The merger of two of the top five players in the life insurance space went a step further last week, with the boards of HDFC and Max Financial Services approving and detailing the deal structure.

The transaction, which now offers a better benchmark to value life insurance companies, has set the bar high, pegging the valuation of the two insurance players and the combined entity at a premium to recent deals in the life insurance space.

The swap ratio means a premium of about 20 per cent in valuation for HDFC Life vis-a-vis Max Life, which is reasonable, given the former’s healthy product portfolio, higher market share and strong bancassurance-led distribution channel. Max Life shareholders nonetheless gain on two counts. One, the deal has given a substantial boost to the company’s valuation. Two, the shareholders will gain over the long run, as the merger will place the combined entity at the top of the pecking order within the private space, across multiple parameters. For HDFC shareholders too, the per share fair value (based on the sum of the parts) will increase by about 15 per cent, based on the deal valuation.

The deal structure First, Max Life will merge into Max Financial Services (MFS), its holding company. For this, the shareholders of Max Life (other than MFS) will get one share of MFS for approximately five shares of Max Life. Second, demerger of the life insurance undertaking from MFS into HDFC Life, for which shareholders of MFS will get seven shares of HDFC Life (the merged entity) for every three shares.

HDFC Life would become a listed company, with HDFC (42.5 per cent) and Standard Life (24 per cent) as the promoters. The transaction also includes a non-compete and royalty fee (for the use of the ‘Max’ brand name) to the tune of ₹850 crore to be paid to the promoters of Max Financial Services.

Valued at a premium When the deal was announced last week, the market cap of Max Financial Services was about ₹14,480 crore. Since the company holds a 69 per cent stake in Max Life, the implied valuation of Max Life works out to about ₹20,900 crore. Based on the agreed valuation and exchange ratio, the relative valuation of HDFC Life and Max Life would be 69 per cent and 31 per cent respectively. The valuation of the merged entity thus comes to about ₹67,600 crore and that of HDFC Life works out to about ₹46,700 crore.

The transaction values HDFC Life at 4.6 times its FY16 embedded value and Max Life at 3.7 times. Embedded value is a measure used to value a life insurance business which, among other parameters, takes into account the future earnings of the company. These valuations are far higher than that pegged for these businesses earlier. Max Life, for instance, was valued at 2.5 times its embedded value. HDFC Life was valued based on its 9 per cent stake sale to its foreign partner last year, which worked out to about ₹19,000 crore, less than half the value assigned in the current deal.

Given this, there is an upside of 10-15 per cent in the fair price of MFS and HDFC. However, this will depend on the valuation at which the combined entity trades, when it is listed.

Life insurance policies are broadly categorised into traditional and ULIP policies. Merger of HDFC Life and Max Life will help widen the product portfolio and drive better margins. HDFC Life, for instance, has a higher proportion of ULIPs (56 per cent of portfolio in FY16), while Max Life has a traditional policies heavy portfolio (72 per cent in FY16). Districution too will be more efficient with Max Life’s agency channel and HDFC Life’s bancassurance channel.

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