XL Group's $3.4 billion bid to buy London rival Catlin may start trendReprints
XL Group P.L.C. will gain scale and a much bigger London presence with its proposed acquisition of Catlin Group Ltd., though some experts express caution about potential pitfalls of the combination.
The deal would boost XL's gross premium volume by roughly 70% — and double the size of its reinsurance operations — but its challenges will include maintaining the underwriting and service capabilities that have helped Catlin succeed, experts say.
“It's the classic service business M&A challenge of maintaining those kinds of attributes in a much larger bureaucracy, while still achieving the scale benefits necessary to make the acquisition additive,” said Stuart Shipperlee, director with London-based Litmus Analysis, a consulting firm.
XL's stock dropped following the announcement and was downgraded by two stock analysts, citing the pending deal.
Meanwhile, several experts expect an increase in merger and acquisition activity — particularly of London underwriters and of units of large insurers — as acquirers look for growth and diversification.
Catlin announced its negotiations with XL last week, after news of the talks broke in London's Financial Times newspaper. Soon after, XL confirmed the talks.
Under the terms of the proposed deal, Dublin-domiciled XL would acquire 100% of Bermuda-based Catlin for cash and XL stock worth £6.99 per Catlin share, or £2.5 billion ($3.93 billion) in total.
Catlin founder and CEO Stephen Catlin personally owns 5.9 million shares, making his stake worth £41.3 million ($64.9 million).
XL and Catlin “both believe that we will be far better positioned and stronger together,” XL CEO Michael McGavick said in a statement. “We see this transaction as deeply accelerating the strategies of both companies.”
Catlin manages the largest Lloyd's of London syndicate, with a capacity of £1.43 billion, and would become larger with the merger of XL's syndicate, with a capacity of £300 million at year-end 2013.
The combined company would also “be a leader in the global specialty and property cat markets,” according to Mr. McGavick.
While XL is larger overall, with 2013 gross premiums of $7.4 billion versus Catlin's $5.3 billion, the companies' reinsurance units are similarly sized at $1.9 billion each and combined would be among the world's 10 largest reinsurers, XL said.
“It clearly will be a business with a lot more scale,” Ben Cohen, an analyst with Canaccord Genuity Ltd. in London said of the reinsurance operations. “The size difference between the two is not so large that Catlin will be swamped in the combined organization.”
With Catlin's largest geographical business segment in London—accounting for $2.5 billion, or nearly half, of its 2013 premium volume—the insurer has also expanded in the United States, Europe and Asia in recent years. Its U.S. business, though, at $1.2 billion in 2013 gross premiums, is less than half XL's U.S. volume, according to the companies' financial reports.
Mr. McGavick cited “the deep cultural and strategic alignment we see between XL and Catlin, with both built on disciplined underwriting.”
Some market observers, though, express caution about the proposed deal. “We're not convinced that specialty insurance market leadership translates into improved underwriting results, other than modest expense synergies that take time to emerge,” analysts with Baltimore-based Keefe, Bruyette & Woods said in a research note downgrading XL's stock.
And while “size and line-of-business diversification increasingly matter in reinsurance, (they are) much less important than underwriting discipline in primary insurance,” KBW analysts said.
“The obvious challenge will be in keeping—let alone enhancing—the value that has built up in Catlin's franchise,” Mr. Shipperlee said. “(XL's) much bigger balance sheet helps, but it is often the soft factors that differentiate in Catlin's markets and that can be much more difficult to maintain post an acquisition.” Such “soft factors,” he said, include underwriting culture, willingness to innovate, claims handling and speed of decision-making.
Whether or not the XL/Catlin deal proceeds, market observers expect growing numbers of merger and acquisition activity in the coming months.
With stronger balance sheets and more available funding, insurers and reinsurers will be increasingly interested in acquisitions, including international companies looking to acquire Lloyd's operations and Bermuda companies looking to diversify away from property catastrophe business, Mr. Cohen predicted.
Property catastrophe reinsurance rates have fallen significantly over the past year, as reinsurers have experienced minimal significant losses and competition from nontraditional capacity providers through cat bonds and other vehicles has intensified.
Thomas M. Dawson, a partner with Drinker, Biddle & Reath L.L.P. in New York, agreed that diversification will be a prime driver of future deals. He cited the recently announced $1.9 billion acquisition of Platinum Underwriters Holdings Ltd. by RenaissanceRe Holdings Ltd., aimed at expanding RenRe's casualty and specialty business.
Cathy Seifert, an equity analyst with Standard & Poor's Corp. in New York, said acquirers are more likely to target specific segments of another insurer's or reinsurer's business rather than the entire company. She mentioned Ace Ltd.'s pending $365 million purchase of high-net-worth personal lines business of Fireman's Fund Insurance Co.
“It's probably going to be Company A buying a division of Company B, not so much A buying all of B,” Ms. Seifert said.