The IPO is the second half of a bold experiment in bifurcating a ~$3bn-premium (re)insurer into an MGA and an affiliated balance sheet.
It’s going to be a challenging IPO for the bankers to price because the 13-15% target RoEs screens as attractive (see RoE regression graphic below), and the Richard Brindle-led underwriting comes with the Travelers seal of approval.
But there are no comparable businesses out there to start from, and investors may have concerns given Fidelis Insurance Group’s reliance on the MGU for value creation that there can be no true franchise value. In essence that backing the business is more akin to owning a high-yielding security.
CEO Dan Burrows and an assemblage of Wall Street’s finest IPO bankers will also have to find a way of finessing the reality that investors are likely more attracted to the MGU than to the balance sheet – an investment opportunity that is not available (and which likely never will be publicly).
Valuing businesses is for investors and equity analysts, but my sense is the pivot point around which the perception of success will turn is whether the IPO can get away at book value (or above). Although it should be noted that even if it goes at a discount, CVC et al are looking at a better return through the bifurcation than they would have made through a straight sale or IPO.
I’ve suggested before that as much attention as the bifurcation has drawn from rivals, it is unlikely that we will see copycats until the balance sheet proves it can be floated, and trade at a creditable multiple. (For background see: “A Fidelis of Two Halves”)
But even if Fidelis Insurance floats at book, or above, and succeeds in trading up through the year, it is difficult to see that company separation becomes a widespread strategy.
This is because if you start trying to identify plausible candidates, you quickly eliminate three groups that shrinks the pool dramatically, namely: (1) public companies; (2) (re)insurers without highly profitable portfolios; and (3) insurers operating in segments like US specialty, where multiples are high.
What seems more likely than a raft of imitators at group level is that others will look to find ways to exploit the same arbitrage that exists between the multiples ascribed to balance sheet businesses and MGAs. This is likely to see more assets – either in the form of MGAs, or teams at carriers – lifted out of insurers and transferred into MGAs, with the crystallization of a one-time gain for insurers.
Here are my key takeaways:
The IPO will be closely watched as it is trailblazing, but many copycats seem unlikely
Public companies are unlikely to risk such radical reorganizations
(Re)insurers without highly profitable portfolios will not be able to deliver a return to capital and fund the fee structure
Well-valued segments like US specialty will offer insufficient valuation arbitrage
“Mini-Fidelis” trades where MGA subsidiaries or teams are spun out of carriers and into MGAs look more likely
The gating factor
The bifurcation route is a highly management-friendly solution given that it gives executives a shot at entrepreneurial wealth creation beyond what is typically possible at a carrier, with the less capital-consumptive nature of the business meaning over time you could see 25-50% management stakes built.
In addition, it offers the promise of disencumbering leadership of the worst excesses of over-regulation and bureaucracy (although this will have to prove out over time).
As such, the gating factor on this kind of transaction seems likely to be support from capital, not interest from management teams.
And here, if Evercore is pounding the pavement with the Fidelis playbook looking for takers, it is likely to hit investor/board-level objections.
First, it is difficult to see boards of carriers that are already public being willing to take the risk of a complex reorganization.
Public companies are by their nature conservative, and bifurcation is a radical step. Trying to shepherd a business through twin equity and debt processes, in parallel with a legal reorganization, while continuing with the requirements of quarterly reporting seems unrealistic.
Trying to convince all shareholders that they had been dealt with fairly through the process would further complicate matters, and dial up risk.
In addition, carriers that are trading well are unlikely to want to imperil their premium multiple. Those that are not trading well are in a weak position to make a bold move.
Second, there is a relatively small group of underwriting companies that have good enough underwriting results to service the MGU fees, while having sufficient margin to deliver an attractive return to risk capital.
The math works with Fidelis because the business has been running at a mid-80s combined ratio over the last five years, with scope for improved performance resulting from rate rises.
Based on projected improved underwriting results based on big rate rises and portfolio changes, this could create room for a double-digit RoE for the balance sheet, alongside the fees and profit commissions that will drive returns at the MGU.
But it is too simple even to say that you therefore need an underwriting business with a good track record.
Because even good underwriting businesses that generate strong risk-adjusted returns based on higher loss ratio business would not work with the additional expense load, with insufficient margin to give the balance sheet investors an adequate return.
Third, the business looking to bifurcate needs to operate in an area that is relatively unfavored by investors and strategic acquirers, creating the material arbitrage that unlocks value.
As a London and Bermuda-based specialty insurer and reinsurer, Fidelis pursued the bifurcation in part because there has been a dearth of strategic acquirers for such firms.
Ascot, Argo, Probitas and Axis’ reinsurance segment all struggled to find acquirers willing to match early valuation expectations over the last 12 months – with only Argo ultimately trading. With the notable exception of Berkshire’s move on Alleghany, balance sheet M&A has largely been in abeyance.
And although Skyward Specialty may have demonstrated more US investor appetite than expected for an insurer, for the last almost 18 months the IPO landscape has looked unwelcoming globally – with IPO activity again extremely depressed in Q1.
However, particularly following Skyward’s strong debut and success in trading up to ~1.7x book, there is just less cause for US specialty insurers to consider a non-traditional exit for investors.
The case for businesses that are focused in the London market, Bermuda and reinsurance to consider bifurcation is stronger because the arbitrage is greater if you assume a common entry multiple for the MGA.
“Mini Fidelis” trades
While it looks challenging (but certainly not impossible) to replicate the Fidelis reorganization at group level, it is far easier to execute “mini-Fidelis” trades.
Deals along these lines that deconstruct the underwriting part of the value chain at subsidiary or team level are already being agreed, and there will certainly be more to come.
In January, Rob Giammarco’s mega MGA Amynta bought transactional liability (TL) and specialty lines MGA Ambridge from Fairfax’s Brit.
As part of the deal, concluded on a bilateral basis, Brit agreed a long-term capacity deal to continue supporting the ~$400mn+ premium MGA’s underwriting. Amynta paid a $400mn consideration, which will yield a significant boost to tangible book value at Brit given MGAs are carried by insurers at a fraction of their true value.
"While it looks challenging to replicate the Fidelis reorganization at group level, it is far easier to execute 'mini-Fidelis' trades"
Amynta gets ownership of the MGA which is probably worth more Day 1 as part of its platform than it paid for it, and creates a more diversified group with more specialty business and a shot at the structural growth of TL and the wider E&S markets.
Aquiline-owned Distinguished Underwriters is also rolling out a similar playbook, and has already negotiated one team out of SiriusPoint in a deal that takes advantage of the same valuation arbitrage. In this case, Doug Stepenosky and his team moved to Distinguished, with a multi-year capacity deal agreed, and a consideration paid to SiriusPoint.
They won’t be the only ones exploring these kinds of trades given the scope for a win-win between carrier and MGA, and the reduced risk that results from attempting it on a smaller scale.
Cutting a multi-billion carrier in two looks likely to remain the preserve of a select group.
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