Bill Kennedy, Global CEO of Analytics, Capital Markets, Specialty Practices and Advisory
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 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.
There are two significant “X-factors” that exist in the market that 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. All major indices are at or close to their lowest levels in the past five years in terms of price-to-book value multiples.
Valuations at these levels have a negative impact on M&A for both buyers and sellers.
- 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.
- Sellers: The board of an insurance company, for example, might receive 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, having a negative impact on M&A.
2. Macro-economic environment: A recent spate of bad news is placing continued strain on the current macro-economic environment. The 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.
All that said, many of the other leading indicators point towards a market that should experience an increased level of M&A over the next 6-12 months:
1. Excess capital: Since the asset-driven capital depletions associated with the global financial crisis in the fourth quarter of 2008 and the first quarter of 2009,
the industry’s balance sheets have been restored to year-end 2007 levels – levels at which many felt the industry was overcapitalized.
2. Soft market conditions: A natural by-product of excess capital is soft market conditions. Pricing levels are back to the pre-2001 levels after a period of steep increases from the period following the events of September 11, 2001 through 2004.
3. Need for growth: The combination of excess capital and soft market conditions creates an environment whereby carriers seek premium growth – driving M&A activity.
Regarding year-to-date activity in 2010, buyers were consistent on two fronts across most transactions, specifically being opportunistic and disciplined and satisfying a need to show top-line growth in discrete segments of the market. GC Securities analysis suggests an increased level of M&A activity over the next 6-12 months as the earnings cycle plays out and the impact of Solvency II is seen. However, the market cannot ignore current valuation levels and the macro-economic environment. Transactions will continue to be done – it is the level of activity that remains uncertain.
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* 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.