2010 has seen a modest level of property/casualty mergers and acquisitions (M&A) activity through the third quarter of the year - far less than what Guy Carpenter & Company, LLC expected to see going into the year. Twenty eight transactions with an aggregate deal value of almost USD3.2 billion have been announced and closed through the third quarter of 2010. This pace lags 2009 levels and is well off prior years’ activity.
Source: SNL Financial, all closed deals (whole entities) through September 30, 2010
We will explore the reasons why one would expect to see more M&A activity occurring in the next 6-12 months. But first, we will review two significant “X-factors” that exist in the market and continue to stifle M&A activity:
1. Valuation levels: After a slight rally in the fourth quarter of 2009, the market struggled to maintain a premium to book value over the first half of 2010 but followed with some updraft in the third quarter of 2010. As the chart below demonstrates, all major indices are at or close to their lowest levels in the past five years in terms of price-to-book value multiples.
Source: SNL Securities
Valuations at these levels have a negative impact on M&A for both buyers and sellers, as follows:
- Buyers: Buyers are resisting using their stock as acquisition currency at current valuation levels. Further, for buyers that have cash to make acquisitions, they have to demonstrate to their investors why a particular acquisition is a better use of cash than repurchasing stock at such relatively low valuations. This requirement serves to “raise the bar” on acquisitions, thereby making terms offered by buyers less attractive to sellers. In addition, the discussion regarding a particular acquisition with investors can become a tricky one for management teams - for example, explaining the rationale for holding excess capital, or, what the appropriate price range is for repurchasing stock.
- Sellers: A contemporary scenario might involve the board of an insurance company receiving an offer at 1.0x book value. The good news is the price represents a 25 percent premium to the current price - which has been stuck for the better part of 20 plus months. The bad news is that less than two years ago the stock was trading at 1.8x book value. This dynamic is challenging boards and management teams in the current market environment, which in turn is having a negative impact on M&A. In this circumstance, one would expect a seller to be inclined to accept stock as currency - that is, trade into a more attractive platform/currency - however, as mentioned above, buyers are cautious about issuing stock at relatively low valuations levels.
2. Macro-economic environment: It seems that a few days cannot go by without some form of bad news being reported that places strain on the current macro-economic environment. This nagging feeling created, combined with the not-too-distant memory of the capital markets being completely frozen, has boards and management teams in a cautious mode. This is not to say that people are not shopping - quite the contrary, we see a tremendous number of clients looking to grow via acquisition. However, getting transactions closed in the current environment is challenging (but not impossible).
A related macro-economic factor impacting M&A activity is a lack of outside capital in the form of debt to help finance transactions. While interest rates remain at or near record lows, buyers are finding it difficult to utilize debt financing to enhance returns associated with an acquisition. Instead, many of the smaller transactions, in particular those on the distribution side, are being financed by a combination of earn-outs and/or seller’s notes.
*Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.
Norman Brown, Geoff Sweitzer and Bart Zanelli are registered representatives of MMC Securities Corp.