The boards of Just Retirement Group (LSE: JRG) and Partnership Assurance Group (LSE: PA) have reached an agreement to an all-share merger. Shareholders in Just Retirement will hold about 60% of the combined group, with shareholders in Partnership Assurance holding the remainder. Each Partnership share will be entitled to receive 0.834 new Just Retirement shares, which implies a 7.6% premium on Partnership’s yesterday closing price of 154.25 pence.
The markets initially reacted positively to the news. Partnership shares reached 170 pence (up 10.2%), before falling back to 159.75 pence (up 3.6%) by early afternoon. Shares in Just Retirement initially rose to a high of 207.1 pence, but fell into negative territory later on. At the time of writing, its shares were 2.8% lower, at 192.1 pence.
Annuity sales recovering more strongly than expected
Partnership also announced its interim results today, which showed new business premiums recovering much more strongly in the second quarter of 2015 than many analysts had expected. New business premiums in Q2 were a third higher than in Q1, at £132 million. But, compared to last year, new business premiums in the first half of 2015 were 43.5% lower.
The drop in individual annuity sales, as pensioners no longer need to purchase annuities following the implementation of the new pension reforms, underscores the necessity for consolidation in the industry. The combined group is expected to benefit from annual cost savings worth £40 million by 2018, and these synergies are expected to have a positive impact on margins, embedded value and capital ratios over time.
Once the merger has been completed, the combined group intends to raise £150 million worth of additional equity. This will be used to fund the integration process and support future business growth. Just Retirement is seeing strong growth in defined benefit sales and is adapting to legislative changes, through the launch of flexible retirement funds.
Although the merger almost certainly seems to be positive for both companies, it will be no panacea. Annuity sales will mostly likely remain subdued and growth in a shrinking market will be difficult. The combined group is said to benefit from substantial synergies, but both companies have already become much leaner on their own, and further cost savings may seem harder to come by.
Both companies seem expensive on an underlying earnings basis, but this is because underlying earnings is more heavily affected by the reduction of new business.
Before today’s announcement, analysts had expected Just Retirement would deliver underlying EPS of just 10.1 pence, after a fall of 38% in 2015. This gives its shares a forward P/E of 19.5. Partnership is similarly overvalued on a forward P/E basis. Its shares have a forward P/E of 18.2, on analysts’ expectation of underlying EPS of 8.5 pence.
On an embedded value basis, valuations are attractive. Embedded value is commonly referred to as the run-off (or liquidation) valuation, as it does not place any value on new business that may be gained in the future. This valuation method is usually better at valuing life insurance companies, as it measures the future cash flows of the company over the long term. As the time of writing, Just Retirement and Partnership are valued at 0.96x and 1.05x their respective embedded values.
As the combined market capitalisation of the two companies trade at virtually no premium to their combined embedded values, the market is not placing any value on their future annuity sales. With future business effectively valued at zero and potential gains from further cost savings, the valuation of the combined group is cheap.