Weak Predators, Demanding Prey Stymie Lloyd’s M&A

By Lorraine Turner and | June 11, 2010

A bid for Lloyd’s of London insurer Brit is unlikely to trigger acquisitions in the battered sector because targets feel they can hold out against lowball private equity bids and trade buyers remain strapped for cash.

Shares across the Lloyd’s sector — a clutch of companies which insure against large-scale risks such as natural disasters — jumped on Friday after Brit said it had rebuffed a £770 million ($1.12 billion) indicative cash offer from U.S. private equity firm Apollo.

The rally flagged wider takeover interest in the Lloyd’s insurers, long seen as potential bid targets because cyclically low insurance prices have in many cases left shares trading below asset values.

European insurance shares have fallen 6.6 percent this year, making them one of the weakest sectors, and Lloyd’s insurers trade at a discount to the European property and casualty insurance industry.

But analysts reckon that, with most trade buyers unable to afford acquisitions, and with sellers’ high price expectations likely to impede private equity bids, Apollo’s pursuit of Brit could prove an isolated event, even if it ultimately succeeds.

“The Brit approach might increase the likelihood that you’ll get M&A speculation, but I’m not convinced that you’ll now get a large number of actual M&A transactions,” said Oriel Securities analyst Tom Dorner.

PRICE GAP
Private equity firms’ interest in the Lloyd’s insurers, illustrated by Pamplona Capital’s purchase of a 10-percent stake in Chaucer last year, is driven by their high dividend yield as well as the potential for a turnaround when global insurance prices pick up.

But private equity bids can come unstuck because of the insurers’ lofty price expectations, reflecting lingering memories of higher valuations that prevailed during the boom years.

“In the last major period of consolidation that went through the sector, deals were taking place at twice book value,” said Mark Williamson, specialist sales executive at stockbroker KBC Peel Hunt.

“Management expectations in these companies could still be that they should be taken out at very punchy premiums to book value,” he said, adding that he estimated the bid for Brit was pitched at a 10-15 percent discount to book value.

Apollo’s bid appeared on Friday to have faltered because of just such a mismatch between the two sides’ price expectations, with Brit confirming it had suspended talks and was holding out for a better offer.

At the same time, bids from other Lloyd’s insurers, or their rivals in Bermuda, who are under pressure to limit their dependence on the U.S. catastrophe market, are hampered by weak share prices that make it difficult to raise finance for deals.

“The problem has been the multiples across the board, including those of large foreign companies,” said Collins Stewart analyst Ben Cohen.
“That makes it difficult to swoop in, even if you see the assets as attractive.”

MERGER DROUGHT

Analysts and industry executives point out that the Lloyd’s sector in any case has a poor track record in M&A, with many merger attempts foundering due to inability to agree on price, or because of personality clashes between senior management.

Deals in the Lloyd’s market are also rare because companies seeking to grow often find that they can achieve their objectives more cheaply by simply poaching teams of star underwriters from rivals.

However, some analysts say the Lloyd’s sector may find it difficult to resist consolidation pressures if global insurance prices, weighed by excess capacity after a low level of claims in 2009, remain depressed for much longer.

Prices will get a much-needed boost if current forecasts for an active U.S. hurricane season prove accurate, but another year of moderate claims and weak prices could force the pace of mergers in the sector.

“If we don’t have a large loss, then we’ve got a huge amount of excess capital and a lot of companies trading at very low valuations in quite similar business lines,” said Execution Noble analyst Joy Ferneyhough.

“It’s at that point that you’d say now is the obvious time for consolidation to happen.”
Brit shares closed up 20 percent. Prior to Apollo’s offer, the stock had fallen 37 percent since mid-2007, against a 7 percent decline in the FTSE non-life insurance index.

(Editing by Sitaraman Shankar)

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