Two acquisition deals in recent days may point to a resurgence in reinsurance M&A in the coming months, Fitch Ratings said. But Standard & Poor’s said the benefits of more deals may be a mixed bag.
Fitch said that SOMPO Holdings Inc.’s $6.3 billion agreement to buy Endurance Specialty Holdings provides one indicator. The other: Chinese state-owned companies Shenzhen Qianhai Financial Holdings and Shenzhen Investment Holdings’ $1 billion acquisition of Singapore Asia Capital Reinsurance.
What helped spur these deals, and might help stimulate others, is a drop in valuation multiples, Fitch said in an Oct. 10 note. The M&A cavalcade that hit the market in late 2015 and early 2016 slowed down after a spike in valuations, with several transactions pricing about 2x book value, something Fitch said likely put off other possible buyers.
But the SOMPO/Endurance deal reflects a 1.4x multiple, Fitch said, and the Shenzhen/Asia Capital Reinsurance acquisition is at a 1.3x multiple. The ratings agency noted that these deals land in the historical range of 1.1x to 1.8x. With that in mind, this points to valuations apparently adjusting to reflect worsening investment returns and overcapacity, elements that will cut into 2017 profits.
A continued push for diversification, scale in a tough market and surplus capacity are also major trend drivers, Fitch said.
“Significant surplus capacity in the market will also drive M&A in 2017 by making organic growth harder to achieve and leaving acquisitions as the main source of growth for larger firms with still-healthy balance sheets,” Fitch said. “Intense competition also makes firms keener to eke out benefits from efficiencies of scale, increased diversification, cost-cutting opportunities and more efficient capital management.”
So which reinsurers will be hardest hit by the market weakness and most likely to merge? According to Fitch, that would be “smaller, less diversified firms operating in markets where premiums have fallen to the point where they no longer cover the cost of capital.”
These conditions will make the affected reinsurers more receptive to acquisition and “more likely to accept lower valuations,” Fitch said.
Standard & Poor’s also said it sees an M&A revival in the reinsurance sector. But it said those merger results will be mixed.
“While a successful M&A can benefit the surviving entity, the general consensus is that the track record of such transactions isn’t great, and we agree, at least from a credit standpoint,” S&P said.
Standard & Poors added that as a result, it places “a heavy emphasis on the risks associated with execution and integration of a transaction, though [it recognizes] the potential benefits from improvements in diversification and competitive position.”
Sources: Fitch Ratings, Standard & Poor’s