Goldman Sachs Upgrades Arch Capital, Lifts Price Target To $79

The brokerage noted that the acquisition shows the willingness of the company to deploy significant capital to scale its mortgage insurance business faster than it could do so organically.

"Our analysis implies that Arch could see approximately 10–50 percent of EPS accretion, which could increase Arch ROEs by approximately 50bps to 300bps, all else being equal," analyst Michael Nannizzi wrote in a note.

The brokerage said the shift to mortgage "would provide the company with an additional earnings lever not available to pure P&C peers." Also, the company appears to be more willing to bypass organic growth via the usage of M&A.

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"Given market conditions and returns in MI are much more attractive than P&C more broadly, on a pro-forma basis a potentially scaled up MI platform could have a significant impact on earnings," Nannizzi highlighted.

Nannizzi also raised his price target to $79 from $66, equivalent to 1.4x 2Q17E book value (from 1.1x previously).

"[W]e believe the company should garner a higher multiple as it continues to shift its business profile away from reinsurance and into mortgage insurance," the analyst added.

Moreover, the analyst is on the sidelines given Arch's high valuation relative to peers. The stock is up over 20 percent in the last year and now trading at 1.6x P/B multiple versus 1.1x for the underwriter group.

In addition, Nannizzi still views Arch as a relatively less likely acquisition candidate due to its comparatively high market cap ($10 billion) and peer-high valuation. If the acquisition of UGC closes, a takeout becomes even less likely given the increased complexity and size of the company.

Shares of Arch Capital closed Tuesday's trading at $82.76. At time of writing Wednesday, Arch was up 0.6 percent at $83.26.

Full ratings data available on Benzinga Pro.