BSE SENSEX S&P CNX 26,626 8,170 Stock Info Bloomberg MAXF IN Equity Shares (m) 267.0 52-Week Range (INR) 514/303 1, 6, 12 Rel. Per (%) 22/14/24 M.Cap. (INR b) 126.2 M.Cap. (USD b) 1.9 Avg Val ( INRm) 170 Free float (%) 70.0 Financials Snapshot (INR b) Y/E Mar 2016 2017E 2018E APE 21.1 24.1 27.6 NBAP 3.8 4.2 5.0 Closing EV 56.2 61.5 67.0 Statutory PAT 4.4 4.4 5.4 APE gr. YoY, % 7.4 14.0 14.5 NBAP margin, % 17.9 17.4 18.1 Oper. RoEV, % 17.0 17.0 17.4 EV/Sh (INR) 210.4 230.4 251.0 P/EV (x) 3.0 2.8 2.5 Shareholding pattern (%) Mar-16 Dec-15 Mar-15 Promoter 30.5 40.4 40.5 DII 47.5 50.4 23.6 FII 12.7 0.0 24.1 Others 9.4 9.2 11.8 FII Includes depository receipts Stock Performance (1-year) Max Financial Sensex - Rebased 500 450 400 350 300 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 20 June 2016 Update Sector: Financials Max Financial Services CMP: INR473 TP: INR545(+15%) Buy Mega merger on the anvil Partnerships with three of top-five private banks biggest positive Event: Max Financial Services (MFS) and Max Life have entered into an agreement for a potential merger with HDFC Life. Under this arrangement, Max Life will first merge with MFS, which will in turn merge with HDFC Life. This arrangement will ensure an automatic listing for HDFC Life. We raise price target by ~30% to INR545: We assign 75% probability to the proposed merger going through, resulting in significantly better growth prospects for Max Life (addition of several bancassurance partners). While the swap ratio remains unannounced, we believe eventually HDFC Life would trade at 2.5x+ FY18E EV, given the strong growth and return profile of the combined entity (refer exhibit 1). Granularity in sourcing to increase post-merger; risk of AXSB exit remains low: We believe there is very low risk of dissolution of Axis Bank (AXSB) partnership 6% stake in Max Life. The current arrangement is valid for five years, with 1% stake vesting each year from 2017 to 2021. Currently, AXSB earns ~INR5b income from selling life insurance policies (excluding equity stake sale gains). Given the strong growth potential, we expect the bank to generate INR10b+ of commission income by FY21 a sizable income contributor that we believe it would not like to jeopardize. Further, post the merger, contribution of AXSB to the combined entity would be significantly lower than the current 50%+. Increase in granularity within the bancassurance network is likely to reduce the possibility of any additional equity offerings to banks. Valuation and view: We like Max Life for its management quality, higher proportion of long-term savings business, healthy operational efficiency, strong bancassurance tie-ups, robust return ratios, and excess capital position. Further, potential merger with HDFC Life is expected to increase the granularity in distribution network. Our probability-weighted target price reflects the upside to appraisal value from possible improvements in operational performance. We value Max Life on appraisal value methodology, leading to pre-merger value of ~INR160b (2.4x FY18E EV) and post-merger value of ~INR225b (3.3x FY18E EV and ~3x FY18E EV excluding dividend payouts). Adjusting for MFS 68% stake in Max Life and adding the INR2.7b cash with MFS, we arrive at a post-merger TP of INR545/share. While the swap ratio for the merger remains unannounced, we believe eventually HDFC Life would trade at 2.5x+ FY18E EV, given the strong growth and return profile of the combined entity. Buy. Key risks: (a) Complex shareholding structure, (b) Regulatory approvals, and (c) Continuity of partnerships with Yes Bank post 2018 and Axis Bank post 2021. Dhaval Gada (Dhaval.Gada@MotilalOswal.com); +91 22 3982 5505 Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com); +9122 3982 5415/Krishnan ASV (A.Krishnan@MotilalOswal.com); +9122 3010 2603 Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/institutional-equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.
Exhibit 1: Merged Financial Snapshot INR m HDFC Life Max Life Merged FY16 NBAP (Pre-overruns) 7,866 3,880 11,746 NBAP (Post-overruns) 6,599 3,780 10,379 APE 33,330 21,130 54,460 Embedded value 102,050 56,170 158,220 Pre-cost NBAP (%) 23.6 18.4 21.6 Post-cost NBAP (%) 19.8 17.9 19.1 RoEV (%) 18.3 15.7 17.4 Product Mix (%) PAR 30 61 42 Non PAR 15 12 14 Linked 55 27 44 Distribution Mix (%) Individual Agency 13 28 19 Bancassurance 68 58 64 Others 18 15 17 Source: MOSL, Company Exhibit 2: Combined entity to become the largest private life insurer with ~24% share Individual APE Market Share (%) FY12 FY13 FY14 FY15 FY16 HDFC Life (merged) 24.1 26.0 24.0 24.6 23.9 ICICI Pru Life 16.1 18.5 18.9 23.0 21.9 SBI Life 12.0 13.4 16.3 15.6 18.8 HDFC Life 15.5 17.5 13.8 14.8 14.7 Max Life 8.6 8.5 10.2 9.7 9.3 Kotak Old Mutual 2.7 2.6 2.7 3.1 4.1 PNB Metlife 2.9 3.1 3.3 3.6 4.0 Reliance Life 6.3 5.5 6.5 6.0 3.9 Bajaj Allianz 7.5 6.9 5.8 3.9 3.2 Birla Sunlife 6.7 5.8 4.9 3.7 3.0 Tata AIA 3.5 1.7 1.4 1.2 2.7 Exide Life 3.5 2.9 2.9 2.2 2.1 Canara HSBC 2.7 2.0 1.6 1.6 1.9 Shriram Life 0.9 1.1 1.1 1.3 1.6 Star Union Daiichi 1.6 1.5 2.0 2.0 1.6 Bharti AXA 1.1 1.2 1.7 1.8 1.6 IDBI Federal 1.2 1.4 1.5 1.3 1.4 IndiaFirst 1.1 1.4 0.9 0.8 1.0 Aviva 2.8 2.3 1.8 1.5 0.7 DHFL Pramerica 0.5 0.8 0.6 0.7 0.7 Edelweiss Tokio 0.1 0.2 0.4 0.5 0.6 Aegon Religare 1.1 0.7 0.8 1.0 0.6 Future Generali 1.4 0.9 0.8 0.7 0.5 Sahara 0.3 0.2 0.2 0.1 0.1 Private Sector 36.5 38.0 38.0 49.0 51.5 LIC 63.5 62.0 62.0 51.0 48.5 Source: MOSL, Life Insurance Council, Company 20 June 2016 2
Raise TP to INR545 v/s INR420 previously Valuation and view Long term opportunity in India s life insurance sector remain attractive; overall the past couple of years, new business growth has recovered with cost control and profitability remaining key focus area for most insurers. Outlook on regulatory environment remains positive with all major areas (product, distribution and expenses) already seeing guideline changes. Interestingly, the last couple of regulatory developments (i.e. proposed bank broker model and expense of management) have ended up being more accommodative for the industry v/s and severe negative impact seen previously. Hence, we remain positive on the sector. Potential merger with HDFC Life will make the combined entity the largest private life insurer. Further, it will also strengthen the market share in Par business (2 nd largest player after LIC). We prefer MAX for its management quality, higher proportion of long-term savings business, healthy operational efficiency, strong bancassurance tie-ups, robust return ratios, and excess capital position. Granularity in distribution network is likely to increase post-merger. We value Max Life on appraisal value basis. We assume cost of equity at 13.3% and terminal growth rate at 4% (unchanged). We assign 75% probability of merger going through, leading to pre-merger value of ~INR160b (P/EV of 2.4x FY18E) and post-merger value of ~INR225b (P/EV of 3.3x FY18E and ~3x P/EV FY18E excluding dividend payouts). Adjusting for MAX s 68% stake in Max Life and adding the INR2.7b cash with MAX, we arrive at post-merger TP of INR545/share. While the swap ratio for the merger remains unannounced, we believe eventually HDFC Life is likely to trade at 2.5x+ FY18 P/EV given the strong growth and return profile of the combined entity. We do not ascribe any holding company discount to MAX, as Max Life is the only major business owned and substantial portion of the dividend income received from Max Life is likely to flow through to MAX shareholders. Exhibit 3: Merged Financial Snapshot (INR b) Pre Post Embedded Value (FY17E) 61.5 61.5 Value of future new business 98.9 163.9 Appraisal value 160.4 225.4 MFS stake (68%) 109.1 153.3 Cash at Holdco. 2.7 2.7 Target price 111.8 156.0 Shares outstanding 0.3 0.3 Target price per share (INR) 420 585 Probability of merger (%) 75% Probability weighted TP (INR) 545 Source: MOSL, Company Key risks to our estimate (a) Complex shareholding structure, (b) Regulatory approvals and (c) Continuity of Yes Bank post 2018 and Axis Bank post 2021. Higher corporate tax rate or negative outcome from final guidelines on commission expenses; based on our interactions with the regulator and industry participants, this looks less likely. 20 June 2016 3
Exhibit 4: Max Life embedded value projections (pre-merger) Traditional Embedded Value MCEV (INR m) FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E Opening Embedded Value 13,160 22,840 27,230 32,160 36,840 37,560 44,010 52,320 56,170 61,509 67,024 73,124 Net Asset Value 3,620 7,670 8,800 11,410 17,110 18,980 19,450 21,150 20,760 Value of in-force business 9,540 15,170 18,430 20,750 19,730 18,580 24,560 31,170 35,410 Unwind 1,900 2,610 3,360 4,190 3,920 3,790 4,000 5,130 5,342 5,727 6,173 6,662 % of opening EV 14.4 11.4 12.3 13.0 10.6 10.1 9.1 9.8 9.5 9.3 9.2 9.1 Value of new business (pre cost over-runs) 3,120 2,670 2,350 1,680 2,130 2,400 4,600 3,880 4,375 5,105 5,873 6,752 Acquisition cost over-run -3,920-3,770-2,550-1,020-150 -60-370 -100-175 -125 0 0 Value of new business (post cost over-runs) -800-1,100-200 660 1,980 2,340 4,230 3,780 4,200 4,980 5,873 6,752 Growth YoY (%) 37.5-81.8-430.0 200.0 18.2 80.8-10.6 11.1 18.6 17.9 15.0 Operating variance -3,830-2,550-1,760-1,950-2,080-340 1,230-140 -175-125 0 0 Operating Profit 1,190 2,730 3,950 3,920 3,970 5,850 9,830 8,870 9,543 10,707 12,046 13,414 Growth YoY (%) 129.4 44.7-0.8 1.3 47.4 68.0 28.2 7.6 12.2 12.5 11.4 Non-operating variance 990-250 980 760-230 -790 2,540-630 0 0 0 0 Net capital movement 7,500 1,910 0 0-3,020-3,090-4,060-4,390-4,204-5,192-5,946-6,682 Capital Infusion 7,500 1,910 0 0 0 0 0 0 0 0 0 0 Dividend 0 0 0 0-3,020-3,090-4,060-4,390-4,204-5,192-5,946-6,682 Closing Embedded Value 22,840 27,230 32,160 36,840 37,560 39,530 52,320 56,170 61,509 67,024 73,124 79,856 Net Asset Value 7,670 8,800 11,410 17,110 18,980 19,310 21,150 20,760 Value of in-force business 15,170 18,430 20,750 19,730 18,580 20,220 31,170 35,410 Embedded Value pre-capital movement 15,340 25,320 32,160 36,840 40,580 42,620 56,380 60,560 65,713 72,216 79,070 86,538 Growth YoY (%) 16.6 10.9 18.1 14.6 10.2 13.5 28.1 15.7 17.0 17.4 18.0 18.3 APE 15,950 15,840 17,240 15,060 15,130 17,690 19,670 21,130 24,080 27,564 31,710 36,459 Growth YoY (%) -0.7 8.8-12.6 0.5 16.9 11.2 7.4 14.0 14.5 15.0 15.0 New business margins (%) Pre-cost over-runs 19.6 16.9 13.6 11.2 14.1 13.6 23.4 18.4 18.2 18.5 18.5 18.5 Post-cost over-runs -5.0-6.9-1.2 4.4 13.1 13.2 21.5 17.9 17.4 18.1 18.5 18.5 Cost over-runs 24.6 23.8 14.8 6.8 1.0 0.3 1.9 0.5 0.7 0.5 0.0 0.0 Operating RoEV (%) 9.0 12.0 14.5 12.2 10.8 15.6 22.3 17.0 17.0 17.4 18.0 18.3 Non-Operating RoEV (%) 7.5-1.1 3.6 2.4-0.6-2.1 5.8-1.2 0.0 0.0 0.0 0.0 RoEV (%) 16.6 10.9 18.1 14.6 10.2 13.5 28.1 15.7 17.0 17.4 18.0 18.3 Source: MOSL, Company 20 June 2016 4
Exhibit 5: Max Life embedded value projections (post-merger) Major impact on growth trajectory Traditional Embedded Value MCEV (INR m) FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E Opening Embedded Value 13,160 22,840 27,230 32,160 36,840 37,560 44,010 52,320 56,170 61,509 67,748 75,225 Net Asset Value 3,620 7,670 8,800 11,410 17,110 18,980 19,450 21,150 20,760 Value of in-force business 9,540 15,170 18,430 20,750 19,730 18,580 24,560 31,170 35,410 Unwind 1,900 2,610 3,360 4,190 3,920 3,790 4,000 5,130 5,342 5,727 6,223 6,816 % of opening EV 14.4 11.4 12.3 13.0 10.6 10.1 9.1 9.8 9.5 9.3 9.2 9.1 Value of new business (pre cost over-runs) 3,120 2,670 2,350 1,680 2,130 2,400 4,600 3,880 4,375 5,779 7,200 8,755 Acquisition cost over-run -3,920-3,770-2,550-1,020-150 -60-370 -100-175 -50 0 0 Value of new business (post cost over-runs) -800-1,100-200 660 1,980 2,340 4,230 3,780 4,200 5,729 7,200 8,755 Growth YoY (%) 37.5-81.8-430.0 200.0 18.2 80.8-10.6 11.1 36.4 25.7 21.6 Operating variance -3,830-2,550-1,760-1,950-2,080-340 1,230-140 -175-75 0 0 Operating Profit 1,190 2,730 3,950 3,920 3,970 5,850 9,830 8,870 9,543 11,431 13,423 15,571 Growth YoY (%) 129.4 44.7-0.8 1.3 47.4 68.0 28.2 7.6 19.8 17.4 16.0 Non-operating variance 990-250 980 760-230 -790 2,540-630 0 0 0 0 Net capital movement 7,500 1,910 0 0-3,020-3,090-4,060-4,390-4,204-5,192-5,946-6,682 Capital Infusion 7,500 1,910 0 0 0 0 0 0 0 0 0 0 Dividend 0 0 0 0-3,020-3,090-4,060-4,390-4,204-5,192-5,946-6,682 Closing Embedded Value 22,840 27,230 32,160 36,840 37,560 39,530 52,320 56,170 61,509 67,748 75,225 84,114 Net Asset Value 7,670 8,800 11,410 17,110 18,980 19,310 21,150 20,760 Value of in-force business 15,170 18,430 20,750 19,730 18,580 20,220 31,170 35,410 Embedded Value pre-capital movement 15,340 25,320 32,160 36,840 40,580 42,620 56,380 60,560 65,713 72,939 81,171 90,796 Growth YoY (%) 16.6 10.9 18.1 14.6 10.2 13.5 28.1 15.7 17.0 18.6 19.8 20.7 APE 15,950 15,840 17,240 15,060 15,130 17,690 19,670 21,130 24,080 31,304 39,130 47,738 Growth YoY (%) -0.7 8.8-12.6 0.5 16.9 11.2 7.4 14.0 30.0 25.0 22.0 New business margins (%) Pre-cost over-runs 19.6 16.9 13.6 11.2 14.1 13.6 23.4 18.4 18.2 18.5 18.4 18.3 Post-cost over-runs -5.0-6.9-1.2 4.4 13.1 13.2 21.5 17.9 17.4 18.3 18.4 18.3 Cost over-runs 24.6 23.8 14.8 6.8 1.0 0.3 1.9 0.5 0.7 0.2 0.0 0.0 Operating RoEV (%) 9.0 12.0 14.5 12.2 10.8 15.6 22.3 17.0 17.0 18.6 19.8 20.7 Non-Operating RoEV (%) 7.5-1.1 3.6 2.4-0.6-2.1 5.8-1.2 0.0 0.0 0.0 0.0 RoEV (%) 16.6 10.9 18.1 14.6 10.2 13.5 28.1 15.7 17.0 18.6 19.8 20.7 Source: MOSL, Company 20 June 2016 5
Financial and Valuations Max Life Insurance INR m FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Policyholder Account Premiums earned (Net) 57,362 63,208 65,703 72,118 81,051 91,389 102,676 116,346 132,583 Income from Investments 9,908 3,034 12,994 21,622 41,057 12,899 36,994 44,113 52,268 Contribution from SH 118 94 12 131 441 19 0 0 0 Other income 24 18 102 177 146 147 154 163 171 Total (A) 67,413 66,354 78,811 94,048 122,695 104,454 139,824 160,621 185,022 Commission 5,399 5,804 6,140 6,828 7,486 8,210 9,160 10,327 11,662 Operating expenses 14,404 12,542 12,288 12,038 12,419 12,496 13,377 14,133 14,933 Benefits paid (net) 13,049 17,815 26,069 29,837 35,323 31,461 41,339 47,555 54,805 Change in valuation of policy liabilities 31,020 23,949 27,999 39,090 61,139 46,888 68,209 80,520 92,817 Other expenses 32 19 38 630 629 767 739 820 920 Total expenses and provisions (B) 63,905 60,130 72,536 88,423 116,996 99,821 132,824 153,354 175,137 Surplus / (deficit) (C)=(A)-(B) 3,508 6,224 6,275 5,625 5,699 4,632 7,001 7,266 9,885 Provision for taxation 0 0 0 0 0 0 0 0 0 Surplus / (deficit) after tax 3,508 6,224 6,275 5,625 5,699 4,632 7,001 7,266 9,885 Shareholder Account Transfer to Shareholders account 3,299 4,112 3,023 2,944 2,835 3,351 3,562 4,436 5,315 Income From Investments 856 1,500 2,193 2,415 2,706 2,192 2,033 2,446 2,585 Other income 0 144 0 0 0 0 0 0 0 Total income 4,154 5,756 5,216 5,359 5,541 5,544 5,595 6,882 7,901 Operating expenses 2,095 1,064 450 198 325 415 500 589 694 Contribution to the Revenue Account 118 94 12 131 441 19 0 0 0 Provisions (other than taxation) 0 0 0 0 0 0 0 0 0 Profit / (Loss) before tax 1,941 4,598 4,754 5,031 4,776 5,110 5,095 6,293 7,207 Provision for Taxation 0 0 519 672 634 718 731 903 1,034 Profit / (Loss) after tax 1,941 4,598 4,234 4,359 4,142 4,391 4,364 5,390 6,173 Total Dividend 0 0 3,020 3,090 4,060 4,390 4,204 5,192 5,946 20 June 2016 6
Financial and Valuations Max Life Insurance Balance Sheet FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Liabilities Share Capital 18,410 19,447 19,447 19,447 19,188 19,188 19,188 19,188 19,188 Reserves and Surplus 2,151 2,581 2,034 1,823 952 954 1,114 1,312 1,539 Networth 20,561 22,028 21,481 21,270 20,141 20,142 20,302 20,500 20,727 Policyholders Funds 122,733 146,898 174,684 217,135 279,846 325,054 403,260 484,353 577,935 Other liabilities 1,568 4,264 6,814 10,197 13,691 14,660 19,837 23,097 28,190 Total Liabilities 144,862 173,190 202,980 248,601 313,678 359,856 443,399 527,950 626,852 Assets Investments Shareholders Investments 13,199 21,882 27,111 27,751 26,227 23,918 28,774 30,413 32,473 Policyholders Investments 36,470 51,612 72,921 106,102 151,980 202,784 253,149 319,773 397,059 Assets held to cover linked liabilities 88,696 98,657 104,547 113,304 133,996 131,538 159,310 175,344 194,590 Loans 116 159 296 417 592 764 925 1,156 1,445 Fixed assets 1,402 1,199 1,257 1,180 1,188 1,679 1,762 1,851 1,943 Net current assets -4,072-4,720-5,845-1,369-304 -827-520 -585-657 Misc. Expenses 756 703 0 0 0 0 0 0 0 Debit balance in P&L 8,296 3,698 2,693 1,217 0 0 0 0 0 Total Assets 144,862 173,190 202,980 248,601 313,678 359,856 443,399 527,950 626,852 Note: We have currently not published accounts for Max Financial Services since it is just a holding company. 20 June 2016 7
SECTOR UPDATES MAX FINANCIAL SERVICES GALLERY
N O T E S 20 June 2016 9
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Nothing here is an offer or solicitation of these securities, products and services in any jurisdiction where their offer or sale is not qualified or exempt from registration. The Indian Analyst(s) who compile this report is/are not located in Hong Kong & are not conducting Research Analysis in Hong Kong. For U.S Motilal Oswal Securities Limited (MOSL) is not a registered broker - dealer under the U.S. Securities Exchange Act of 1934, as amended (the"1934 act") and under applicable state laws in the United States. In addition MOSL is not a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act" and together with the 1934 Act, the "Acts), and under applicable state laws in the United States. Accordingly, in the absence of specific exemption under the Acts, any brokerage and investment services provided by MOSL, including the products and services described herein are not available to or intended for U.S. persons. 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Any business interaction pursuant to this report will have to be executed within the provisions of this chaperoning agreement. The Research Analysts contributing to the report may not be registered /qualified as research analyst with FINRA. Such research analyst may not be associated persons of the U.S. registered broker-dealer, MOSIPL, and therefore, may not be subject to NASD rule 2711 and NYSE Rule 472 restrictions on communication with a subject company, public appearances and trading securities held by a research analyst account. For Singapore Motilal Oswal Capital Markets Singapore Pte Limited is acting as an exempt financial advisor under section 23(1)(f) of the Financial Advisers Act(FAA) read with regulation 17(1)(d) of the Financial Advisors Regulations and is a subsidiary of Motilal Oswal Securities Limited in India. This research is distributed in Singapore by Motilal Oswal Capital Markets Singapore Pte Limited and it is only directed in Singapore to accredited investors, as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. In respect of any matter arising from or in connection with the research you could contact the following representatives of Motilal Oswal Capital Markets Singapore Pte Limited: Varun Kumar Kadambari Balachandran Varun.kumar@motilaloswal.com kadambari.balachandran@motilaloswal.com Contact : (+65) 68189232 (+65) 68189233 / 65249115 Office Address:21 (Suite 31),16 Collyer Quay,Singapore 04931 Motilal Oswal Securities Ltd Motilal Oswal Tower, Level 9, Sayani Road, Prabhadevi, Mumbai 400 025 Phone: +91 22 3982 5500 E-mail: reports@motilaloswal.com 20 June 2016 10