AXA : A complex but transforming acquisition

>Strengths/Opportunities - - Remarkable geographical spread, with a successful refocusing on emerging markets, especially in Asia, which enables AXA to capitalise on changing needs (dependency) and more vibrant growth than in its mature markets. Its business will be refocused on 16 countries, however. - The forthcoming change in the business mix with the sale of life/AM operations in the US and the acquisition of specialty non-life insurance specialist XL Group. AXA becomes the world leader in commercial insurance with revenues of around € 30bn in 2016 and close to € 48bn of total P&C revenues. As a result, AXA will be less dependent on declining financial margins and more on technical margins. - The major deals announced – the IPO of the US business and the acquisition of XL Group. These allow AXA to confirm all the targets of its 2020 strategic plan, both thanks to their similar earnings capacity and shareholders' equity, with a balance-sheet size favourable to the second ($ 63bn vs. $ 216bn), and to expected synergies and diversification gains. - Sound and strengthened fundamentals in 2017: stable and recurring operating results, a strong Solvency II margin, conservative asset/liabilities management and strong liquidity.Weaknesses/Threats - - The transformative € 12.4bn acquisition of XL Group will initially raise AXA's leverage from 25 to 32%. That said, this leverage could increase if the IPO of the US business is delayed and/or its valuation falls short of expectations. - The acquisition of XL Group may add volatility to results given its exposure to major risks, even if AXA intends to reduce them. - There are many intangible assets on the balance sheet that weigh on available capital (with an improvement expected following the IPO, but this will be offset by the goodwill recorded when XL Group is consolidated). In contrast, the quality of Tier 1 regulatory capital is improving.Credit opinion: Negative; Market recommendation: Buy 2047/27, Reduce CMS/TEC and 2040/20 and Neutral on the other notes - The announced transactions are in line with AXA's strategy of focusing on commercial insurance but they are also large-scale, complex deals. Risks associated with the financing of the XL Group acquisition, partly dependent on AXA raising at least € 3.3bn from the IPO of its US business, have prompted the three agencies to warn of possible downward actions on the ratings in the future. We believe AXA's ratings will be confirmed after the IPO but that negative outlooks will be warranted to reflect the sharp increase in leverage and goodwill. As in previous years, AXA bonds performed fully in line with the market and insurance indices in 2017. Since the offer for XL Group was announced, and in a complicated market that is more of a seller of insurers, the spreads of AXA's benchmark bonds have widened more than those of its peers and indices. As such, the market has already largely priced in a possible downgrade of the ratings. In addition, the 2047/2027 notes have undergone a bigger repricing following the issuance of the new 249/2029 notes. We are therefore upgrading our recommendation on this paper to Buy from Neutral. Lastly, we are lowering our recommendation on (i) the 2040/2020 notes, as we find more value in CNP and Groupama paper and (ii) in CMS/ TEC, as we think that the previous pickup no longer exists given the spread widening on fixed-rated notes and the absence of a reaction on the CMS paper.