Generali ended months of speculation over its emerging Europe strategy last month, announcing plans to buy out its regional joint venture partner PPF for €2.52 billion.
The Italian insurer agreed to acquire the 49% stake from Czech billionaire Petr Kellner, the controlling shareholder of PPF Group, in two tranches. The first payment of €1.29 billion, for 25% of Generali PPF Holding (GPH), is due by March 28. Generali has until end-2014 to find the remaining €1.23 billion.
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The division of assets will also involve Generali exchanging its 27.5% share in private equity firm PPF Partners for sole ownership of investment vehicle PPF Beta, which includes a 38.5% stake in Russian insurer Ingosstrakh, on a non-cash basis. In addition, PPF will pay €80 million for GPH’s consumer finance insurance operations in Russia, Ukraine, Belarus and Kazakhstan. Moody’s decision
The termination of the five-year partnership between Generali and PPF was sparked by Moody’s decision in July to downgrade Generali by three notches to Baa1 on the basis of the weakening economic situation in Italy and Generali’s substantial holdings of Italian government bonds.
The rating action triggered a prepayment clause in a €2.1 billion loan taken out by PPF in 2007 to fund its participation in the joint venture. That in turn increased the likelihood that the Czech group would activate an option to sell its stake, either to Generali at the higher of fair market value and a floor of around €2.5 billion or to a third-party bidder with Generali ensuring payment of the floor price.
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| Generali’s new chief executive Mario Greco |
To forestall activation of the put option, Generali’s management – under the leadership of new chief executive Mario Greco – opened negotiations with PPF and its lending banks in the early autumn. The resulting agreement, announced after a meeting of Generali’s board on January 7, was broadly welcomed by analysts as providing much-needed certainty around both the price of the acquisition and Generali’s strategy in CEE. The implied price for GPH of €5.1 billion was agreed by most observers to be above fair market value, estimated by Bernstein Research at €3.7 billion to €4.6 billion based on annual net income of €300 million to €400 million and a sector average price/earnings ratio of nine. As Bernstein’s senior research analyst, Thomas Seidl, points out, however: "Given the restrictions of the agreement with PPF, Generali was left with little room to manoeuvre."
Some concerns were also raised about Generali’s choice of subordinated debt – in the form of a €1.25 billion lower tier 2 bond sold on December 5 – to fund the first part of the acquisition. "We would have preferred to see this being financed by equity capital rather than additional subordinated debt given the fact that Generali is already more highly leveraged than most of its peers," says Seidl.
Antonello Aquino, an insurance analyst at Moody’s, agrees. "From a financial point of view the PPF transaction is marginally negative as it involves a slight increase in leverage and a reduction in the quality of capital," he says.
Given Generali’s relatively weak capital position – at end-September it posted a Solvency 1 ratio of 140%, well below the 229% average of its main western European peers – analysts will now be closely monitoring the company’s ability to fund the second stage of the PPF transaction as planned, via a combination of retained earnings from the CEE businesses and asset disposals.
Generali has already raised €705 million from the sale in September of a 69% stake in Israeli insurer Migdal in September. The group’s US life reinsurance arm and Swiss private banking unit BSI are also on the block.
Renewed focus
A presentation given by Generali’s management on January 14 at the culmination of a strategic review of the group says that in total asset sales are expected to raise around €4 billion of regulatory capital by end-2015. Speaking to investors and analysts in London, Greco added that the pull-back from non-core markets would allow Generali to focus on its operations in growth markets in Asia and CEE.
"We expect CEE market growth to be double that of western Europe [through 2017] and for profitability to rise at similar levels," Greco said.
Analysts say Generali’s target is realistic given its already dominant position in CEE. Along with Allianz and Vienna Insurance, GPH is one of three large regional insurance players. It has a presence in 10 countries, including the number one slot in the profitable Czech market.
"CEE is a profitable operation for Generali and the company is one of the best performers in the region," says Aquino.
Roger Gascoigne, CEE head of insurance sector at KPMG, adds that the prevailing trend towards consolidation – as seen in last year’s sale by Aviva of its operation in Czech Republic, Hungary and Romania to MetLife – would likely favour the larger regional insurers.
"As these markets mature and growth slows it’s becoming harder for companies to justify maintaining second-tier or third-tier positions, particularly in the smaller economies," he says. "I would expect to see further consolidation in the region and for the bigger players to become more dominant."
