Barbican Asset Management

How fair is first Mutual’s rights offer price?

Background information THE First Mutual group is the product of the demutualisation of the Society in 2003.



a, sans-serif”>It is the holding company of First Mutual Life, First Mutual Asset Management, African Reinsurance, African Actuarial Consultancy and various property holding companies.


First Mutual Life has its primary business inthe provision of life assu-rance, disability insura-nce, pensions and investment products for individuals and institutions.


The African Reinsurance Company is a recently established and commissioned reinsurance company.


First Mutual Asset Management is a wholly-owned subsidiary of First Mutual Ltd and its core business is the investment management of unit trusts, pension funds, property management, as well as treasury activities.


African Actuarial Consultancy is a 70% owned subsidiary of First Mutual.

It was established this year and its core business is to provide actuarial services for First Mutual, its subsidiaries and associates.


In addition, it is also involved in financial risk consultancy services particularly for insurance companies, medical aid societies, banks and employee benefit schemes.


Intentions


First Mutual proposes to raise a total of $52,5 billion through a non-renounceable rights offer to current shareholders and placing of ordinary shares to a few selected institutional investors.


The group seeks to issue 500 million ordinary shares under the rights offer and a further one billion ordinary shares under private placement, at a price of $35 a share.


The rights offer will be on the basis of one ordinary share for every five shares held and is expected to raise $17,5 billion for the group.


These funds are expected to finance the continued growth and transformation of the group into a fully diversified financial services institution.


Calendar


The calendar for raising funds is shown in the above table.

Worth noting is that the rights offer closes on November 3 and the company intends to list on November 20.


Valuation


In a bid to assess the fairness of the rights offer price, we proceed to use a blend of both fundamental analysis and relative valuation techniques.


For fundamental valu-ation, main referenceis made to the embedded value technique initially calculated by the Society’s Actuary and Renaissance Merchant Bank.


For relative valuation, we use the earnings yield and the net asset value method. For comparative basis, the peers for First Mutual are SARE, Zimre Holdings, Fidelity Life, and Nicoz-Diamond.


Old Mutual is not included in the sample since its financial statistics appear to be an outlier compared to the other counters, constituting the sample.


In addition, more than 90% of Old Mutual’s bottom line is attributed to its South African operations.


Hence, we consider Old Mutual not to be representative of a local insurance company such as First Mutual.


Fundamental analysis


Based on the embedded value that was calculated as of June 30, by the Society’s actuary in liaison with the statutory actuary, the implied share price per share after the rights offer is around $6,30.


However, as noted by Renaissance Merchant Bank, there have been significant market move-ments, which have occurred in the market. These have impacted on the embedded value components comprising listed equities and properties.


Based on our projections of the behavior of the investment markets, that First Mutual is a player, we arrive at an estimate of about $29,75 for the rights offer share price.


Relative earnings yield valuation


Worth noting is the fact that the current sectorial average of around 20,46 is significantly deviating from the five-year historical sector average of around 12,5. Consequently, we make a downward adjustment to the current sectoral price-to-earnings ratio to come up with an estimate of $95 a share.


Relative net asset valuation


Traditionally, the insurance industry norm is that the shares do not trade significantly above their net asset value per share.


The five-year average price-to-net asset value ratio for the sector is 2.5 times, which is more or less similar to the current average price-to-net asset value of 2.82.


Based on these observations, we come up with an estimate of $38 using the relative net asset valuation method.


Fair valuation of rights offer price


Based on the three methodologies used in our analysis, we estimate the fair value of the share price by attaching more weight on the net asset value method and the fundamental analysis and less weight on the relative earnings yield method.


This is due to the relative stability in the estimates produced by the fundamental and net asset value methods compared to the earnings yield method that seems to exhibit high levels of “noise”.


We come up with a fair value of the First Mutual share price after the rights offer at around $42, which happens to be higher than the actual rights offer price of $35.


Conclusion


Based on our valuations, the rights offer price for First Mutual can be considered to be at a discount of around 20% to the fair value of the share price.


Consequently, we con-sider it to be a sound investment decision for investors to exercise their rights.