Street finds discomfort in ICICI Lombard-Bharti Axa merger deal

Bharti Axa's weak underwriting and high combined ratio are earnings dilutive, while valuations are on the higher side

Even though the BSE Sensex was up about one per cent on Monday, the stock of ICICI Lombard General Insurance Company (ICICI Lombard) shed 1.4 per cent. following thde announcement of merger of Bharti Axa General Insurance Company’s (Bharti Axa’s) general insurance business into ICICI Lombard. While the deal, announced on Friday post market hours, improves ICICI Lombard’s market share to 8.7 per cent from seven per cent currently, making it the third largest general insurer, analysts believe the valuation given to Bharti Axa's general insurance business is not justifiable given the latter’s operating performance.

“Bharti Axa, is a sub-optimal business and yet to deliver strong financial performance. In that sense, the deal is expensive,” analysts at Kotak Institutional Equities said in a note. Based on share swap ratio of 2 shares of ICICI Lombard for every 115 shares of Bharti Axa, and ICICI Lombard’s closing price of Friday, the valuation comes to Rs 4,623 crore, or 7 times Bharti Axa’s FY20 book value. Though valuation is lower than ICICI Lombard's around 10 times FY20 book value, the deal would result in a 7.3 per cent equity dilution for ICICI Lombard’s shareholders given the valuations and an all-stock deal.

Bharti Axa’s weaker underwriting performance coupled with poor combined ratio are key operating concerns, which would dilute the combined entity’s near-term earnings. FY20 numbers of both the companies indicate over 20 per cent earnings dilution. Bharti Axa’s combined ratio stood at 120.4 per cent in FY20 versus 100.4 per cent of ICICI Lombard. Combined ratio – profitability measure for a general insurer – is operating costs plus incurred losses divided by total earned premium.

 

Also, Bharti Axa’s minuscule share of profitable retail health segment and higher exposure to crop insurance (2.6 per cent market share in FY20), which ICICI Lombard is staying away from due to volatility would mean no significant direct business expansion in near term.

However, there are benefits in the motor segment (48-51 per cent of overall business for both entities). According to the management, Bharti Axa has strong presence across original equipment manufacturers and dealerships, which would help in increasing penetration for ICICI Lombard. Some analysts also believe there is space to improve overall performance over medium term post merger, led by cost savings and distribution synergies.

Yet, there may be a stake sale overhang for ICICI Lombard’s stock as post this deal ICICI Bank will have to reduce stake in the general insurance arm to 30 per cent to comply with RBI rules. However, JM Financial analysts said, the bank is expected to seek an exemption to bring down its stake over a period of time. The jury, however, is out on this.