Don’t Overpay, for Insurance M&A

I’ve been mulling over whether I should write about insurance M&A.  Ugh, yes, I should say something.  What pushed me over the edge was a piecein the WSJ on the purchase of Philadelphia Consolidated.  When I first heard about the deal, I blinked, and said, “Foreign acquirer overpays to enter the US.”  Is Philly a good company?  It’s a great company, but it may not be so under foreign ownership.  And, the price was well in excess of what it would have taken to create/attract the talent for a new venture.  Paying 2.7x book is not a winner.

But, the have been other missteps as well recently.  Liberty Mutual buys Safeco and Ohio Casualty for 1.8x and 1.6x book.  High prices for the assets obtained, and Liberty Mutual can’t lever that much as a mutual company.  It feels like the current management is going for growth at all costs, and the only losers will be the participating policyholders, who will eventually get a lower dividend stream.

I’m also not into funky holding company structures, for example, where a mutual company sells off a piece of a subsidiary to be publicly traded.  In that sense, it was good of ALFA to buy in their stock subsidiary (2.0x book), and now Nationwide is doing it as well (1.6x book).  Someone buying Nationwide Financial Services at the IPO earned an 8.7% annualized returnto the buyout.  ALFA shareholders did better, but I am not sure how much better, because I can’t tell how many times the stock split.  Both beat the returns on the S&P 500.  (I won’t mention the details of how Provident Mutual took Nationwide to the cleaners when they sold themselves; that had an effect on the returns.)

But, think about it from the perspective of the participating policyholders, who nominally own the mutual insurance companies.  That was expensive capital that diluted the dividends that they would have received.  But, mutual policyholders are sleepy, and mutual company managements take advantage of them.

I will mention three more deals before I close.

  • Commerce Group sold itself to Mapfre SA (1.6x book).  Another foreign company overpaying for a US presence.  I like the deal, because Safety Insurance will out-compete Commerce/Mapfre.
  • Midland Companies was bought by Munich Re for 2.0x book.  Midland was well-run, but I don’t see the fit with Munich Re.
  • Castlepoint Holdings was bought by Tower Group at 1.0x book value.  Perhaps a little incestuous, because it was Tower Group’s main reinsurer, but Tower helped bring th IPO to market, and I can’t tell whether this is a bright or dumb idea.

Insurance accounting is opaque to outside experts, and sometimes even to those doing the figures inside the companies.  Management often see marketing or cost synergies in doing deals, but my experience says those aren’t common.  Also, diversification benefits have to be weighed against lack of focus.  It is very difficult to manage disparate business lines.

To those are getting bought out, or who have been bought out, I encourage you to be grateful for the gift that you have received.  For those who own the acquiring company, I must say that the return performance for acquiring companies has been poor.  Consider investing in companies pursuing organic growth, which is often a better idea.

Full Disclosure: long SAFT