Ping An comes to life

Does Ping An deserve to price at a premium to China Life?

Pre-marketing began on Monday for a roughly $1.5 billion to $2 billion IPO for Ping An Insurance via joint leads BOCI, Goldman Sachs, HSBC and Morgan Stanley. Pending successful pre-marketing feedback, roadshows will begin on Monday June 7, with pricing scheduled for the beginning of the week of June 21.

Alongside the leads, Daiwa SMBC will run a POWL (public offer without listing) in Japan, while Cazenove, Citigroup and Fox Pitt Kelton will act as co-leads in the international tranche and BNP Paribas Peregrine as co-lead in the Hong Kong IPO.

Ping An is coming to market at a time when Chinese stocks are starting to signs of upward momentum, with China Life trading up from a 2004 low in mid-May around the HK$3.80 mark to HK$4.525 as of yesterday's close (Thursday).

The company's greatest selling point undoubtedly derives from its reputation as the most innovative and sophisticated of the three big Chinese insurers. Such dynamism reflects its roots as the company established to break the monopoly of SOE People's Insurance, (later split into PICC and China Life). In recent years, this aggression has been further re-inforced by extensive hiring of foreign managers and equity investments from overseas investors such as Goldman, HSBC and Morgan Stanley.

However, at a time when many investors remain risk averse, Ping An may be handicapped by a complex and subjective valuation that places far greater emphasis on future growth than China Life did. Specialists believe retail investors, in particular, will find the nuances of the valuation difficult to grasp and the leads have sought a waiver to limit initial retail participation to 5%.

They have also given themselves additional flexibility to play around with the deal size and valuation by going out with an issued share capital range of 20% and 30%, although 25% is said to be the desired ratio (pre shoe).

Most investors are likely to have three key considerations. Firstly they need to decide whether they are still interested in the Chinese insurance sector when high growth levels are no longer a given: secondly whether they prefer Ping An to China Life and thirdly whether they are prepared to pay a premium for it.

China Life is the obvious benchmark for Ping An since both companies are essentially life insurers, with the latter deriving 90% of its 2003 operating profit from this business. However, like-for-like comparisons between the two are made difficult by the fact that China Life carved out unprofitable legacy policies to its parent pre IPO and Ping An did not.

Since 1999, the Chinese government has instituted a 2.5% cap on the guarantees insurance companies can offer their clients. Prior to this, companies were promising high guarantees at a time of declining investment returns and ended up incurring negative spreads.

According to syndicate research, unprofitable legacy policies account for 45% of Ping An's shareholder policy reserves. As Ping An continues to grow, the legacy policies will become a progressively smaller percentage of the total.

Yet at IPO, they significantly depress the company's book value and embedded value numbers, in the process making the prospective valuation seem much more expensive than China Life, which does not suffer from the same issue.

This is especially problematic in the case US investors, whose key metric is normally book value, which accords no value to future growth. China Life is currently trading at about 1.8 times 2004 book, whereas Ping An is being pitched on a range of about 2.5 to 2.7 times and has a syndicate fair value range of over three times.

EV/AV

As a result, specialists believe the deal's anchor orders are most likely to come from Europe where investors are used to valuing life insurance companies on the basis of embedded value (EV) and appraisal value (AV), both of which take far more account of future growth.

"This deal is going to be driven by a core group of funds that are prepared to do some pretty detailed homework and probably already own China Life," says one.

EV measures book value and the NPV (net present value) of policies in force and is used as an indicator of a company's current business. AV is a far more subjective valuation that measures NPV and assigns a value to new business. The less mature an insurance business, the closer it will normally trade to AV, because its growth prospects are typically a more important part of the equation.

At the time of its IPO, China Life published an EV figure of Rmb47 billion ($5.7 billion) based on a 12.5% discount rate. The stock is currently trading at a price of 1.8 times EV.

Using the same discount rate, Ping An has published an EV of Rmb19 billion ($2.29 billion). Syndicate analysts have assigned a fair value price to EV range of 2.1 to 2.4 times, or a price range of about 1.78 to 2.04 times based on a 15% IPO discount.

At the bottom end of the range, Ping An would, therefore, price flat to China Life and at a premium thereafter.

Where AV is concerned, the figure is normally calculated by taking the value of one year's new sales, then applying a growth multiplyer. After applying a 12.5% discount rate, the value of one year's sales equates to Rmb3.5 billion at China Life and Rmb4.3 billion at Ping An. This means that one year sales account for 22% of Ping An's total EV, but only 7% of China Life's.

Specialists say China Life is currently trading at 13 times its new business value, down from a high of 33 times and up from a low of 9.5 times. Fund managers say Ping An is being pitched on a range of about 11 to 14 times, which should represent an attractive discount given its more impressive new business profile.

In terms of global comps, a number of syndicate members contrast the Chinese insurers to the Italians, which have also benefited from high growth and are currently averaging 18 to 19 times new business value.

PE multiples

The final metric some accounts may use is PE, but again, specialists say the figure is skewed by different product mixes at the two companies. China Life is currently trading at about 17.5 times 2004 earnings, whereas Ping An is being pitched at roughly 20 to 24 times.

Observers say Ping An deserves to trade at a premium because a large percentage of China Life's earnings derives from policies, which book more profits upfront. They also argue that the quality of earnings at Ping An is stronger, although there is some disparity between 2004 forecasts at syndicate banks.

Morgan Stanley, for example, is forecasting a 32% jump in 2004 net income to Rmb3.052 billion ($369 million), whereas Goldman is forecasting a 17% jump to Rmb2.7 billion ($327 million). The latter figure is more in line with the previous year, which saw a 15% jump to Rmb2.3 billion ($278 million).

Non syndicate analysts forecast that China Life's net income will jump about 24% in 2004 to Rmb7.25 billion ($877 million).

However, while China Life is projecting relatively strong earnings growth, Ping An supporters say its quality of earnings is lower. For example, Ping An is recording a 15% profit margin on one year's new business versus 3.8% for China Life.

This is said to stem from the fact that China Life has been aggressively building market share with low margin products. About 94% of Ping An's overall life policies are regular premium products compared to 21% at China Life, which has been pushing single premium policies that more closely resemble bank deposits and pay a slightly higher margin.

A leveraged play on rising interests

Ping An has also been able to record a much higher investment return than China Life despite the many restrictions imposed by the Chinese government on where insurers can invest their premium income. During 2003, China Life reported an investment yield of 3.4% compared to 4.5% at Ping An.

Indeed, specialists say Ping An is a leveraged play on rising interest rates since any increases in its investment yield will have a big impact on profitability and its embedded value figure.

They also argue Ping An has a better geographical footprint than China Life, which lost ground in key cities during the 1990's because it was prevented from establishing an agency sales force by the regulators for two years. Consequently, Ping An was able to acquire a much stronger hold over cities like Shanghai and Beijing where growth is more concentrated.

However, insurance specialists believe that even in urban areas, growth levels are tapering because insurance penetration is now quite high on a relative basis. They argue that although an overall national penetration rate of 2.8% of GDP seems low compared to 5.4% in Hong Kong, the argument becomes less compelling when income per capita is taken into consideration. Income levels are much lower in China even in the richest cities than they are in Hong Kong.

This means the 30% plus CAGR in premium growth recorded over the last five years is unlikely to be repeated. Indeed, from January to February this year, the Chinese Insurance Regulatory Commission reported a miserly 1.9% increase in premium growth and some believe the figure moved into negative territory during March.

Over the coming five years, analysts believe a 12% to 15% growth range would be more realistic and still represent a premium to GDP growth. This is based on the fact that state-owned benefits will continue to be substituted for those offered by the private sector and the Chinese will migrate high savings into insurance products.

International standards

Pre IPO, HSBC owns 10% of Ping An, Goldman Sachs 6.9% and Morgan Stanley 5.9%. The presence of these three big international investors, plus a employee base where more than 50% of top management have international experience is expected to be a major swing factor with investors. Supporters believe it will not only re-inforce investors' belief in Ping An's adherence to good corporate governance, but also persuade them there is a more interesting long-term story in the making.

"These are not state-owned employees, but international managers who come into the office every day trying to develop a strategic vision for their company," says one observer.

And that strategic vision appears to be a financial holding company structure, where Ping An may make heavy use of M&A to develop a bank network in order to cross sell its insurance products. The company already derives some revenue from the property and casualty sector and late last year gained its first toe-hold in the banking sector with the acquisition of Fujian Bank. Potential benefits from its relationship with HSBC also remain an imponderable

Ping An is also said to have spent a lot of time thinking about its CRM and IT systems and has a unified system across all its product line unlike China Life, which has yet to centralise its IT systems.

Supporters argue that Ping An will win investors over because it is shareholder focused and has a more sophisticated growth profile than China Life. It remains to be seen whether investors will conclude the variables behind this forward looking valuation are too uncertain for volatile equity markets.