How To Profit From The Insurance M&A Frenzy
When the directors at Aspen Insurance Holdings Ltd. (NYSE: AHL) were asked if they would sell the company to Endurance Specialty Holdings Ltd. (NYSE: ENH) for $3.2 billion, their answer was, “no thanks.”
Endurance was making such overtures in early 2014. At the time, Aspen sported tangible book value per share of $50, roughly 10% more than the proposed purchase price. Thanks to ongoing profit gains since then, Aspen’s tangible book value per share raised to $54 a share.
If Endurance really wants to buy this insurer, then it needs to hike its buyout offer another $10, to around $54 a share.
Aspen’s board is aware of a simple investing fact, which was often discussed by Graham & Dodd, the patriarchs of value investing. If a business carries more net assets on its books than the current share price reflects, then the business could simply be broken up to fully realize the best price.
In fact, as recent mergers and acquisitions trends show in the insurance industry, book value can be seen as a floor not a ceiling.
Roughly six weeks ago, Renaissance Holding Ltd. (NYSE: RNR) offered to buy Platinum Underwriters Holdings Ltd. (NYSE: PTP) for around $76 per share. Book value stood at $68 a share at the end of the third quarter. RenaissanceRe can justify paying a premium to book value by deriving synergies from the acquisition.
Investors can take these lessons to the bank, and snap up below-book insurers — before they catch a buyout bid. Right now, 10 major insurers hold such solid value
| Company | Recent Price | Tangible Book Value Per Share | Percent Of Book Value Per Share | 2014 EPS |
|---|---|---|---|---|
| Genworth Financial (GNW) | 8.47 $ | 29.27 $ | 29 % | .15 $ |
| American Int’l Group (AIG) | 55.59 $ | 77.35 $ | 72 % | 4.74 $ |
| Meadowbrook Insurance (MIG) | 6.32 $ | 8.35 $ | 76% | .41 $ |
| Loews Corp (L) | 41.04 $ | 51.08 $ | 80 % | 2.55 $ |
| Aspen Insurance Holdings (AHL) | 44.09 $ | 54.09 $ | 82 % | 5.13 $ |
| Unum Goup (UNM) | 33.78 $ | 35.90 $ | 94 % | 3.54 $ |
| United Fire Group (UFCS) | 29.97$ | 31.21 $ | 96 % | 1.37 $ |
| Old Republic Int’l (ORI) | 14.62 $ | 15.04 $ | 97 % | .85 $ |
| Hartford Financial (HIG) | 41.55 $ | 42.29 $ | 98 % | 3.36 $ |
| XL Group (XL) | 35.96 $ | 36.08 $ | 100 % | 3.42 $ |
To be sure, not all of these companies are primed for a buyout.
#-ad_banner-#​Genworth Financial, Inc. (NYSE: GNW) is still in the process of cleaning up its books, a necessary precursor to any eventual buyout.
American Insurance Group, Inc. (NYSE: AIG), with a $77 billion market value, would be an awfully large fish for any company to swallow, except for the nation’s largest banks. Earlier this week, my colleague Joseph Hogue wrote about the traditional banking business model is about to get a whole lot tougher and may soon find insurers quite appealing.
As noted in table above, all of these insurers are profitable. This means that book value will keep growing (the impact of dividends and buybacks not withstanding).
In addition, a long-term catalyst for this group is about to become a near-term catalyst. In the next two-to-three quarters, the Federal Reserve is expected to raise interest rates. Considering these insurers have billions of dollars tied up in cash, higher interest income will help book value grow at an accelerating pace. This explains why the insurance industry is seeing increased M&A activity lately. Values are in place and growth drivers are emerging.
Insurance pricing remains very competitive, as most players are so well funded that they are offering attractive policies to retain or attract clients. That factor may partially explain why some of these insurance companies have yet to reach their fully-realized valuation.
Gloria Vogel, who follows insurance companies for research firm Drexel, thinks this is an opportune time to focus on buyout candidates.
“M&A is being driven by pricing pressure from alternative capital; more M&A is likely as other companies seek to join forces to realize cost savings and thus improve growth and returns,” Vogel said. “The best candidates for acquisition, in our view, are smaller companies trading close to book value with less diversified books of business, while the buyers are likely to be the larger firms seeking growth.
Shares of insurance company Loews Corp. (NYSE: L) were marching toward book value in late 2013, but in recent weeks and months, they have been in a downdraft. Loews is the rare insurer that also has stakes in the oil and gas exploration sector. That exposure opened a 20% gap between book value and the share price.
A simple solution: Sell those assets when oil prices and industry valuations stabilize. Loews could then use the money to continue a massive share buyback. Previous buybacks already shrank the share count to a recent 381 million from 553 million in 2006. Buying back stock while it trades far below book is a no-brainer investment.
Risks To Consider: Insurance stocks carry a low beta and represent less risk than most other kinds of stocks. Still, they are exposed to competitive pricing, which can dampen margins. The other main risk is a rising set of claims — for example, when a hurricane season is especially strong, or an earthquake rattles Southern California.
Action To Take –> All of the insurers in the table above hold appeal, simply because they have a solid asset base in place. As interest rates start rising, look for these stocks to trade toward, and then past, book value as profit growth accelerates. The nearer-term catalyst, in terms of M&A, is an added virtue to an already appealing group.
If you want to take a broad-based approach to this mergers and acquisitions trend, our Stock of the Month newsletter wrote about (and owns) an exchange-traded fund that specializes in capitalizing on M&A activity. You can gain access to this newsletter and the analysis of this fund by clicking here.