Lawrence Zack Galler
In the brief few days since last I wrote, there have been eight
SEC filings and a Wall Street Journal
on the tender.
The new information strongly supports the conclusion that the
- materially undervalues the company, and
- doesn't meet criteria of fairness to the minority, whether in
price, process, intent, or result.
The documents also strengthen my inference that National
) published loss reserves are not reliable for valuation,
may reflect Purchaser's (vs. Management's) best estimates,
and are likely overstated.
In balance, I offer the following cautionary remarks:
The documents describe the most aggressive overreach by a
majority owner (American Financial Group, NYSE: [[AFG]],
"Controller") I've seen in my investment career. Controller has
provided written intent to achieve a super-majority, a delisting,
or change the Articles of Incorporation to eliminate cumulative
voting in the event the Tender is unsuccessful. Readers should
think long and hard about suitability.
Still, in my experience, it is precisely when something within
reach becomes very valuable, the largest entity in the room becomes
the most aggressive. I intend to stick around and discover what's
behind the behavior.
With that caution in mind, we return to our story.
A Review through February 20th
National's Board ("Board") consists of ten members; six
affiliated with the purchaser inclusive of the CEO, and four
independents, including the Founder (Alan R. Spachman) and his
On February 5, 2014, AFG (with 51.7%) initiated a two step
transaction for the remaining public shares, consisting of a tender
to 90%, followed by a back-end merger. Terms were $28 per share in
On February 7th, the Board rejected a request by the Founder to
form a Special Committee and hire independent advisors.
On February 10th, the Board instead retained Duff & Phelps
to provide a fairness opinion, though splitting on this decision
along affiliate/independent director lines.
On February 17th, Duff & Phelps opined that the "the
consideration to be received by the public shareholders of the
Company in the Proposed Transaction is not fair from a financial
point of view to such shareholders."
At this point, according to filings, a Director affiliated with
the Controller offered to raise the bid to $30 per share, if the
Board were to disseminate a neutral, vs. an adverse opinion.
Published accounts differ, but suggest Duff & Phelps
resigned rather than continue their engagement, or offer an opinion
on the improved price.
On the morning of February 18, AFG publicly raised its bid to
$30 per share in cash, representing it was both best and final.
The Board reconvened later that day to vote on delivering a
Neutral recommendation to that bid, but the vote was split six to
four along affiliate/independent lines.
Two competing 14D-9s were subsequently filed. One representing
the affiliates, the other representing the dissenting views of
independent Director Alan Spachman.
The majority filing expressed no opinion on the deal, while the
latter recommended shareholders not tender.
A Brief Interlude on Loss Reserves and Insurance
Readers familiar with the subject or uninterested can safely
skip this section.
Cash is a restless thing. It's always either
- on its way in,
- just arrived,
- preparing to leave, or
In an insurance company, cash arrives in the form of premiums
and investment income, and leaves to pay claimants (the people who
have gotten into accidents).
Turning to the last two categories
, preparing to leave
When it seems likely, based on past experience, that a pile of
cash is preparing to leave, an insurer will record a liability
against it. This liability is called a loss reserve. Its creation
reduces equity (recall that Assets less Liabilities equals
But sometimes the cash never leaves. It sticks around! This is a
There are a couple of reasons for this. Occasionally the
claimants are willing to take less money for a faster settlement.
Sometimes the estimates were just too high.
At the end of the day, loss reserves are just a guess.
When, in the fullness of time, the guess proves too big, the
reserves are reduced. This is called "favorable loss
Such favorable development increases shareholders' equity, more
commonly called "book value" or "book."
Since the market value of insurers is commonly based on
multiples of book, the company is worth more.
Now back to National.
National's Loss Reserves: Management's Best Estimates or
In our last piece, we discussed the accounting treatment of the
Vanliner loss reserves. A new issue has been disclosed.
On Feb 19th, the Founder made an assertion in an SEC filing
regarding a change in how loss reserves were computed during 2013,
and the subsequent effect on earnings.
I quote the paragraph in its entirety:
In particular, Mr. Spachman notes that the Share price was
negatively affected by reserve increases made by the Company
during 2013. For many years, Purchaser has provided actuarial
services for the Company. As part of these services,
Purchaser has reviewed the adequacy of the Company's loss
reserves. Until 2013, Purchaser opined on the adequacy of the
Company's loss reserves only
the Company had closed its books for each financial quarter.
In 2013, however, Purchaser's actuaries began to recommend
significant changes to the Company's loss reserves for the
the Company announced its financial results for that quarter.
This new process was implemented by management without
advance review by, or knowledge of, the Company's full Board
or Audit Committee. As a result of this new process, loss
reserve deficiencies were reported, and reserves increased,
in the second, third and fourth quarters of 2013. 
More disclosure from the Company should be provided on this
National: M&A Infinite Improbability
Douglas Adam's Hitchhiker's Guide to the Galaxy describes the
Infinite Improbability Generator, a device near which incredibly
unlikely events occur with great frequency.
National seems to have one in their boardroom.
For reference, here's a list of events you just don't often
(actually, ever) see in corporate M&A.
In chronological order:
- Request to form Special Committee rejected.
- Financial Advisor opines Tender is financially unfair.
- Financial Advisor abruptly resigns.
- Board disregards 'Unfair' opinion, adopting
Purchaser-requested 'Neutral' stance by split vote.
- Competing Form 14D-9s are filed with the SEC on the same day,
one expressing no opinion, one recommending against tendering
- Multiple Directors discuss dispute in national media.
- Allegations of Accounting Shenanigans by Purchaser, made by
Director in an SEC filing.
And the night is still young!
Why the Rush?
Why the drama? Last I checked, the Academy of Motion Picture
Arts and Sciences doesn't yet recognize scenery-chomping overacting
in a Boardroom as an Award category.
Are things not as bad as loss-reserves might indicate? Is the
future perhaps, brighter than the past?
I don't know. In the absence of the tender, the next two major
events in National's life would be release of the 2013 Form 10-K
with loss-development triangle (which would shed some light both on
magnitude and origin of Q2, Q3, and Q4 reserve strengthening) and
the expiry of the Vanliner collar.
My purely speculative conjecture is this if either of those two
events were at all adverse to valuation, Controller wouldn't be in
a rush to go private ahead of them.
What Should Happen Next?
If you're a shareholder, don't tender.
Shareholders who still want to transact with the Controller
should, as a prerequisite, demand an
independent audit of the loss reserves
to serve as a reliable basis for valuation.
It would certainly be useful to know what the original 2013 Q2,
Q3, and Q4 loss reserve and earnings numbers were before the
purchaser admittedly reviewed and allegedly made discretionary
alterations without the knowledge of National's full Board or Audit
I don't understand how behavior like that falls into any safe
harbor, in any domicile. Courts show great deference to
Management's estimates, not those of a Purchaser.
Even in Ohio, Directors have a fiduciary duty of loyalty to the
corporation, not their employers.
The original loss reserve numbers, and alterations, if any,
should be shared with
without further delay. The data has no competitive relevance or
proprietary value and should be publicly released.
The National's Audit Committee has responsibilities here
independent of whether a transaction is ongoing. The matter should
be investigated and resolved.
People with Better Access to Information Keep Telling Us
The Company is Worth More
From the public disclosure and many, many filings, it has become
everyone who has gotten a private look at National's books and
records in that boardroom tells a story of a company that is worth
so much more than its market price
. Duff & Phelps, Spachman, AFG: everyone is saying the same
thing, if we just listen carefully.
It's just the shareholders who are being kept in the dark about
It's time for this to stop.
In sum, more disclosure to shareholders, please.
 Tender Offer for Insurer Divides a Boardroom, Wall Street
Journal, Feb. 20, 2014.
 National SC TO-T, filed Feb 5, 2014. See: Special Factors,
item 7 - Effects of the Offer if Purchaser Waives the Minimum
Tender Requirement and Purchases all Shares Tendered in the Offer,
 National Form SC 13D, Filed Feb 14, 2014 by Alan R.
Spachman, Item 4, p 4.
 Majority Opinion, National SC 14D9, filed Feb 19, 2014. p
 Ibid, Exhibit (15).
 Dissenting National SC 14D9, filed Feb 19, 2014. p 3.
 WSJ: "Duff & Phelps considered that move inappropriate
given Mr. Consolino's access to their analysis, according to
Messrs. Spachman and Schiavone. That prompted the firm to resign
its role as the company's adviser"
 Dissenting National SC 14D9, filed Feb 19, 2014. p.4.
 Dissenting National SC 14D9, filed Feb 19, 2014. pp.4-5.
Emphasis in the original.
 National SC TO-T/A2, filed Feb 21, 2014 p. 9.
 Dissenting National SC 14D9, filed Feb 19, 2014.
 See for example, Ohio General Corporation Law 1701.59.
National Interstate Corporation (NASDAQ: [[NATL]])
Great American Insurance Company (private)
American Financial Group (NYSE: [[AFG]])
I am long NATL. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
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