Initial Merger View: AIG Making a Solid Growth Acquisition of Validus

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It is no secret that the investing community has treated American International Group Inc. (NYSE: AIG) with a cold shoulder of late. Its stock has been stuck between $50 and $65 for almost three years now, while many other broad financial stocks have seen their shares vault much higher. Some investors may think this is continued resentment after its role in the Great Recession, but the reality is that AIG was trying to shrink itself back into a more focused and more easily managed company.

That makes AIG’s announced multi-billion-dollar acquisition of Validus Holdings Ltd. (NYSE: VR) that much more interesting.

AIG shares were down only 0.8% at $61.03 after announcing the acquisition. AIG’s market cap is just under $55 billion, so the deal’s size of $5.56 billion would represent close to 10% of AIG’s value. The big question is what exactly AIG will get out of this deal.

Validus, a Bermuda-based provider of reinsurance, primary insurance and asset management services, was last seen trading up 44% at $67.40 per share on the news.

AIG touted that the Validus acquisition is a significant step forward in its strategy for profitable growth. It is also said to bring a diverse and complementary set of attractive franchises in the field of specialized products and regions. AIG further noted that the acquisition will enhance its own General Insurance capabilities and add a leading reinsurance underwriter that is a highly regarded operation at Lloyd’s.

Some mergers come with dilution, but AIG is claiming that the Validus acquisition is expected to be immediately accretive to AIG’s earnings and to its return on equity. The units being acquired as a result of the deal were listed as follows:

  • Validus Re: a treaty reinsurer with a focus on property catastrophe, marine and specialty
  • AlphaCat: manager of $3.2 billion on behalf of clients by investing in insurance-linked securities products
  • Talbot: a Lloyd’s of London syndicate focused on short-tail specialty lines
  • Western World: a U.S. specialty property and casualty underwriter focused on the small commercial E&S and admitted markets — AIG will gain Crop Risk Services

Validus had total revenues of $2.44 billion in 2016, versus $52.8 billion for AIG. Thomson Reuters most recently projected that the consensus analyst forecasts were $49.7 billion for AIG and $2.57 billion for Validus. The estimates were also for Validus revenues to grow to $2.75 billion in 2018 and $3.05 billion in 2019.

Validus’ common shareholders will receive $68 per share in cash under the merger terms. AIG also said that the deal will be funded by cash on hand.

Earnings of the Bermuda-based insurer will now be subject to the U.S. corporate tax rate under tax reform, but AIG has said that the acquisition may accelerate the utilization of AIG’s large and existing pile of deferred tax assets that could cover years worth of Validus’ profits. The transaction is also said to increase AIG’s more business insurance unit by about 19%.

AIG’s balance sheet showed that it had over $12 billion in cash and short-term investments as of September 30, 2017, but its long-term investments were $313.7 billion. AIG’s total assets were $503 billion, versus $430 billion in total liabilities.

CFRA (S&P) has weighed in on the merger by maintaining its Buy rating and $70 target for the shares, with a projected book value of $80 per share. The firm noted:

We view the deal positively, since it gives AIG a Lloyd’s marketplace presence, and enhances its specialty insurance and reinsurance presence. Also, by converting Validus to a US-based entity, this deal will enable AIG to accelerate the utilization of its $20 billion deferred tax asset.

Credit Suisse has an Outperform rating on AIG and a $73 price target. The firm sees the Validus deal bring improved underwriting quality that should offset concerns over the rationale and valuations. Credit Suisse sees the deal as $0.30 to $0.40 accretive in earnings per share. Its report said:

AIG was able to address several initial uncertainties we had on the deal and we are net positive on the deal as the financial considerations outweigh apprehensions around valuation and strategic rationale. Additionally, AIG seemed to indicate that reserve activity fourth quarter will be muted, as reserve uncertainty has been weighing on shares… With the buybacks stopped, and an expectation that organic underwriting improvement will take time, AIG is in need of alternative sources of earnings accretion and credible drivers towards loss ratio improvement. AIG gets both of these with this deal… AIG gets a well-run company with a good book of business and well-below average execution risk on the deal. With little to do from an integration standpoint, we expect AIG management to maintain most of its focus on improving AIG’s organic commercial business, which will still be 84% of the Commercial Insurance segment pro forma this deal.

With AIG shares near $61, its consensus analyst target price from Thomson Reuters is $67.44 and its 52-week range is $57.85 to $67.30.