No Doesn’t Always Mean No

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This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: IAG
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

As we speak, Insurance Australia Group’s ((IAG)) board is in friendly discussions with a delegation from QBE Insurance ((QBE)). While IAG CEO Mick Hawker will no doubt be keen to lighten the mood initially with a bit of chat about how the Waratahs might fair in their semi on Saturday, the reason for the get-ogether is the sweetened offer from QBE to takeover IAG.

The earlier offer of 0.142 QBE shares and 70c cash for each IAG share has been increased to 0.145 and 90c respectively. Working off Friday’s closing prices, this represents about $4.60 for IAG, or about a 24% premium over the volume-weighted average price (VWAP) calculation QBE used to base the offer on. If you work from the last closing price of IAG before the first offer was made, it’s a 19% premium.

Depending on where you start from, the new deal is some 6-10% better than the first one. The first deal always looked like a bit of a tester from QBE, despite the company extending the bid time. Given IAG flatly rejected the first proposal, QBE clearly went about its due diligence again to find the limits of its desire to pick up the troubled general insurer. The QBE board perhaps hoped IAG might simply jump at the first offer, given its poor performance recently in the face of competition, weak markets and a succession of weather disasters.

A 30% premium over VWAP is standard fare for control of another company. However, as we saw with the quick acceptance of the St George board of a less than 30% offer from Westpac, if that company has problems then it is often best to take the money and run. Not only has IAG been struggling, it further downgraded guidance in the middle of the initial QBE offer period. IAG is hoping to use its capital to make incursions into the Asian market and grow by acquisition, as its local earnings outlook is bland at best. Aspect Huntley notes this makes IAG a far riskier proposition for shareholders than if the company were to return capital, particularly given IAG has no experience offshore.

QBE has plenty of experience offshore, but is attracted to IAG’s general insurance base – at the right price – as a good way to consolidate the home front as a firm footing for more expansion. The new offer implies slight accretion after the first year, with zero accretion potentially the benchmark. For QBE has suggested this is the final, take-it-or-leave-it offer. While GSJB Were analysts would not be put off if QBE actually moved to slight dilution after the first year, all analysts agree that final probably doesn’t mean final.

IAG immediately rejected the new offer, but has invited QBE to a round-table discussion about the Super 14 and what is a realistic price. At least we now know that IAG is not foolish enough to reject any offer for the sake of it. If a successful takeover requires just a little bit more from QBE, perhaps QBE will throw in a set of steak knives, shake hands, and join Mick and friends in the box as the Waratahs mercilessly crush the Stormers.

Or perhaps the requisite level of theatre will ensue, as the QBE delegates scoff at IAG’s counter price and rapidly exit the scene, vowing never to return. We don’t really need you IAG, they will say, and we can bide our time and look for some other acquisition. We are strong and you are weak. This is exactly what Microsoft has done recently with Yahoo.

Analysts agree that the real price for IAG should be somewhere around $3.80-4.00 without a bid on the table. Maybe even lower. But even if QBE walks away, a takeover premium will linger in the IAG share price. Will QBE come back on stage again when we thought only one encore would be forthcoming?

Merrill Lynch’s analysts suggested this morning that while the new deal brings the offer into the $4.50-4.80 range they had first suggested, one can actually construe a price of $5.25 as implicit in the numbers. This is achieved by “taking cost synergies, market structure benefits, diversification gains, resolution of IAG’s capital issues and other factors into account”. This leads Merrills to suggest, and the suggestion is echoed by many of its peer group, that IAG had better come up with some convincing public demonstration of why it is worth more than QBE is offering, or forever suffer the indignation of the market. Again the circumstances are not dissimilar to the Microsoft-Yahoo battle, where frustrated Yahoo shareholders have begun a proxy fight to force the board’s hand.

As Citi puts it, “it looks a tough ask for [IAG] to prove it is right and the market is wrong”.

However, while QBE might make a show of walking away, the truth is the market has responded poorly to the new offer and sold down IAG shares. This is because the market is not expecting a deal to be done. In the meantime, QBE shares have rallied for the same reason. Not all QBE shareholders would be thrilled that the successful insurer is trying to buy the dog that is IAG, in their view.

What this means is that the new offer, with its 80%-odd scrip component, is getting better and better on a relative share price basis. QBE may only have to walk away and say “Come to Papa”. The market will do the rest.

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