The enigma of Enterprise Group (2)
Enterprise Group Ltd (“Enterprise”) held its annual general meeting on Tuesday August 8, 2017. Like the dog that did not bark in Silver Blaze, one of Sherlock Holmes’s mysteries, the most intriguing feature of that meeting was the dearth of praise for an impending corporate transaction that exposes the tremendous value created for Enterprise’s shareholders over the last two decades.
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I refer to the inauguration of a new strategic partnership between Enterprise and Prudential Financial Services, Inc/Leapfrog (“Prudential”) of the United States.
Listed on the New York Stock Exchange, Prudential is one of America’s largest insurance groups, sporting a market capitalisation of $45 billion.
New valuation
This new partnership raised the valuation of Enterprise Group, even before its impending rights offering, from a market capitalisation of $1.3 million on January 2, 1997 to $181.9 million on June 23, 2017-the announcement date of that partnership. According to the Ghana Stock Exchange, Enterprise’s market capitalisation on that very June 23 date was a materially lower $72.3 million. Since 1997, Enterprise’s shareholders have received $17.5 million in dividends. Thus, if one goes by the Ghana Stock Exchange’s valuation of Enterprise, its long-term shareholders have enjoyed an annual compounded return, in US Dollars, on their 1997 investment of 23.6 per cent; if one accepts the implied valuation of Enterprise by Prudential, that return rises to 28.6%.
To provide some perspective, the annual compounded return of Standard Chartered Bank of Ghana over this 20 year period was 18.4 per cent; that of Naspers, owner of DSTV and the largest company in South Africa, was 17%, while that of Berkshire Hathaway, Warren Buffet’s insurance group, was 11%.
Enterprise has been a dark star on the Ghana Stock Exchange. How could an experienced foreign insurance group recognise its stellar quality by according it a valuation 2.5x higher ($181.9 million/$72.3 million) than the valuation of investors on the Ghana Stock Exchange? The goal of this article is to attempt to answer that question.
Allow me a confession! My interest in Enterprise is far from academic. My clients are shareholders of Enterprise. Take my opinions, therefore, as those of a biased believer in Enterprise. I do not urge anyone to take any action-whether buying or selling or subscribing to Enterprise shares or relating to Enterprise based on this article. Action-oriented individuals should consult their professional advisers about the wisdom or folly of owning or selling Enterprise shares. Allow me also a pre-emptive apology. This article employs a lot of jargon and words to attempt to explain how to understand the life company at the heart of Enterprise. I apologise for the terminology and length of this newspaper article.
The first question posed by Prudential’s entry into Ghana is: Why Ghana? Ghana offers potent prospects of profit for the insurance and pension industries. 2015 insurance penetration (gross premiums paid as a % of Ghana’s gross domestic product) was 1% versus 3.9 per cent for Botswana, 2.9 per cent for Kenya and 2.8 per cent as the average insurance penetration rate for emerging markets. As an aside, Nigeria’s insurance penetration rate of 0.3 per cent makes Ghana look positively mature.
Inflation-adjusted returns to Ghanaian savers have been high. Ghana’s economy, in a bad year, grows by no less than 3% while its youthful population is forecast to grow at a 2% annual rate. Unsurprisingly, a down year for Ghana’s life industry, like 2016, is one in which premiums rise by less than 20 per cent in nominal cedi terms.
Contrast this state of affairs with the conditions faced by insurers in developed markets such as the United States of America (USA), France, or the United Kingdom (UK): stagnant and aging populations, negative real interest rates and insurance penetration rates in the 6% range. One can see, then, how Prudential, Sanlam, and other major insurance groups have been attracted to Ghana. Our long-term private financial assets industries (insurance and pensions) combine infancy with the allure of explosive profitable growth. Enterprise is one of the strongest private insurance operators in Ghana; therefore, it is a logical acquisition or joint venture partner for foreign entrants into Ghana and West Africa.
Background
What is Enterprise? It is a holding company with majority and wholly-owned operating subsidiaries in six fields: a 51 per cent Ghanaian life assurance subsidiary with the largest market share (by gross premiums) in that field; a 60% Ghanaian property and casualty insurance subsidiary, which has the second largest market share; a 60 per cent pensions management and administration subsidiary, which has the largest market share in Ghana’s new private pensions industry; a 100% owned property developer subsidiary; a 51 per cent indirect subsidiary in the funeral services field; and a majority-owned life assurance subsidiary in The Gambia. In terms of net profits, it was no. 1 in the Ghanaian life industry in 2015 and no. 3 in property and casualty insurance. Operating in different industry segments, its overall market capitalisation should be the sum of its parts (or subsidiaries) in the six fields. But, first, some history.
History
Enterprise was born in 1924 as an agency of Royal Exchange Assurance of the UK. The oldest insurance company in Ghana, it became a fully- fledged insurance company providing life and property and casualty.
The 1965 Insurance act prohibited foreign-owned insurance companies from insuring Ghanaians lives. Consequently, Enterprise withdrew from the life sector. In the early 70s, foreign –owned insurance companies were required to sell 40% of their shares to Ghanaians.
Enterprise so did. Then, the Ghana government requested an allocation of 20 %of the share capital of foreign –owned insurance companies in the mid – 1970s and duly received that allocation.
Thus, the British shareholders –then known as Guardian Royal Exchange Assurance –ended up owning 40% of Enterprise’s share capital. Throughout this period state insurance maintained its practical monopoly over the insurance of Ghanaian lives and the insurance of the property of state owned enterprises.
Enterprises experience of the 1970s arose out the Ghana government’s desire to “seize the commending height “of our economy.
Enterprise was one of the first companies to li=ease on the Ghana stock exchange in 1990. Venture and Acquisition (“V&A”), the controlling shareholders of the enterprise made its initial appearance on Enterprise’s share register in 1997.
It signified, for the first time, that Enterprise’s direction and strategy would determined, for good or ill, by the Ghanaian private sector. With the incumbent senior manager of Enterprise, V&A would allocate Enterprise’s capital based on their sense of Ghana’s long term prospects. What is the record of those capital allocation decisions? Very impressive!
Enterprise has chosen to pay out, on average, no more than 1/3rd of its net income in dividends. Its most important capital allocation decision was made in 200 when it decided to re- enter the life industry.it set up a joint venture with Africa Life of South Africa (subsequently acquired by Sanlam in 2005) and the International Finance Corporation in which it made 51% of the equity capital Contribution with Africa Life provided the training and expertise to both build a brand new life agency force and design the initial products offered by Enterprise Life Assurance Company-the name of the joint venture.
Remember that signature move because it has become an Enterprise trait-as a new entrant in the industry, teamed up with foreign partners technologically superior to local incumbents to play for dominance in that industry. By 2004, it had the 5th largest market share- 10% compared to24% held by the State Insurance Company.
By 2010, Enterprise Life surpassed its property and casualty insurance parent, in gross premiums, in 2010. It took another five years to become the largest life company in Ghana, by gross market share of 28.4%. It’s best to appreciate this outcome in US Dollars to eliminate the effect of inflation.
Enterprise Life generated $53 million of gross premiums in 2015 versus $2.4 million in 2004. By contrast, SIC Life grew from $5.7 million in 2004 to $48 million in 2015. A far from shabby 8,4x increase in SIC Life’s gross premiums was handily surpassed by a 2.3x increase by Enterprise Life. Of course, profits, not gross premiums, are what counts for shareholders.
In accrual accounting terms, Enterprise life and net profit of $10.3 million in 2015 and $13.8 million in 2016. Yet the truth is that Enterprise Life generates even more profits than are recognised under principle of accrual accounting.
This truth lies at the heart of the price paid by Prudential to replace Sanlam as Enterprise’s strategic partner. To find out about those additional profits, one has to learn about Enterprise’s “embedded value earnings”.
It does not help that those earnings are disclosed on page 102 of the 112 page Enterprise 2016 annual report; not on page 3 in Enterprise’s report summary. Enterprise Life’s 2015 embedded value earnings were$19.4 million and $20.6 million in 2016 respectively, 88% and 49% higher than reported 2015 and 2016 profits. What are those “embedded value earnings”? What is “embedded value”?