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Analysts mull Ace valuation following 29% dilution

Despite analyst support for the Ace-Chubb deal's strategic rationale, the 29 percent upfront dilution to Ace's tangible book value leaves open the question of whether the earnings accretion is sufficient to support the surge in the carrier's valuation on a price-to-book multiple.

The dilution erodes around five years of tangible book value, which will return to roughly 2010 levels.

Nonetheless, management are confident that tangible book value will return to its current level three years after the deal closes - which is currently slated for Q1 2016.

Ace has also said that the transaction will be immediately accretive to the carrier's earnings per share (EPS) and book value per share.

By year three, the firm expects the deal will result in double-digit EPS accretion and will drive improved return on equity (RoE). However, Ace CEO Evan Greenberg refused to quantify these figures when asked - in line with the company's long-term stance on providing guidance to analysts.

Furthermore, Ace expects to realise $650mn of annual cost synergies by 2018.

Nomura analyst Cliff Gallant said that his calculations confirmed the expected EPS accretion, with pro forma earnings estimated to be around $5.0bn and a pro forma EPS of $10.50-$10.70 for Ace, compared to his current 2016 estimate of $10.15.

Kai Pan, analyst at Morgan Stanley - the bank advising Ace on the deal - forecast a pro forma 2016E EPS of around $9.84 and a book value per share of circa $102.19 for the combined entity, representing a 2 to 3 percent accretion in both cases. He also projected a circa 10 percent 2016E RoE.

Meanwhile, BMO Capital Markets analyst Charles Sebaski said he was concerned about Ace's valuation.

"The Ace-Chubb transaction has been outlined as accretive to EPS and book value per share immediately; however, there is a significant dilution to tangible book value per share," he said in a note published last week (1 July).

"This means based on Ace's current share price of approximately $104, Ace is trading at nearly 2x tangible book value - a level about which we have some concerns in the near term," he said. Sebaski added that Ace has not traded at this level since 2003.

"While we understand that an Ace-Chubb merger would create a market-dominant insurer in many classes of business, in the near term it is still likely to be a 10-12 percent operating RoE business, which makes such a lofty valuation a challenge," he remarked.

Sebaski highlighted that the stated dilution recovery period implied a 12 percent compound annual growth rate (CAGR) in tangible book value per share over the next three years.

"Given that the cost savings of $650mn will not be fully realised until 2018, we think this implies limited capital management over that period," he added.

By way of contrast, since 2008 through to Q1 2015 Ace's tangible book value per share has grown at a CAGR of 12.2 percent, while total valuation creation over the period was 165.8 percent.

"We will say that Ace has proven to be one of the best insurers in terms of M&A timing and execution, so it rightly should be given some benefit of the doubt. We just wonder whether the stock might not pull back at some point in the interim," he concluded.

Bernstein analyst Josh Stirling echoed some of Sebaski's comments, saying that Ace shareholders now face an "interesting dilemma".

"Long term [the deal] is likely to be earnings accretive [...]. Against that, the pro forma tangible book value - normally the benchmark for insurance company valuation - is down 29 percent on the deal. Rough math from the call suggests Ace's current stock price is trading at something approaching 2x pro forma tangible book value, which is high relative to its history and most peers," he said.

"Given that, we think the debate for Ace's stock is likely to centre around whether the future prospects for earnings growth is sufficient to fund the immediate upfront book value dilution and the current stock multiple," he concluded.

Meanwhile, Janney analyst Larry Greenberg has maintained his "buy" rating on Ace's shares despite the 2x pro forma tangible book value stock valuation.

"We believe there are a lot of levers that can be pulled to make this transition realise its ambitious expectations. These levers would include: expense efficiencies, savings on reinsurance purchases, tax rate optimisation and revenue enhancement opportunities," he explained.

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