Cathay Financial prices at a premium

The insurance conglomerate prices its GDR.

After seeing its share price slaughtered two days ago - it collapsed 6.8% to $39.80 - Cathay Financial managed to price its GDR at a 0.5% premium to its close yesterday. Few people can remember the last time a GDR from Taiwan has priced at a premium, marking a significant achievement for lead manager, JPMorgan.

The GDR was priced with each GDR unit worth $11.63, and on that basis represented a slight premium (at NT$40 per share) to the close of the underlying stock. Should the greenshoe be exercised the deal will raise $523 million - with monies being used to bolster capital in the insurance/ banking conglomerate and prepare for its expansion into China.

The size of the deal came in the middle of its premarketed range of $400-600 million, although it is some way off the $1 billion originally filed and which some observers had assumed would be the deal's size.

Whether the launch of First Financial's $515 million GDR via Deutsche last week took some of the wind out of Cathay Financial's sails is a subject of speculation. For while the two companies are not directly comparable - with Cathay being the country's dominant insurer, and the other a bank with NPL issues - some fund management accounts may have viewed them both as merely 'financial sector' deals and had their sectoral limits tested by the proximity of the two deals.

This view may be slightly undermined by the wide placement of this deal, which was allocated to 150 accounts and was two times oversubscribed. About 40% of the deal was placed in Asia, 30% in Europe and 30% in the US.

Cathay Financial is primarily an insurance company (91.2% of the revenue comes from Cathay Life, the country's dominant insurer) and so a key to valuation was embedded value. The embedded value basically equates to what the company would be worth if it stopped writing new life insurance policies and just managed its existing portfolio over their approximate 50 year life.

The firm had not published an embedded value since 2001, and this previous lack of transparency, combined with investor's views that life insurers are the ultimate black boxes, led some to predict the deal would face some difficult questions.

However, fund managers were pleasantly surprised by how transparent the management chose to be in presentations. Two weeks ago it also released a new embedded value for the insurance business, that equated to NT$26-28 a share.

JPMorgan calculated that fair value for the combined entity comprised 1.3 times the embedded value of the insurance business, 1.1 times the book value of the bank and came to a fair value of NT$45. However, as recently as May, a UBS research report calculated Cathay Financial's sum of the parts valuation at NT$35.

This disparity between these two views has clearly been reflected in the stock's trading range this year which has hit a high of $46.40 and a low of NT$36.90.

However, JPMorgan views its embedded value calculation as being conservative in light of the fact that a 4.5% return-on-investment figure is being used when 5.2% has been achieved so far this year. Indeed, much of the success in improving investment returns has been down to the speed with which Cathay has moved to investing offshore, thanks to a new government regulation, which has led to 20% of assets now being outside Taiwan.

One of the most persuasive selling points of the company was the attitude of the management on the embedded value issue. It has now committed to publish an annual figure for embedded value, a major step forward for transparency in the Asian life insurance industry - putting it on par with the Australian insurance industry. Indeed, this move will surely put pressure on the Korean life insurers to follow suit, especially as they are also keen to list.

Apart from investor concerns about how the embedded value was arrived at, the other key question in presentations was a concern about whether synergies were being achieved fast enough with its newly acquired banking unit, UWWCB.

All in all, the quality of Cathay Financial's franchise seems to have won through and persuaded investors to back the deal. In the Taiwanese financial scene, Cathay Financial is a genuine blue chip and market leader. It has 9.3 million customers, and they are quite loyal - indeed, its insurance business saw its 25 year persistency ratio climb from 70.7% in 1999 to 84.65 today, suggesting very good churn rates. Meanwhile Cathay Life's expense ratio has come down from 21.3% in 1998 to 13.8% and the bancassurance model will further improve this number, analysts believe. UWWCB also has an efficiency ratio of 35.8%, one of the best in the banking industry.

Indeed, combining the bank (38.8% of group assets) and the insurer (61.2% of group assets), the resulting force is a goliath in the Taiwan financial arena. It ranks top among the financial services groups in market capitalization, assets, revenue and net income and has a return on equity of 15% - with Cathay Life achieving an ROE of 27% in the first quarter.

Cathay now sells insurance (where its market share is 32%) through its  108 branches and 26,000 agents. A measure of the power of this distibution network was when it recently sold out of entirely a NT$6.3 billion investment-linked policy in a single day.

The group is targeting a business mix of 45% insurance, 45% banking, and 10% asset management and securities. The potential for growth in China moreover is reckoned to be the kicker that could eventually take the company into a much bigger league.

¬ Haymarket Media Limited. All rights reserved.
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