So, Markel (MKL) is buying Alterra (ALTE). We realize Markel is acquisitive and wants opportunities. So it is here. Of course Markel shareholders might have gotten sticker shock from the stock being down so much. If the deal is accretive to book value, then why the stock is performed by the heck price need to be down so much?
Markel was trading above publication value, and they will buy Alterra for around reserve value. But the real way the market sees it, at least initially, is that on the sum-of-the-parts basis, nothing really changes with this deal. 6.8 billion, so the publication value accretion to Markel (positive for MKL shareholders) is offset by the increasing contact with reinsurance (negative; reinsurers are trading below book). Anyway, the merger demonstration (which is always educational) is on the MKL website.
I like Markel, therefore I tend to like this deal. It’s a good idea. Buy float for cheap and boost returns by enhancing investment comes back. Markel’s strategy is to do well on both underwriting and investing. Most insurers work on the underwriting but spend money on bonds mainly. This deal is accretive to book value. 434/talk about, around 1.02x post-deal publication value per talk about. 2/share in booked gains on fixed income securities held to maturity (booked at amortized cost). 424/share post-deal is clean and simple (unlike the LUK post-deal BPS that included goodwill from the JEF purchase).
I don’t believe MKL would do that deal planning on sub-10% return-on-equity for ALTE in the years ahead, so MKL should be considered a decent buy at around book value. Is one of the keys to this deal Here. ALTE’s investment portfolio is mostly in cash and fixed income securities with a little allocation to hedge funds (more on that later). ALTE has increased BPS year-to-date almost 10% (including dividends), which is not bad at all given the low interest environment and still weakened insurance market.
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ALTE’s average ROE in the past five years is just about 8%, and again, that’s in a minimal interest rate environment and weak insurance/reinsurance market. Interest rates are low: Insurance companies are leveraged credited to float so their investment valuations are delicate to interest rates and investment profits. At 3x float leverage, an 8% interest rate means a 24% pretax come back on equity simply for holding the float. In a 3% interest environment, that falls to 9%. With an after-tax basis, this is the difference between a small business appreciated at 1.5x book and 0.6x publication; that’s a 60% decline in value. Also, rising rates will cause connection prices to decrease placing pressure on bond prices.
Some feel that owning insurance companies is owning bubbled up bonds on leverage (well, it is). The insurance market is smooth: As the graph above shows, the insurance market due to numerous factors (extra capital, weakened economies round the world etc.) has been poor quite. The economy is weak: This overlaps with the other factors, but a vulnerable economy leads to lessen activity and less demand for insurance overall obviously. Weak investment returns: This too overlaps with the others, but low currency market’s returns over the past decade has put a lid on valuations of insurance firms that do invest actively in equities.
If MKL continues to do well over time, the book value is a superb opportunity to get in. But wait. Before you go out and purchase MKL stock, we have to think about buying ALTE instead. 10 in cash for each share of ALTE stock. The offer is expected to close in the first half of 2013, so let’s call that 6 months.