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The Investment Case – Rand Merchant Insurance Holdings Ltd.

The diversified insurance play.

Orapa – Of the handful of new listings that joined the main board of the JSE last year, one stands out for its size. RMI Holdings (RMIH) (JSE:RMI) has a market capitalisation of over R20bn, placing it comfortably within the top echelon of stocks on the bourse.

RMIH was formed by separating the insurance investments out of RMB Holdings (RMBH) and combining them with FirstRand’s interest in OUTsurance. The new company was established with major stakes in two listed companies, namely 26% of MMI Holdings and 25% of Discovery Holdings. It also took ownership of 90% of OUTsurance and 76% of RMB Structured Insurance.

The restructuring of RMBH’s investments followed the merger between Metropolitan and Momentum that created MMI Holdings. It effectively created separate entities controlling the group’s banking and insurance assets.

“The unbundling gave the management of MMI the freedom to follow their own strategic direction, with the backing of an anchor shareholder,” says 36ONE analyst Jean Pierre Verster. “It also increased the financial visibility of OUTsurance through improved disclosure through RMIH. This is due to OUTsurance’s materiality for RMIH, which wasn’t the case with FirstRand, simply due to FirstRand’s size.”

History

RMIH was created through the restructuring of RMB Holdings and FirstRand in early 2011. While RMB Holdings retained only its interest in FirstRand, RMIH was listed separately to hold all of the group’s insurance investments.

RMB Holdings and RMIH share the same management team and resources.

Dividends

The total dividend paid to RMIH shareholders for the year ended 30 June 2011 was 56.5 cents per share. This translates to a dividend yield around 3.8%.

Which funds hold this stock?

Only a handful of the top-performing local unit trusts over the last three to five years include RMIH in their portfolios. Of the three leading equity financial funds, only one has any exposure to the stock. The Momentum Financial Services Fund gives it a weighting of 2.1%.

Two of the four best asset allocation flexible funds find room for RMIH in their portfolios. It is the top equity holding in the Centaur Flexible Fund with a weighting of 8.6%, while the 36ONE Flexible Opportunity Fund holds 0.3% of its assets in the counter.

Of the six leading general equity funds, only the PSG Equity Fund and Kagiso Equity Alpha Fund have any exposure to RMIH. The former gives the stock a weighting of 1.8% and the latter 0.6%.

To see which funds are buying and selling the counter, visit Moneyweb’s Unit Trust Portfolio Tool.

Why would an individual consider investing in this company?

Although the financial statements put out by some insurance companies can be ludicrously complex, the industry’s way of making money is essentially a simple one. These companies collect premiums from clients and invest this money while waiting for claims to be made.

The two big benefits to this approach are obvious: the first is that premiums are paid regularly, giving insurers a steady stream of income. The second is that they are able to make returns by investing other people’s money.

This is a formula that Warren Buffett is famous for taking advantage of. He used the float provided by Berkshire Hathaway’s insurance investments to fund many of the group’s acquisitions.

Through its holdings in some of South Africa’s premier insurance brands, RMIH offers investors an interesting entry point into the local industry. The group’s diversified portfolio not only provides exposure to companies operating in life insurance, medical insurance, short-term insurance and asset management, but also to companies with different business models – the traditional broker channels used by MMI and Discovery and the direct channel employed by OUTsurance.

When considering RMIH over a direct investment in either of its listed associates, investors will also be drawn to its 90% holding in the unlisted OUTsurance. This stake is its single most valuable asset, making up more than a third of RMIH’s value.

OUTsurance is one of South Africa’s most profitable short-term insurers, and also recently began offering a direct life insurance product. Its start up venture in Australia, Youi, is showing promise and is expected to break even by next year.

RMIH also benefits from the security of having two major shareholders of its own. Remgro owns an effective 30.3% of the group, while Royal Bafokeng Holdings controls a 15% stake.

What risks does this company face?

The pertinent risks facing RMIH are really those faced by the companies in which it is invested. Primary amongst these are regulatory and market reforms taking place in the South African insurance and healthcare industries.

From 2014 the Financial Services Board (FSB) will be adopting Solvency Assessment and Management (SAM), which will lay down certain minimum standards for risk management and capital requirements for insurers. The FSB also plans to introduce a framework called “Treating Customers Fairly”, which aims to regulate the way in which customer relationships are handled. While these reforms should be of benefit to consumers, they will place additional burdens on insurers.

The introduction of the National Health Insurance scheme (NHI) will also have implications for health insurance businesses, and there remain questions about how private medical schemes will operate within an NHI environment. However, the private sector is generally of the opinion that, while there will be disruptions, its role will still remain important.

“RMIH’s associates are exposed to risks as companies in their own right, but I don’t see major additional risks facing RMIH as an investment holding company,” says 36ONE’s Verster. “Although a low probability risk is a disappointment on the dividend, should RMIH hold back a portion of the cash received from its associates, rather than passing it on to shareholders.”

Where does this company’s growth potential lie?

When announcing its listing, RMIH stated that the only acquisitions it would consider would be already established businesses with proven earning power. However, it’s not obvious where it will find such targets.

“Personally, I don’t think RMIH will look for further acquisitions itself,” Verster contends. “It passes on the dividends received from its underlying investments to its own shareholders and it would be difficult to explain further investments in the insurance sector, whether life, short term or specialist lines, due to the conflict of interest there would be with its associates. The associates themselves might make acquisitions, but are also better known for greenfield operations, such as Youi in the case of Outsurance and many of Discovery’s new ventures.”

For more, visit Moneyweb’s click-a-company profile on Rand Merchant Insurance Holdings Ltd.

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