This week has seen some momentous merger activity: insurer Ace acquiring rival Chubb for $28.3bn; quickly following the broking announcement of Willis and Towers Watson merging.
Eamonn Flanagan at Shore Capital has put together an equity analyst's view on who will be next to go, among London market underwriters, in the "mergers and acquisitions (M&A) juggernaut".
“One day we have the comically described “merger of equals” with Willis merging with Towers Watson, the next day we have Ace buying Chubb,” said Flanagan.
But these are just two in a long list of M&A over a relatively short period.
There has already been HCC and Tokio Marine, Brit and Fairfax, Catlin and XL, Montpelier Re and Endurance, while the battle between Exor and Axis Capital for PartnerRe rumbles on.
Flanagan argues for several factors driving this flurry of activity: softening rates, low investment yields, incoming Solvency II regulation, and the opportunity for cost savings through scaling up. For the likes of Catlin, the factors can be extended to include access to Lloyd’s and the London market.
“And what’s the relevance for the UK quoted players? Well, the starting point is the about 1.8x historic book value rating that Chubb has been valued at by Ace,” said Flanagan.
According to Bloomberg, Chubb’s return on equity (RoE) has averaged about 12.5% over the past three years against a weighted average cost of capital (WACC) of about 8%. So what price for the Lloyd’s quoted insurers?
The attached chart shows the valuations underlying the quoted Lloyd’s insurers based on the premium to net tangible asset values (existing and against share price forecasts).
With a broadly similar WACC, the average RoE over the past three years were as follows for the big four: Amlin – 16.5%; Beazley – 18.7%; Hiscox – 16.7% and Lancashire – 16.3%.
“To us, two times historic net tangible asset value (NTAV) is a useful starting point in terms of valuation with a premium then required for control,” said Flanagan.
“Note that Ace’s bid was pitched at about 30% premium to Chubb’s price at closing on the June 30, with the deal involving significant dilution (about 29%) for Ace shareholders (also the case for XL and Catlin),” he continued.
Who will go next?
First on Flanagan's list among the contenders for sale is Amlin. “A discount to its major peers for 2016 appears anomalous to us. This is a high quality operation offering a powerful Lloyd’s exposure, a burgeoning business outside and a major player in the alternative capital space (via Leadenhall) is vulnerable to predatory attention,” said Flanagan.
Next up is cyber market leader and specialty re/insurer Beazley. "Beazley offers significant diversification benefits for many potential bidders from its specialty business. The rating may deter some but this is a terrifically managed company," he said.
London market and Bermudian proposition Hiscox "remains a high calibre business", he notes, having “excellent exposure to Lloyd’s complemented by a successful retail operation and a third party capital business…
Of Lancashire, another Anglo-Bermudian re/insurer, Flanagan said: “The combination of Lancashire outside Lloyd’s, Cathedral inside Lloyd’s and Kinesis (the capital markets play) together with surplus capital and a relatively low rating leaves the group vulnerable to M&A."
In the same class is Novae which, according to Flanagan, has been seen as a likely M&A target over the past couple of years, but now he is not so sure.
“The size of recent M&A activity (Catlin departed at about $4bn market cap) suggests that scale is viewed as increasingly important. Why pay about £500m for Novae when another £900m may get you Lancashire/Cathedral/Kinesis and lots of surplus capital?” he commented.
RSA is the final UK insurer on his list, which Flanagan said "boasts the strategic positions in Scandinavia and Canada. That together with the potential for cost cutting in the UK leaves RSA a potential bid candidate. However, the pension scheme deficit may deter many, especially if ‘cleaner’ plays are possible elsewhere," he said.