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The Markel-Alterra Combo, and Remembering Gayner's Lowdown on Evaluating Insurance Stocks
It has been about a week since the two insurance companies
announced an acquisition agreement where Guru
's Markel Corp. (
) will adopt Alterra Capital Holdings Ltd. (
)'s majority stake.
As Markel's stock has been entering negative territory in the past week since the revealing of the news (its stock is down by 0.33 percent Thursday morning), it is apparent that widespread doubt still lingers about the acquisition.
As reported by reinsurance magazine Reactions , capital market credit rating provider, Moody's has changed Markel Corp.'s rating outlook to "negative" from stable, "reflecting the significant execution and integration risk associated with sizable transaction, as well as the combined group's higher business risk profile."
This sizable transaction refers to Markel being officially entitled to 69 percent of the combined company on a fully diluted basis after the completion of the transaction, while Alterra's shareholders are approximately left with 31 percent, according to the original news release announcing the merger. Markel will be acquiring Alterra for a combination of stock and cash. Each common share of Alterra stock will be exchanged for 0.04315 common shares of Markel stock plus $10 in cash. The aggregate consideration paid for Alterra is approximately $3.15 billion.
What Markel expects to get out of this business deal is diversification of its service offerings, as well as to strengthen its business in specialty insurance and investments, with the two companies' combined equity of $6.9 billion.
"The merger brings together seasoned and accomplished underwriting teams with limited overlap in diverse specialty and reinsurance lines," the release stated.
As for Alterra, Moody's has retained its stable financial strength rating, while its debt rating has been set to "negative" from stable as well, expected to weaken after the merger, which is scheduled to close in the first half of 2013.
Enrico Leo, Moody's Markel analyst, said, "While the group [Markel] will benefit from an enhanced market presence, the change to a negative outlook reflects the significant execution risk associated with a large transaction as well as the combined group's higher product risk that includes greater catastrophe-exposed property and long-tail casualty lines of business."
Former accountant turned value investing Guru, Tom Gayner , gave GuruFocus the play-by-play on evaluating different types of insurance companies, during an interview back in January. Whether property and casualty insurance (P&C), reinsurance or title insurance, Gayner shared his insight during the conversation:
"Think about the differences between life and P&C. If you're a large life insurance company...the dispersion of possible outcomes is pretty tight. Large numbers of people, suddenly dying...just doesn't happen. Whereas, in a property and casualty company, you might have series of things just link in 2011 [Gayner names a series of catastrophic events in 2011, such as the tsunami in Japan, the flood in Thailand and the series of earthquakes]. Those are big catastrophic events that happen in the P&C world, that don't really happen in the life world. That gives us a sense of what the possible outcomes for businesses might be."
Gayner then brings forth deferred acquisition cost, or DAC, which he highlighted, is important when looking at life or P&C companies.
"P&C companies are going to have certain methodologies and certain ways of putting DAC costs on their balance sheets. A life company is going to have a very different way of doing that, and usually a much higher amount of DAC than what a P&C company does. That introduces some components of uncertainty that you just need to be thoughtful in thinking about."
When asked about Markel's intrinsic value, Gayner said:
"I would not put a specific number on it, but the mentality that I would have in thinking about it is, I would think about our insurance businesses with a normalized amount of premium volume, and a normalized amount of underlying profitability. That gives a normalized amount of operating earnings from the insurance company. Then I would look at our net investments per share, which was total investments minus all the debt. I would then think to myself, well, if this insurance company continues to operate at an underwriting profit, and at least stays the same size, then all of the net investments per share are actually working for the shareholder, so that value should be added. Then the third thing I would think about is the Markel ventures set of companies and what the operating cash flows and operating earnings are on a normalized basis and assign a multiple of that. I would divide that by the number of shares outstanding, and get a sense of what Markel's each share is worth."
Around the time of the interview, Gayner said the insurance part of Markel has had its book value compounded in the high teens in his 20 years of working there. "Going forward, I'd say that that's an aggressive goal... and I would hope that would end up being a double-digit return to our shareholders from doing so," he added. (Read the entire interview at Tom Gayner's Interview with GuruFocus.)
Market capitalized at $4.16 billion, GuruFocus ranks Markel Corp. 1 star in Business Predictability , 5 in Financial Strength and 8 in Profitability and Growth. Its P/B ratio is 1.1 and its Price/Tangible Book Value is 1.6.
Similarly, Alterra, too, has a Business Predictability rank of 1 star, a Financial Strength of 5 and a Profitability and Growth rank of 7. It has a $2.69 billion market cap, and is trading at $27.98, with its stock up 0.14 percent Thursday afternoon.
Gayner remains Markel Corp.'s president and chief investment officer, as well as the president of Markel Ventures, a Markel Corp. subsidiary.
Markel is a diverse financial holding company serving a variety of niche markets, with its principal business as marketing and underwriting specialty insurance products. Alterra Capital is a global enterprise dedicated to providing diversified specialty insurance and reinsurance products to corporations, public entities, and property and casualty insurers.
To read more about the merger of the two companies, view the 16-slide presentation that Markel put together.About GuruFocus: GuruFocus.com tracks the stocks picks and portfolio holdings of the world's best investors. This value investing site offers stock screeners and valuation tools. And publishes daily articles tracking the latest moves of the world's best investors. GuruFocus also provides promising stock ideas in 3 monthly newsletters sent to Premium Members .