(Aug 2, RM1.15)
Recommend buy at 92.5 sen with a target price of RM1.65: The media speculated that Prudential UK has submitted an application to Bank Negara Malaysia (BNM) to commence talks on the potential acquisition of local general insurance company, Pacific & Orient Bhd (P&O). The details of the potential merger and acquisition (M&A) exercise between the two parties are still unclear. This has added fuel to recent market talk that P&O had emerged on the radar of potential buyers.
P&O’s share price has climbed by 46% since we initiated coverage on July 22. The news flow on the M&A is in line with our expectation as one of our key investment cases was that P&O is well positioned to benefit from industry dynamics and regulatory shifts by leveraging its niche customer base, well organised distribution network, improving infrastructure and high rated underwriting culture. These key strengths pave the way for P&O to be an attractive M&A target for foreign insurers seeking to gain a foothold in Malaysia.
We believe BNM wants to see a consolidation of the insurance sector, with weaker insurers merging with the larger and well capitalised players. This expedites the consolidation of the industry, tackling the over-insurance issue. Interestingly, the central bank has also deregulated the industry allowing a higher foreign equity limit of more than 70%. This will be considered on a case-by-case basis for players that can facilitate the consolidation and rationalisation of the industry.
Lately, large foreign insurance companies in the general insurance sector have been on the lookout for prospective M&A deals. Two listed companies with general insurance businesess have announced that BNM has given the green light to commence negotiations on the potential disposal of their insurance units. Jerneh Asia Bhd made an announcement six months back while Pacific Mas Bhd made its announcement in April.
We see a 25% upside to our base case valuation of RM 1.15. This values the group at an undemanding FY2011 PER of six times, which is at the low end of the six to 15 times 2010/11 PER of Malaysian general insurers.
P&O has an M&A valuation of RM 1.65. Although there is already substantial price upside to our base case valuation, the stock is worth even more on an M&A basis. We value P&O in the range of 1.5-2 times FY11 P/BV, which is in comparison with first phase consolidation of Malaysian banking sector. — Kenanga Investment Research, Aug 2
This article appeared in The Edge Financial Daily, August 3, 2010.
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