	3.7	10.5
Adjusted Net profit	433	515	666
% change y-o-y	-57.4	18.9	29.2
Book Value / Share (Rs)	313.0	326.4	345.9
E: Estimates (prior to deal announcement) Source: BoA-ML Report

Insuring future growth
Japan’s largest private insurer, Nippon Life has over 14 million policies in Japan and posted revenues of $72 billion and profit of $2.6 billion for 2009-10. Apart from the fund infusion, Reliance Life Insurance will gain from Nippon's vast experience in areas of product development, underwriting, investment management, and risk management. While the deal is expected to be completed in next 3-6 months, around 90 per cent of the Rs 3,062 crore proceeds will accrue to Reliance Capital, which will use them to grow its commercial finance, distribution and exchanges businesses.
 

SUM OF THE PARTS*
In Rs per share  of Rel. Capital	FY12E BoA-ML
Life Insurance	285
General Insurance	30
Asset Management	212
Reliance Money	29
Investments @ Book Value	75
Consumer Finance	134
Total	765
Less: Holding Co.  discount @15%	115
Final Value per share	650
* SOTP valuations arrived a day prior to the deal announcement                                                     E: Estimates Source: Bank of America Merrill Lynch Global Research

The balance (about Rs 200-300 crore accruing to Reliance Life) will be used to fund its business growth, which hasn’t been good off late thanks to regulatory changes. For the fiscal year till January 2011, the company witnessed around 19 per cent contraction in its annual premium equivalent (APE) as against a 13 per cent dip witnessed by the private life insurance industry. This was partly due to the upper cap on expenses and increase in lock-in period imposed by IRDA on ULIP plans of all insurance players. However, Reliance Life Insurance’s new business achieved profit (NBAP) margins grew by 18 per cent for the nine months ending 31st December 2010, driven by a growing share of traditional business coupled with cost rationalisations. It posted minimal profits in the December 2010 quarter and is expected to break even in the current quarter. The management has indicated that new business has started picking up and should witness good growth in the next fiscal. Analysts estimate the company’s NBAP margins to be around 14.5 per cent in 2011-12.

The deal valued at 26 times Reliance Life’s trailing 9 months NBAP and 4.8 times trailing APE is at significant premium to analysts’ estimates. However, it will now act as a benchmark for valuing other insurance companies besides, Reliance Life’s IPO whenever regulations permit.

The road ahead
Overall, the deal does look positive for Reliance Capital. Notably, the prospects and profitability of its other businesses like consumer finance segment and asset management (AMC) which account for a major part of its SOTP valuations is also looking up and should fuel the consolidated growth for the company. To given an example, the consumer finance business reported a 37 per cent year-on-year growth in loans in December quarter with the share of unsecured loans falling to a low of 5 per cent compared to over 20 per cent a year ago. Focus on profitable growth has ensured this business’ profits jump 108 per cent to Rs 79.3 crore in the quarter, even as total income grew just 7 per cent to Rs 348 crore. Similarly, the AMC business has been focussing on cutting costs and increasing the share of more stable retail sales, which has helped improve profitability in the recent past.

Given the improving prospects, analysts estimate Reliance Capital’s earnings’ to grow at around 27-30 per cent in 2011-12, much faster than the topline growth. While consensus EPS is estimated to be around Rs 26 for FY12, this is likely to go up after the deal. That’s because, while a lower stake in Reliance Life Insurance will proportionately reduce the consolidated financials of Reliance Capital, the nearly Rs 2,500 crore of fund inflows consequent to the stake sale should earn the company other income, till these funds are invested in its other growing and profitable business. Most analysts have a ‘buy’ rating on the stock and see a 20-25 per cent upside from current levels of Rs 561.80.