After the market close, Prudential announced its purchase of Hartford’s individual life business for a $615 million ceding commission ($400 million after tax), which is expected to close in early 2013. Management expects this deal to be earnings neutral in 2013 and analysts expect some earnings benefit in 2014 on expense saves.
No detail on capital, financing, expense saves or PGAAP
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In addition to the ceding commission, Prudential Financial Inc (NYSE:PRU) will need to commit capital to support the acquired business. However, the company provided no guidance on committed capital, financing, expense saves or purchase GAAP accounting adjustments beyond saying that committed capital would likely be less than what was allocated to this line by he Hartford Financial Services Grup Inc (NYSE:HIG) ($900 million).
Deal is likely accretive to shareholder value
Prudential has been disciplined in past acquisitions and some believe that the appropriate hurdle rate for deployment of on balance sheet excess capital should be the 10%-11% historical cost of equity capital and not the current elevated implied cost of equity. It is impossible for Prudential Financial Inc (NYSE:PRU) to draw down on balance sheet excess capital today to buy back stock. A substantial draw down of excess capital would likely be possible only when the overall environment improves, at which point life valuations should be significantly higher (and share repo less attractive). In contrast, the appropriate hurdle rate for acquisitions funded by free cash flow should be the implied cost of equity capital based on the current stock price because FCF can be used to buyback shares.
No change to story, but expect some frustration
Prudential’s purchase of Hartford Financial Services Grup Inc (NYSE:HIG)’s individual life business is expected to be neutral to earnings in 2013 and accretive to earnings by 2014. Due to the relatively small size of the deal (perhaps $1.0 billion) Management commented that the earnings stream for Prudential would look different than the earnings reported by Hartford Financial Services Grup Inc (NYSE:HIG) from this business. The fact that one block of business could produce two different accounting earnings streams perpetuates the view that insurance financials are overly complex and opaque.
Prudential chose also not to disclose other key financial elements of the deal, including the expense savings it expected to enjoy and the integration costs it expected to incur, the capital that it would need to assign to back the newly arrived Hartford business, and ultimately therefore the ROE and earnings impact that adding The Hartford Financial Services Grup Inc (NYSE:HIG)’s individual life business would have on Prudential’s earnings and returns. A Prudential Financial Inc (NYSE:PRU) spokesman said this lack of seemingly important disclosure reflected what he said was the small size of the deal (although the addition of The Hartford’s policies will add roughly a quarter to the size of Pru’s individual life business, the $615 million price tag pales in comparison to the more than $4 billion that Pru spent last year to acquire major companies of American International Group, Inc. (NYSE:AIG) in Japan—American International Group, Inc. (NYSE:AIG) Star and American International Group, Inc. (NYSE:AIG) Edison.
Disclosure: No position