QBE Offer For IAG Only Chapter One

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This story features QBE INSURANCE GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: QBE
The company is included in ASX20, ASX50, ASX100, ASX300 and ALL-ORDS

By Chris Shaw

In a long-mooted move QBE Insurance ((QBE)) has proposed a “merger” (read: takeover)  with Insurance Australia Group ((IAG)) and the offer of 0.142 of its own shares plus $0.70 in cash per IAG share implies little in the way of a premium for the target’s shareholders, who have suffered from a period of poor performance by the company.

Shares in Insurance Australia Group responded to the offer by moving above the $3.95 implied value of the bid (based on QBE’s share price when the offer was made official) and this suggests the market expects a higher offer, whether it be from QBE or another interested party.

Deutsche Bank makes a case for a higher offer, suggesting QBE’s opening gambit is opportunistic but a move worth taking given the potential upside from a successful takeover. On the broker’s numbers the deal makes sense from both a financial and strategic perspective, assuming of course QBE doesn’t end up overpaying to finalise the deal.

The broker calculates the company could lift the offer by as much as 10% and still have it accretive to earnings in FY10, though the gain would likely be in the order of 2% rather than the 4% it estimates will be achieved on the current bid terms.

As a result the broker is positive on the proposal as the synergy benefits QBE could derive from bringing the two businesses together are significant, while the timing of the deal at what may prove to be the turning point in the personal insurance business also offers potential earnings upside.

As well the deal would increase the proportion of QBE’s earnings that are generated in Australia and this would help in delivering franking benefits to shareholders, while the merged group would have very strong positions in home and motor vehicle insurance and commercial insurance in the Australian marketplace.

Merrill Lynch is even more bullish on what the deal would deliver for QBE and estimates it would be around 9% earnings accretive on current terms (this is including synergy benefits) . Citi also calculates the deal would be earnings positive for QBE, though it notes the resulting increase in shares on offer means it would take some time for the benefits to fully flow through to shareholders.

As Merrill Lynch notes the offer puts a floor under IAG’s share price at around $4.00, though the broker cautions that while unlikely there remains some risk QBE ultimately walks away and pursues what it suggests are a range of other acquisition opportunities around the world.

The broker suggests IAG is now a Hold at current levels as it remains early days and the deal needs to play out, a rating in line with most other brokers in the market. Deutsche Bank has actually downgraded IAG to Hold from Buy, as having been relatively bullish on the stock it had a price target of $4.80 and the QBE offer falls well short of that. Deutsche Bank expects a sweetened offer to emerge at something around $4.50 per share, which it suggests would likely be enough to get the deal across the line.

Credit Suisse poses the most questions with respect to the deal, struggling to understand why it has been pitched now and why at the price implied by the offer. On the broker’s analysis the deal is at a premium to other recent acquisitions, which is puzzling given there appear to be a large number of potential deals QBE could do overseas for insurers trading on lower multiples.

As well the broker questions whether QBE can sustain its margins in coming years given likely cyclical pressures and the price it is offering for IAG. It counters this by suggesting the bid indicates a clear preference for growing group exposure to personal lines at what is seen as a low point in that particular cycle.

The broker doesn’t expect the current deal, which expires on April 21, will be successful so it has not changed its Neutral stance on QBE. Overall the FNArena database shows the stock is rated as Buy four times, Accumulate once and Hold three times, with Macquarie and UBS now restricted from offering recommendations given their involvement in the deal.

The database shows IAG is rated as Buy three times but all three ratings were made prior to the merger offer being announced, the stock also scoring five Holds and one Underweight recommendation. The average price target for IAG is $4.29, up slightly from $4.22 prior to the bid, while the average price target for QBE has fallen to $28.85 from $29.75.

Shares in both companies are stronger today and as at 11.15am Insurance Australia Group was up 18c or 4.3% at $4.37, while QBE Insurance was 43c or 1.9% higher at $23.33.

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