How the 64-year-old Life Insurance Corporation should be valued for stock market listing
Chief Economic Advisor K.V. Subramanian recently hinted that the government could mobilise Rs 90,000 crore by selling 6-7 per cent stake in Life Insurance Corporation (LIC). This was the first statement by a senior government functionary on the issue after Finance Minister Nirmala Sitharaman announced plans for LIC's initial public offering (IPO) in her FY21 Budget speech. "I have done some back-of-the-envelope calculations," he said. This Rs 90,000 crore for a 6-7 per cent stake puts LIC's valuation at Rs 12.85-15 lakh crore, making it India's second most valued company after Reliance Industries (RIL), ahead of marquee names such as HDFC Bank, TCS, Infosys and HUL.
But it's too early to celebrate. Valuing the 64-year-old company is perhaps the toughest of tasks because of its opaque style of operations. One reason is that it is governed by the LIC Act of 1956 with Insurance Regulatory and Development Authority of India (IRDAI) having very little say in regulating its operations. Then there is the complex product portfolio skewed towards savings than protection (in contrast to other listed life insurers) and a sovereign guarantee backing every policy. There are also concerns about a unique profit-sharing arrangement under which policyholders pocket 95 per cent surplus and shareholders (right now, government of India) get 5 per cent. "The entire structure of LIC has to be revisited to make it more investor friendly. If a major part of surpluses goes to policyholders, investors, especially institutional, will be wary of investing," says Ajay Sharma, Managing Director, Valuation Services (India) at Colliers International. Last, but not the least, a large chunk of LIC's equity investments comprise PSU shares it was forced to buy over the years to help the Centre meet its disinvestment targets.
Even positives such as brand name and fixed assets such as its prime real estate are tough to value with precision. "The valuation of the corporation will be based on several factors like products, real estate, assets and investments. The totality of all that plus the brand value," LIC Chairman M.R. Kumar said recently. BT's request for a meeting with Kumar was pending at the time of going to press.
In spite of these challenges, the process of valuing LIC has begun with the appointment of SBI Capital Markets and Deloitte as advisors for the pre-IPO process.
The How Question
LIC is India's 2nd-largest financial services institution with Rs 31 lakh crore balance sheet, next to the country's largest bank, State Bank of India (SBI), which has assets of Rs 39.51 lakh crore. But there is no comparable company in terms of top line. For example, LIC earned Rs 57,958 crore first-year premium and Rs 1,20,317 crore single premium in FY20. Renewal premiums were Rs 2,01,113 crore. These figures (including investment income) gave it net revenues of Rs 6.15 lakh crore. RIL reported Rs 3.65 lakh crore revenues in FY20. This shows the enormity of the task before LIC's valuers.
Then there is the issue of embedded value (EV) that life insurers have to mention in their IPO documents. Insurance is a long-term business where a company receives recurring payments over long periods. One of the most popular ways of valuing such a business is finding out the EV, the sum of present value of all future profits from existing business plus net worth. "LIC does not publish either its EV or value of new business," says Rajeev R. Shah, Managing Director and CEO of RBSA Advisory, which is into valuation, investment banking and corporate restructuring.
Banking and financial services businesses are valued on the basis of price to book (PB) value while manufacturing and some services businesses are valued on price to earnings (PE) multiples. There is also sub-classification within financial services - percentage of assets under management (AUM) for valuing mutual fund (savings) businesses, EV multiples for insurance (protection) firms and PB for lending businesses (banks and NBFCs).
PB is the key parametre for valuing lending businesses in the stock market. For example, Kotak Mahindra Bank is trading at one of the highest PB values of 5.97 times, which means the market is valuing it at almost six times its book value. SBI, on the other hand, is trading at a PB value of just 0.85.
Once investors get an EV of LIC, the market will put a value over and above it. "It could be one time or five times," says an insurance expert. ICICI Pru Life is valued at 2.68 times its FY20 EV of Rs 23,000 crore. Similarly, HDFC Life is at 6.10 times its FY20 EV of Rs 20,650 crore.
One of the simplest ways of valuing a life insurer is percentage of AUM. India has three listed private life insurers. HDFC Life's market capitalisation is almost equal to its AUM. ICICI Pru Lifes market cap is 34 per cent of its AUM. Advisory firm RBSA says the reasonable range for LIC is 30-35 per cent of AUM. The valuation comes to Rs 10 lakh crore.
However, AUM may not be the right way to value LIC as its owner gets way less than shareholders of private insurers. LIC shares its surplus with policyholders in the ratio of 95:5. The shareholder, the government, gets only 5 per cent. Private sector insurers share 100 per cent surplus from non-participating business (such as term plans) with shareholders. This is in addition to 10 per cent surplus from participating business (share in profits, savings products).
This is also the reason for LIC's low book profits. It reported a profit of Rs 2,712 crore in FY20 as against HDFC Life's Rs 1,300 crore and SBI Life's Rs 1,420 crore. "While LIC's AUM is 24 times HDFC Life's, its PAT available to shareholders is just twice that of HDFC Life," says Shah of RBSA. Another reason for lower shareholder returns is low yield on investments. "We do not know the quality of LIC's investments," says Ajay Sharma of Colliers International. LIC's investment yields are 100 basis points lower than that of private sector insurance companies.
Experts also suggest use of market share method for valuation. LIC's share of first-year premium is 68 per cent. HDFC Life, with 6.71 per cent share, is valued at Rs 1,25,912 crore. ICICI Pru Life, with 4.76 per cent share, is at Rs 61,514 crore. LIC's most conservative valuation with 68 per cent market share comes to Rs 12-13 lakh crore.
But valuation experts raise doubts about AUM or market share method as LIC's profile is very different from that of private sector insurers. "LIC has a larger share of savings products, which are less insurance products as compared to pure life products. The private sector has a larger share of protection plans," says Santosh N., Managing Partner, Duff & Phelps Advisory. Unlike private players, bulk of LIC's business is traditional policies (non-unit linked).
The larger share of savings products distorts the AUM. "Payout liabilities in savings products or participating plans are high. LIC gets huge cash flows by way of first-year premium and renewals but liability to pay out in future is also large," says Sharma. "The profitability of protection products is significantly higher than that of savings products," says Santosh. So, taking the AUM multiple of a private sector life insurance player and applying it to LIC is not fair, say experts
LIC is in the process of appointing an actuarial firm to find out the present value of existing business. The business mix includes pension, savings and protection plans. The actuarial firm will first make assumptions about mortality rate, profit margins, etc, to zero in on present value of existing business to arrive at the EV. Another factor impacting present value is persistency, that is, for how long do policyholders pay premiums. Insurance companies calculate persistency for 13 months to 61 months. LIC's 61 months persistency is way higher than that of all three listed life insurers -SBI Life, ICICI Pru Life and HDFC Life. "LIC's persistency levels will tend to be higher because of higher share of savings products. People who buy a money-back or any other policy with expectation of returns if they survive continue the policy for longer. In pure protection products, there is every chance of a policyholder deciding not to continue," says Santosh. It is easier to compare persistency levels of private sector companies with each other but not with LIC.
EV is the sum of not only present value of future business returns but also net worth. The net worth of LIC is currently low because of its narrow capital base of just Rs 100 crore. A decade ago, it was just Rs 5 crore. IRDA has not forced LIC to increase the base because of the LIC Act and sovereign guarantee (there is no solvency risk). "The balance sheet of LIC has to be restructured accordingly," says Nitin Aggarwal, Vice President, Motilal Oswal Securities.
The government, say reports, is considering authorised capital of Rs 20,000 crore. Since it is facing a cash crunch, one option is to add back any revaluation of LIC's assets as capital. RBSA Advisory says many assets have not been recorded on balance sheet at fair value because of LIC's long history and closely held nature.
Therefore, one of the first big tasks for the advisors will be revaluation of real estate assets. LIC has eight zonal offices in prime cities. It also has 113 divisional offices that control operations. Then there are 2,048 branch offices whose main job is customer service and sourcing. This is apart from 1,526 satellite offices and 3,354 mini offices in small towns. In the latest balance sheet, freehold land is valued at Rs 91 crore and leasehold land at Rs 76 crore. The value of the buildings is mentioned as Rs 1,750 crore. "The market value of these assets will be significantly higher than what has been put in the balance sheet," says a retired LIC official.
How will the revaluation be done? First, LIC has to take stock of how much real estate it needs to run the business and how much is surplus given the rise in digitisation and the changing business model. The real estate required can be sold and taken on lease to generate additional cash flows. "Operational assets like land, building and machinery are assumed to be part of the business and, hence, reflect in the valuation. But real estate, which is an operational asset, can always be sold at a higher value and taken on lease," says an expert. The present value of future lease payments could be less than the lump sum raised by selling the properties. "This monetisation of assets will enhance value as margins will increase," says Santosh of Duff & Phelps Advisory.
Some experts suggest that revaluation of assets will not drastically change the valuation. "You cannot encash your assets. LIC buildings cannot be sold," says an investment banker. But how much revaluation can be taken on books is something the corporation will have to decide in consultation with the government.
Once EV is known, it will be assigned a multiple to arrive at the valuation. "Either you can consider a multiple of EV or a multiple of value of new business. Both these parameters are not available in public domain," says Shah of RBSA. HDFC Life gets a multiple of five-six times its EV. But will LIC get the same multiple as private sector insurance companies?
Some experts predict a discount to private peers because of public sector tag and lower profitability. It's a quasi sovereign wealth fund as government often uses it as a war chest if there is trouble in the financial system. In future, too, LIC will be used to save the financial system (it recently bought the failed IDBI Bank). "We fear that LIC will continue to be used as a lender of last resort. The private sector, however, is focussed on profitability. This will make LIC less valuable than private sector companies," says an expert.
LIC's public sector nature will not change as the proposed divestment is just 25 per cent. That is why public sector banks trade at such huge discounts to private sector banks - they get a PB value of less than one whereas private sector banks are at two-plus because of better growth and performance. Investors in government-owned companies generally have concerns regarding government interference, archaic performance management system, legacy issues, slower digitisation, etc. "The market valuation will also depend on the nature and shape of corporatisation as LIC has to adhere to the Companies Act," says Shah of RBSA. The insurance regulator has strict prudent regulations such as capping of stake in other companies at 15 per cent; LIC owns more than that in some companies.
There is also the issue of sovereign guarantee. "The value will be different if sovereign guarantee continues and vice versa," says RBSA. The government has to take a call on giving sovereign guarantee for all policies or only for policies in force, which is yet another unknown as of today.
LIC's costs are also higher than that of its private peers. For instance, it largely depends on its agents, which results in higher commissions. LIC's commission ratio, which is gross commission paid to gross premium, is 5.40 per cent as compared to 4.56 per cent for HDFC Life. LIC gets most of its business through agents whereas the private sector heavily uses online and banking channels to keep customer acquisition costs low. "The cost of getting revenues is very high because of higher acquisition costs and commissions," says Santosh.
However, on the positive side, the value of subsidiaries will also get reflected in the valuation. RBSA Advisory, in its report in March this year, said LICs cost of investments in unlisted equities is Rs 1,338 crore, while in subsidiaries and joint ventures, it is Rs 25,488 crore. "We understand that these are recorded at cost; the market value of these investments may be substantially higher," says RBSA. LIC Housing Finance, which is 40 per cent owned by LIC, is valued at Rs 15,740 crore. IDBI Bank, majority owned by the corporation, is valued at Rs 39,000 crore. LIC's ratio of management expense to gross premium is also low at 14.66 per cent compared to private players' 20 per cent.
A Macquarie India report has pegged the EV of LIC at Rs 25,000 crore, equal to that of the much smaller private sector players. This is without the restated net worth, which includes new capital base and revaluation of assets. Still, Rs 25,000 crore is very low, say experts. Brokerages in India have decided not to guess LIC's valuation.
Clearly, valuation of LIC is going to be a complex exercise. A small error could cost the government dearly as happened in case of railway catering services company IRCTC Ltd. The government divested a little over 12 per cent in IRCTC at Rs 315 -320 per share in September last year. The stock zoomed to Rs 1,400 within months. It is still at Rs 1,300-1,400 levels. This means a notional loss of Rs 2,200 crore for the government. On the other extreme, another state-owned company, GIC Re, has seen a 50 per cent fall in its share price since listing three years ago. CEA Krishnamurthy, who is an economist, must have a basis for his Rs 15 lakh crore valuation figure for LIC but the real test of valuation will happen on floors of stock exchanges.