Warren Buffett’s conglomerate has agreed to pay $11.6bn in cash for Alleghany, valuing the business at ~1.3x book and ~1.5x tangible book, at a 29% premium to the undisturbed share price.
The deal includes a 25-day “go-shop” provision (implying a bilateral deal), but there seems a very high likelihood it will close, something also hinted at by the absence of a break fee.
Very few buyers in the sector have the resources to pay upwards of $12bn for a business, and all of these are probably taken out of the running by the proportion of the target that is constituted by reinsurance, which is heavily out of favor.
Add to this Alleghany’s conglomerate structure, and you then need to find a buyer willing to pay in excess of 1.3x and happy to have the value tied up in machine tool manufacturing, toys, and hotel management assets. This is a model that is only really followed by Berkshire, Alleghany, Markel and Fairfax – and the latter two seem unlikely names for a deal this big.
The three stand-out players with large checkbooks and the appetite for deals in the $10bn-$15bn range are Tokio Marine, Chubb and Allianz. All would likely be put off by the need to acquire reinsurance business TransRe, and a back-to-back sale would be uncertain and complex, although there is a certain logic in breaking up the corporate form to maximize value.
It is hard to see much beyond this list because the bidder would need to be able to fund the deal in cash to have a chance of trumping Berkshire.
The other issue for any management team thinking about crashing the deal would be the fact that Berkshire, with the size of its resources, would always be in a position to outbid you if it wanted to. Which is to say that you wouldn’t have control of the situation.
As always in situations where there is potentially scope for more money to be paid if the business was broken up, the challenge is finding someone with the M&A skillset and the guts to do it. Alleghany shareholders may wonder where Ed Noonan is when you need him.
But in all seriousness, there is no one in the sector who would seriously consider the play, and hedge funds tend to be reluctant to role out this kind of playbook in insurance.
Reuniting with an old friend
There is a perspective that says it was natural for Alleghany to exit the public markets because it was never 100% comfortable with that status.
Having slowly morphed from a business operating as a kind of family office for the Kirby family to a firm with only 2.5% family ownership, the under-the-radar, soft sell of the stock makes a degree of sense.
But it also perhaps pointed to a degree of discomfort with public company status, something that has likely been exacerbated by the weak trading performance, with the pre-deal price flat on 12 months ago, and only 10% ahead of three years ago, and 9% ahead of five years ago.
This deal will allow the company to continue to operate with a degree of autonomy as part of the confederation of Berkshire, but spares it from the scrutiny and distraction of the public markets. It also ensures Alleghany has an owner that knows insurance and is focused squarely on long-term compounding of book value rather than maximizing quarterly earnings.
In striking the transaction, Berkshire secures some nice insurance/reinsurance assets at a competitive valuation. These include RSUI, which is one of the premier E&S franchises and a firm with real scarcity value that is highly comparable to the best peer companies (think RLI and Kinsale).
It also provides the firm with a US-weighted brokered reinsurer, a natural complement to Gen Re’s direct focus (as was indicated when TransRe and Gen Re struck their recently dissolved MGA-style deal in 2016).
But perhaps as importantly, it brings Alleghany CEO Joe Brandon back into the Berkshire fold, less than three months after he succeeded Weston Hicks in the position.
Brandon was CEO of Berkshire’s Gen Re between 2001 and 2008, and he has strong established working relationships with Buffett, vice chairman Charlie Munger and insurance chief Ajit Jain.
The returning executive left the company after the AIG-Gen Re finite reinsurance imbroglio, in which Brandon’s predecessor Ron Ferguson was charged for fraud and Gen Re paid $92mn to settle charges. (Ferguson ultimately agreed to pay a $200,000 fine as part of a deferred prosecution agreement, with four other executives – which did not include Brandon – also signing such agreements with the US government.)
After Brandon’s exit, he is believed to have kept up relationships with the Berkshire executive team, and Buffett took the unusual step of describing him as a “long-time friend” in the press release announcing the deal.
"I am particularly delighted that I will once again work together with my long-time friend, Joe Brandon"
Warren Buffett
Often relationship mapping between executives in retrospect proves crucial in deals coming together, with prior recent examples in the sector including the long-standing relationship between Prem Watsa and Mark Cloutier, which helped the Fairfax-Brit deal to come together.
At this stage, there is no confirmation from sources, but there must be a strong assumption that Brandon is now in pole position to succeed Jain as Berkshire’s insurance chief, when the latter ultimately takes the decision that he wants to relinquish the position, or reduce his duties.
The closeness between Brandon and the Berkshire team is likely to be an area of scrutiny for investors and analysts, although with a high percentage of passive shareholders and a ~30% control premium it is hard to see this ultimately becoming an obstacle to close.
The Inside P&C Research team will delve more deeply into the valuation paid for the business tomorrow, seeking to assess whether Alleghany shareholders will secure full value on exit.
The kind of competitor you can do without
In terms of the read-across to the broader sector, Berkshire’s ownership of these businesses will be a net negative for pricing at the margin.
“Alleghany and its subsidiaries will continue to operate as an independent entity with increased capital strength and support from Berkshire Hathaway,” the press release said (emphasis added).
Berkshire had $144bn of undeployed cash at year-end, and is looking for areas to deploy this profitably, with an early indication that it will provide these subsidiaries with additional fire power.
For a long time there has been a background danger that Berkshire will choose to change the game by deploying its capital more heavily into reinsurance, and it has made moves – both through its now-$5bn+ specialty platform BHSI and with attempts to revitalize Gen Re from 2015 on.
But it has never chosen to go as big as it could given the parent company’s scale, and it has always played the game in a relatively disciplined way, operating on the assumption that if you aim for a 98% combined, you risk over-shooting on the high side. To prevent this, it has always been willing to walk away from business, and operate under-levered on the top line.
This suggests that the negative impact is likely to be modest, but nevertheless, competitors will not welcome the news that TransRe, RSUI and CapSpecialty will now be able to call on Berkshire’s capital resources.
It will also be a nasty wake-up call for all the reinsurers of these entities that are highly likely to see the spend drop to zero, as they adapt to the Berkshire approach to outwards protections.
The specter of further Berkshire M&A
It is always difficult to predict how Berkshire will behave. For a long time, it has held back on the obvious deal for a firm of this scale, the acquisition of AIG (with the moment to strike now likely passed).
The Alleghany transaction serves as a reminder that Berkshire is out there as a potential consolidator. Of course, it never fully left, but it is now seven to eight years since it quietly made plays for legacy Chubb and HCC (losing out to Ace/Chubb and Tokio Marine, respectively), and over 10 years since Alleghany beat it to TransRe. Its only major P&C deal during this period was in the specialist medmal space, where it bought MLMIC in 2016 for $2.5bn.
And, of course, it is always worth standing back to remember what Berkshire could do M&A-wise if it chose to train the elephant gun on insurance.
And in this vein, owning more platforms means that more deals could potentially fit the group. Could CapSpecialty be used as a beach head for small commercial?
Or could TransRe be used as a consolidation vehicle for reinsurance?
Berkshire may have had a reinsurer already, but as a direct player in the US, Gen Re may have been a poor vehicle for consolidating reinsurers focused on the broker channel.
And this could prove fertile ground in terms of deal flow. It is increasingly clear that Axa will at some point seek to divest Axa XL Re, its $5bn-premium reinsurance arm. It may not be the only available reinsurance business, or book. Banking sources continue to suggest that AIG may not be the long-term owner of Validus Re, while SiriusPoint’s major pivot into reinsurance could also open up a possible future path where it is no longer in reinsurance.
With Covea finding a deal with PartnerRe, it is widely assumed that there are no buyers out there in reinsurance land. If he chose to, Warren Buffett could change that with a vengeance.
With Brandon – a reinsurance guy by background – set to play a key role in the Berkshire insurance hierarchy post-deal, the magnitude of the consolidation opportunity and the best way to play it may be an early question for him.
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