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Fairfax nears deal to buy Allied World for $4.9B


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WOW!

 

https://www.bloomberg.com/news/articles/2016-12-19/fairfax-nears-deal-to-buy-allied-world-for-4-9-billion

 

Fairfax Financial Holdings Ltd., the Canadian investment fund run by Prem Watsa, is nearing an agreement to acquire Allied World Assurance Co. for about $4.9 billion in a cash-and-stock deal that would be the largest yet for his firm, according to people familiar with the matter.

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It strikes me that this is the kind of deal you would do when you are about to take a hit to book.  It is always difficult to know exactly what they hold but my guesstimate is

 

Equities=  Flat

Bonds = -300m even after the sale of UST. If they hadn't sold they would have wiped a further $350m

Hedges = -250m even after reducing them by half.  If they hadn't closed out half then it would have wiped a further $300m

 

So another quarter with assets dropping around 500-600m

 

Add back (perhaps) U/W profit of 175m and say $75m of interest and divs

 

Gives a loss of around $250m - $350m pre-tax

 

I am tipping book value declined by $10-15 during the quarter.

 

Also why wait until now when AWH was trading much cheaper  (-20% to -30%) for most of 2016. 

 

I guess by the time the deal closes in 2017 book value will hopefully be back to the level the deal was made at and then some.  Perhaps this is why they want the flexibility to do cash rather than stock in the event something radically changes in the next 6 months. 

 

As it stands Prem seems to be sending a pretty strong signal that, at the current share price, the stock ain't cheap

 

cheers

 

nwoodman

 

 

 

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Of course, I don't like further dilution... But:

1) Insurance is their business, and very few people know it better than FFH. Therefore, the risk of a major mistake is very much mitigated imo.

2) Allied seems to be a very high quality company: average CR during the last 10 years of 87%, and a CAGR in BVPS of 14%.

3) As shown in slide 14, the transaction seems to be accretive to BVPS after considering the impact of new shares issued, while also decreasing the total debt / total capitalization ratio.

 

Cheers,

 

Gio

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Could the driver to do a deal today be the paradigm shift we are seeing in US interest rates/bond yields? Back in June we saw 10 years treasury yields fall to 1.35% Tough environment for insurance companies' earnings.

 

Today bond yields are spiking. The 10 years is now at 2.6% and some pretty smart people like Gundlach are suggesting yields may continue to move up significantly in the coming years. If this happens then earnings for insurance companies should benefit. It would make sense that stock prices would also move higher.

 

Perhaps Fairfax feels that as bond yields continue to increase over the next year insurance companies will get repriced higher by mr market; hence, the decision to buy now even though their own shares are trading near 52 week lows.

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If Prem is paying 1.3x BVPS to acquire Allied, he probably thinks Allied's FV is higher.

If he were signaling that FFH is not cheap, it would mean that he thinks FFH's opportunities for BVPS growth going forward are much smaller than Allied's.

I don't think that is the case. Imo it is still more of the same: Prem wants to keep the flexibility that cash gives him.

 

As for why now, maybe Viking is right... or maybe simply because Allied's management was not willing to sell the company while its stock was too cheap...

 

Cheers,

 

Gio

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If Prem is paying 1.3x BVPS to acquire Allied, he probably thinks Allied's FV is higher.

If he were signaling that FFH is not cheap, it would mean that he thinks FFH's opportunities for BVPS growth going forward are much smaller than Allied's.

I don't think that is the case. Imo it is still more of the same: Prem wants to keep the flexibility that cash gives him.

 

As for why now, maybe Viking is right... or maybe simply because Allied's management was not willing to sell the company while its stock was too cheap...

 

Cheers,

 

Gio

 

To me it seems like a reasonable purchase price,... seems they are paying 10x for 2014 earnings, 12x for 2013 earnings.

 

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Here's a note from Insurance Insider - apologies if the information here has already been posted / covered:

----------------------------------

Fairfax-Allied deal to create fifth-largest E&S writer

Catrin Shi

 

Fairfax Financial's proposed acquisition of Allied World will take pro-forma gross written premiums (GWP) to around $12.5bn and make the group the fifth-largest excess and surplus lines (E&S) writer across all of its operating companies.

 

Based on figures for the 12 months to 30 September 2016, pro-forma GWP amounts to $12.5bn, with a combined ratio of 92.4 percent, according to an investor presentation.

 

Three-quarters of the combined portfolio would be North American business. The combined E&S businesses would make the pro-forma company the fifth-largest E&S writer by direct written premium, up from Fairfax's current ranking of 11th and Allied World's current position of 20th.

 

The combined entity would generate $1.28bn in E&S direct written premium.

 

Notably, in Fairfax's announcement of the deal, the firm said it would run Allied World on a "decentralised" basis, making pro-forma figures less substantive.

 

The deal would also make the pro-forma company the seventh-largest North American insurer by market capitalisation.

 

In the investor presentation, Fairfax said the complementary business profiles of the two firms would create a "leading franchise" in global specialty insurance, and would significantly deepen Fairfax's presence in the North American specialty market.

 

The combination of the two firms would enhance the size and scale of the business and bring "significant" invested assets, it said.

 

Allied World's investment portfolio will give Fairfax an additional $9.4bn of assets to invest, with the Bermudian's investment leverage currently at 2.59x.

 

Fairfax has averaged an 8.6 percent return on its investments over the past 20 years, with its model based upon central management of investment float generated by autonomous operating entities.

 

The acquisition would also create a diversified portfolio by line of business, geography and distribution, while adding a strong and diversified source of earnings to the Fairfax group.

 

Based on full-year 2015 figures, casualty business would account for 57 percent of the pro-forma portfolio across Fairfax's operating entities, which include OdysseyRe, Brit, Crum & Forster and Northbridge.

 

Property business would comprise 30 percent of Fairfax's overall portfolio, while specialty would account for 13 percent.

 

Pro-forma shareholders' equity would total $13.4bn following the completion of the deal. The figure includes the impact of new shares issued based on an offer price of $54 per share.

--------------------------------------------------------------------

Another:

Valuation in spotlight as Allied goes for 1.34x and 18% uplift

Laura Board and Adam McNestrie

 

Investors will be carefully surveying the scene for a competing bid for Allied World after the company's board agreed a sale to Canadian insurance holding company Fairfax Financial at a relatively low 18 percent premium to the undisturbed share price.

 

Allied World CEO Scott Carmilani and the rest of the executive team have secured their futures with the management-friendly $4.9bn cash-and-shares deal given Fairfax's preference for a decentralised model.

 

Although the valuation represents a peer-comparable 1.34x trailing diluted book value, the premium to the closing share price on Friday (16 December) was only 18 percent against a rule-of-thumb 20-30 percent.

 

And the cash component is also modest, potentially as low as $10 per share of the $54 takeout price - with half of that coming from a pre-closing special dividend paid from Allied World's resources.

 

This could put the cash component of the deal that comes from Fairfax as low as $443mn, although the Canadian bidder has the right to flex this up by a further $30 per share, or $2.66bn - potentially rendering the transaction significantly more attractive.

 

The premium compares with the 40.3 percent offered in October by Sompo in its $6.3bn deal to buy Endurance, and the 30 percent paid by Ace when it bought Chubb for $28.3bn in July 2015.

 

Exor's winning $6.9bn bid for PartnerRe in August last year was 23.1 percent more than the undisturbed share price, after the Axis nil-premium deal was successfully broken up following a four-month tussle.

 

Tokio Marine offered a 37.6 percent premium in its $7.5bn bid for HCC in June 2015, while Mitsui paid 36 percent in its £3.5bn purchase of Amlin in September last year.

 

And the $4.1bn XL agreed to pay for Catlin in January last year equated to 23.5 percent more than the carrier's share price just before the companies announced they were working on a deal.

 

However, the benchmarking exercise is complicated by the sharp rise in Allied World's share price in the five month's leading up to the deal.

 

The share price has risen almost 29 percent since 19 July, when the company announced forecast-beating second quarter results.

 

The stock rose again in early October, climbing 8.7 percent in two days of trading, when The Insurance Insider reported that the company had held abortive talks about a takeover with Markel.

 

The company, like most in the sector, has also benefited from the market bounce following Donald Trump's victory in the US presidential election.

 

Fairfax will point to a deal structure that could give Allied World shareholders up to 27 percent of the enlarged entity.

 

This would give shareholders access to the benefits of being part of a group which has delivered compound annual growth in book value per share of 20 percent since 1985, driven by CEO Prem Watsa's investment prowess.

 

But with the headline control premium relatively low and the exact stock-and-cash mix of the offer unclear, there is ample room for an interloper to enter the fray.

 

That said, there are relatively few likely acquirers for a $5bn asset with roughly $1.5bn of goodwill, particularly given the deteriorating operating environment.

 

Potential spoilers include Japanese big three member MS&AD, which is said to be on the lookout for a US specialty insurance franchise of the type Allied World offers.

 

Chinese interest would be another possibility, but the execution challenge of a hostile deal is likely to be a major hurdle to any such interest.

 

Markel could also be tempted back in, although the attractiveness of a contested deal where it had previously been in position to consummate a friendly transaction is questionable.

 

Deal-wrecking specialist Validus, which disrupted Allied World's agreed acquisition of TransRe in 2011, is another possible rival bidder. However, the company is believed to be much more wary of hostile deals than it has been in the past after its share price suffered in the wake of its successful breakup of the TransRe sale.

 

Scor and Alleghany are likely to find a valuation above 1.4x book plus a break fee too dilutive to contemplate such a move.

 

Axis has marked itself firmly as an acquirer in recent months, but despite its size advantage versus Allied World its trading multiple of 1.07x is likely to rule it out of the running.

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Of course, I don't like further dilution... But:

1) Insurance is their business, and very few people know it better than FFH. Therefore, the risk of a major mistake is very much mitigated imo.

2) Allied seems to be a very high quality company: average CR during the last 10 years of 87%, and a CAGR in BVPS of 14%.

3) As shown in slide 14, the transaction seems to be accretive to BVPS after considering the impact of new shares issued, while also decreasing the total debt / total capitalization ratio.

 

Cheers,

 

Gio

Think it adds to BVPS simply because shares are being issued at a premium to book. Doesn't mean it's accretion to value.

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You might want to consider the possibility that this deal ultimately doesn't go through.

 

This is just the opening round, FFH has to top other bidders, and the final cost could well end up a fair bit higher.

We also don't know how much FFH currently controls (stock + options); if it goes to someone else there could be a significant gain.

 

At 26%+ dilution, FFH obviously thinks it a good deal.

Given the European focus that FFH would get from this, that additional share float is probably a good thing.

 

The string of insurance acquisitions evidence that FFH is bootstrapping its insurance business. Nothing wrong in that.

Last time out this didn't go so well; they had more to lose - and they almost lost the business. History tends to rhyme.

All acquisitions are of course a risk, and we learn as we go.

 

We wish them luck.

 

SD

 

 

     

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Think it adds to BVPS simply because shares are being issued at a premium to book. Doesn't mean it's accretion to value.

 

If FFH issues $4 billion in stocks, there will be 8.7 million new stocks outstanding (assuming today's price of US$461). As of September 30, 2016 there were 23.2 million stocks outstanding. That would bring the total up to 31.9 million stocks outstanding. Net income combined is projected to be $740 million. Therefore, EPS after the acquisition will be $740/31.9 = $23.2. EPS before the acquisition are $443/23.2 = $19.1.

 

Of course, you might argue that FFH + AWH deserves a lower multiple of EPS than FFH alone... But I would not be sure why: if anything, the combined entity looks to me as a more diversified, better financed, and stronger company than FFH alone.

 

Cheers,

 

Gio

 

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The string of insurance acquisitions evidence that FFH is bootstrapping its insurance business. Nothing wrong in that.

Last time out this didn't go so well; they had more to lose - and they almost lost the business. History tends to rhyme. 

 

What do you mean exactly?

It seems to me that from Zenith to Brit they have made a series of great acquisitions in the insurance field. Their investment abilities in stocks can be very much critiqued of course. Not their abilities in buying good insurance companies at fair prices, imo. By now they have proven many times their focus has rightly shifted from poor insurance businesses for a price well below BV to good insurance businesses for a premium to BV. And Allied seems to perfectly fit this healthy change.

 

Cheers,

 

Gio

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The string of insurance acquisitions evidence that FFH is bootstrapping its insurance business. Nothing wrong in that.

Last time out this didn't go so well; they had more to lose - and they almost lost the business. History tends to rhyme. 

 

What do you mean exactly?

It seems to me that from Zenith to Brit they have made a series of great acquisitions in the insurance field. Their investment abilities in stocks can be very much critiqued of course. Not their abilities in buying good insurance companies at fair prices, imo. By now they have proven many times their focus has rightly shifted from poor insurance businesses for a price well below BV to good insurance businesses for a premium to BV. And Allied seems to perfectly fit this healthy change.

 

Cheers,

 

Gio

 

 

No, I believe he's referring to the TIG and C&F acquisitions which almost destroyed the company.

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The string of insurance acquisitions evidence that FFH is bootstrapping its insurance business. Nothing wrong in that.

Last time out this didn't go so well; they had more to lose - and they almost lost the business. History tends to rhyme. 

 

What do you mean exactly?

It seems to me that from Zenith to Brit they have made a series of great acquisitions in the insurance field. Their investment abilities in stocks can be very much critiqued of course. Not their abilities in buying good insurance companies at fair prices, imo. By now they have proven many times their focus has rightly shifted from poor insurance businesses for a price well below BV to good insurance businesses for a premium to BV. And Allied seems to perfectly fit this healthy change.

 

Cheers,

 

Gio

 

 

No, I believe he's referring to the TIG and C&F acquisitions which almost destroyed the company.

 

Correct, I'm referring to TIG and C&F. This is a big acquisition; if it turns out to be a dud - it could hurt them badly.

However they've had more practice since these two, and been successful. Obviously, we hope that it continues.

 

That's just the nature of business.

 

SD

 

 

 

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You might want to consider the possibility that this deal ultimately doesn't go through.

 

This is just the opening round, FFH has to top other bidders, and the final cost could well end up a fair bit higher.

We also don't know how much FFH currently controls (stock + options); if it goes to someone else there could be a significant gain.

 

At 26%+ dilution, FFH obviously thinks it a good deal.

Given the European focus that FFH would get from this, that additional share float is probably a good thing.

 

The string of insurance acquisitions evidence that FFH is bootstrapping its insurance business. Nothing wrong in that.

Last time out this didn't go so well; they had more to lose - and they almost lost the business. History tends to rhyme.

All acquisitions are of course a risk, and we learn as we go.

 

We wish them luck.

 

SD

 

 

   

 

 

What's the likelyhood that this deal is approved by both sides but Regulators object?

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The string of insurance acquisitions evidence that FFH is bootstrapping its insurance business. Nothing wrong in that.

Last time out this didn't go so well; they had more to lose - and they almost lost the business. History tends to rhyme. 

 

What do you mean exactly?

It seems to me that from Zenith to Brit they have made a series of great acquisitions in the insurance field. Their investment abilities in stocks can be very much critiqued of course. Not their abilities in buying good insurance companies at fair prices, imo. By now they have proven many times their focus has rightly shifted from poor insurance businesses for a price well below BV to good insurance businesses for a premium to BV. And Allied seems to perfectly fit this healthy change.

 

Cheers,

 

Gio

 

 

No, I believe he's referring to the TIG and C&F acquisitions which almost destroyed the company.

 

Correct, I'm referring to TIG and C&F. This is a big acquisition; if it turns out to be a dud - it could hurt them badly.

However they've had more practice since these two, and been successful. Obviously, we hope that it continues.

 

That's just the nature of business.

 

SD

 

 

If I recall correctly, TIG and C&F were both cash acquisitions, which increased the level of re-financing risk that FFH faced.  This new Allied deal looks to be a little bit less risky to the extent that it seems like FFH is only obliged to write cheques for US$5 per Allied share, which by my calculations is only a cash use of about US$500m.  So, not much risk of needing to re-finance the debt for that.

 

However, there is still the risk that Allied could have some skeletons in its underwriting closet.  There is always a possibility that reserves are insufficient, meaning that the loss triangles come back to bite FFH on the ass five years from now.  The worst case (highly unlikely) would be the need to bolster reserves.  There is no mention of a SwissRe cover for reserves for this acquisition  ::)

 

I like how the deal is structured in a way that lets FFH pay cash if they discover that they've bought a plum or pay in shares if they discover that they've bought a lemon.  Prem's a pretty slick operator.

 

SJ

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I like how the deal is structured in a way that lets FFH pay cash if they discover that they've bought a plum or pay in shares if they discover that they've bought a lemon.  Prem's a pretty slick operator.

 

SJ

 

It doesn't make much difference how you pay for it - if you've overpaid, you've overpaid, whether you decide to use cash or your own shares to finance the purchase.

 

The flexibility that I like is that it gives Watsa the opportunity to use FFH shares if their value rebounds a bit, or if raising more cash suddenly becomes more difficult, or he can use cash if FFH shares stay at low prices or if he has no worries about Fairfax's balance sheet.

 

dm

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Well guys, have to say, kind of seems real strange to me.

 

Fairfax is on a rollup spree in insurance... but unlike a rollup they aren't doing anything strategic to get synergies.  They are running a decentralized rollup and paying prices that don't seem great, and funding from sources where they also don't have a cost advantage (debt or equity).

 

I think there are few charitable explanations of their recent actions, but there are a few bad explanations.

 

Hate to reign on the parade, but doesn't seem right to me. 

 

I'm out of my position here.  Will revisit and decide whether to re-enter.  Been an interesting >10 year hold for me... but I think the thesis has changed too much, and the negatives have accumulated too much for me to continue to hold.

 

Cheers,

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Here are a couple of interesting quotes from Prem regarding the rational for the purchase:

 

“The recent election . . . has a strong potential to make the business climate for growth great again,” he said. “We believe the US may see significant growth in GDP and our business in the US will benefit from any such positive development.”

 

Mr Watsa suggested that there could be more US deals in the future: “When the biggest economy in the world is on the way up we think the downside is significantly reduced and it becomes a value-oriented, stockpickers’ market. In the last few years we’ve played defence. We expect to play offence.”

 

https://www.ft.com/content/da6d1b3a-c5f5-11e6-9043-7e34c07b46ef?ftcamp=traffic/partner/feed_headline/us_yahoo/auddev&yptr=yahoo

 

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