ICICI Lombard rating: Buy — Significant deal at not too high valuation

We view this as a significant but not really game-changing ramp-up of I-Lom’s distribution capacity—accomplished at a not-too-onerous valuation.

ICICI Lombard (I-Lom) has entered into a scheme of arrangement to amalgamate Bharti AXA General Insurance (BAGI)—a diversified general insurance business ~25% its size in gross direct premium income (GDPI) and 15–25% in terms of distribution node count.

I-Lom is making a fresh issue of 35.76 mn shares (7.3% dilution) to current BAGI promoters, which translates into two shares per 115 shares of BAGI. At I-Lom’s current market cap of ~Rs 588 bn (~6.1x FY20 NWP, 9.6x FY20 P/B), the share issue implies valuation of ~Rs 46 bn for BAGI (~2.3x FY20 NWP, 6.5x FY20 P/B—accounting for accumulated losses).

Arithmetically, this arrangement dilutes I-Lom’s FY20 EPS as BAGI made a loss of ~Rs 2.44 bn. However, given the acquisition likely entails immediate cost overhauls, this may not be the best gauge of value creation from the merger. We view this as a significant but not really game-changing ramp-up of I-Lom’s distribution capacity—accomplished at a not-too-onerous valuation.

We await detailed financials of the de-merged BAGI to build them in our estimates. Our chief concerns are twofold: (i) integration challenges and net capacity gain after elimination of redundancies; (ii) implications of this buy for its appetite for acquiring a monoline health insurance business, which could drive its dominance in every business that ‘matters’. I-Lom remains our preferred long-term BFSI top pick; reiterate Buy with a TP of Rs 1,600.

Goals clear, timeline less so
Mgmt was tight-lipped on the rationalisation timeline, only stating that it will be more than a year. They were forthcoming about the elements wherein they anticipate synergies. Other than economies of management/branding, they believe these may span: (i) renegotiation of distribution contracts from a position of greater BS strength as well as size; and (ii) integration of agency channels and OEM/product/data capabilities.

Last but not least, while gauging merger benefits one must contextualise overlap in product/distribution capabilities—specially considering shared strengths in auto OEM relationships. All said and done, BAGI’s cost ratio of 42% seems mainly a function of sub-optimal scale and therefore much easier to rectify.