The LIC IPO, Decoded

Finally, it’s here! After months of speculation, guesstimation and bureaucratic hemming and hawing, the prospectus for India’s biggest and most-awaited IPO was filed with SEBI on Sunday evening.

We hope you are as excited as we are to explore the length and breadth of the capital markets bonanza that is this IPO.

So, dive right in!

Mother of All IPO Stats

• Issue Size: Entirely an Offer for Sale for up to 31.62 crore equity shares. (Note: The IPO issue is only 5% of the total capital of 632.49 crore shares. The Government of India is retaining 95%.)
• Issue Breakup:

1. Reserved for Employees of LIC — 5%
2. Reserved for Eligible Policyholders — 10%
3. Retail Investors — 35% (minimum)
4. Anchor Investors — Up to 60% of QIBs (discretionary)
5. Domestic Mutual Funds — One-third of anchor investor portion

• Issue Type: Book built
• Face Value: ₹10 per equity share
• Listing Date: March 15th 2022 (tentatively)

IPO Pointers

The pandemic-era stimulus and spending ran the state’s coffers dry. So, the benefits of this IPO and a need for its proceeds to replenish the Government coffers can’t be overstated. Much of the Government’s FY23 disinvestment target (₹78,000cr ($10.3bn)) will depend on this issue.

Today, LIC boasts of 30 crore policyholders. As India’s designated state insurer, it had enjoyed an absolute monopoly in the domestic market for close to four decades until the sector was opened up to private players in the 1990s. Following that, its influence shrunk, but didn’t obliviate, still leaving it as the market leader with a 64.1% share (pg. 13, DRHP).

Regardless of that, private sector players have been gaining market share consistently over the past few years owing to a number of reasons — diversified product mix, strong distribution channels and investments in the online insuretech space. Even commercial banks are now permitted to invest in, or form alliances with, insurance companies, thereby adding to competition for LIC, which happens to be the sole public sector player among 24 life insurance companies in the country.

But now that the wheels of divestment for the 65-year-old public sector enterprise have been put in motion, there are many risks which will determine the success of this IPO.

Let’s study these risks one by one. We begin by taking a look at the…

Financials

As of FY21, LIC holds around $507.33bn in total assets, making it the tenth-largest life insurer on the planet. Even better, it has the highest return on equity or RoE (82%) amongst its peers — Ping An Insurance (19.5%), Aviva PLC (14.8%), China Life Insurance (11.9%) etc.

In addition to strong underlying fundamentals, one area where LIC outshines its peers is in its robust distribution network. It has:

1. 1.34 million individual agents
2. 72 bancassurance partners, comprising — eight public sector banks, five private sector banks, one foreign bank, 13 regional rural banks, 45 cooperative banks.
3. 174 alternate channel partners — 44 insurance marketing firms, 59 brokers and 71 corporate agents (pg 199, DRHP)

That being said, the company faces stiff competition in India and overseas markets. During Fiscal 2016–2021, the total premium for private players from life insurance businesses in India grew at 18% CAGR as opposed to 9% for LIC (pg 36, DRHP).

Given that inflation has been a growing concern across global markets lately, central banks around the world are primed to raise interest rates. In addition, markets have been taking a serious hit due to the ensuing tensions at the Russia-Ukraine border whose events have added to the volatility risk. A decline in the equity markets in the near-term would also reduce the Government’s (and by extension, LIC’s) ability to command higher premiums which would directly impact the company’s financials.

The point is, even though the mega issue is good for capital optics and privatisation, the market’s appetite for an issue of this size remains unknown.

But then again, what is going to be the exact size of the IPO and its price?This is a question that remains an enigma for investors. And this brings us to its…

Valuation

The keyword that’s been buzzing around business media circles this week is LIC’s embedded value (EV). This is the sum of the present value of all future profits and net worth.

Any valuation metric that’s determined using two different tenses as the one above ought to be complicated. Since life insurance is all about upfront costs and calibrated profits over a long period of time, EV is a popular metric by which insurers are valued.

LIC’s EV has been estimated at ₹5.39Lcr ($71.3bn). But what’s interesting is that the insurer’s EV has soared 5x in the past six months.

To understand why, one must understand that insurance companies like LIC operate differently from other companies. First, it’s not just the shareholders who get a bite out of their profits but also the policyholders. Now, GoI was the sole shareholder of LIC until now but almost all of its profit was generated from policyholders.

Secondly, there are two types of policyholders in LIC — those who participate in its profits and those who don’t. Earlier, LIC had a single consolidated fund to hold all its profits. But post 2021, it bifurcated this fund into two — one for those generated from participatory (par) policies and one from non-participatory (non-par) policies. As of September 2021, both funds hold ₹24.57Lcr ($325.4bn) and ₹11.37Lcr ($150.6bn) respectively.

Now, two things: 1) non-par profits go entirely to the shareholders because their benefits don’t go to the policyholders, by definition, and 2) the share of non-par profits has increased substantially over the last few years.

What does this tell us? If non-par profits are increasing, it means more profits would be distributed to the shareholders which means the value of the in-force business goes up and, by extension, so does the EV. Just like it did over the last six months.

Bottom Line: LIC’s valuation has ballooned simply because of the way it shares its profits with policyholders and shareholders.

Premium Valuation vs Discounted Listing

Having said that, many analysts predict that LIC will be valued at a discount to other private sector insurers, which seems irrational considering that it’s LIC — a behemoth which has a robust market share, bankable AUMs and whose products are backed by sovereign guarantee.

There are multiple reasons behind this but let’s start with the one that’s been staring at our faces — its public sector overhang. Post-listing, GoI will maintain a majority ownership in LIC, which means the company could face the same handicaps as other state-run enterprises like Government meddling, outdated systems and processes, slow technology adoption etc. LIC’s non-performing assets hover at close to 7.8% compared to 0.10% for the top three private insurers.

Next reason is the product mix of LIC which is skewed towards savings products, also called endowment plans. Private players, in contrast, have a higher share of pure protection products, also called term plans that fetch better margins.

Given its legacy constraints, LIC still depends largely on agents for its business whereas private players conduct most of their business through the bancassurance channel. This also results in a higher commission-to-premium ratio for LIC thereby adding to costs.

And last but not least is LIC’s VNB (value of new business) margin which has been dragging far behind its private competitors. Although its RoE remains higher (82% for FY21) than its peers, its VNB lags behind. VNB is essentially the EPS equivalent of an insurance company that measures the value of new business and thus the profits to be generated therefrom which help gauge the profitability of the business.

Therefore, it is unlikely that LIC will trade at 3x/4x EV as its listed peers do. This leaves policyholders at the short end of the stick as they may have to settle for a discounted IPO price, should they choose to bid. But even if it lists at twice the EV, LIC’s market cap would reach ₹10.7Lcr ($141.7bn) making it India’s biggest public issue.

In any case, a lot will depend on how much liquidity will be drawn from the market when this Everest of an issue drops into the pool. A big IPO may not always be beautiful but it’s sure to be beguiling.

(Originally published February 16th 2022 in transfin.in)