IAG shares have shot up as speculation swirls of a takeover bid by Wesfarmers, which has a smaller insurance operation of its own and is trying to ramp up its insurance sales through the Coles supermarket network.
Strategically a deal makes sense. Wesfarmers has long had IAG – and for that matter a whole suite of potential acquisitions – on its radar. It has been trying, without much success, to run some general insurance lines through its Coles network.
Politically though, a deal of this size could be fraught; no so much because of competition concerns – Wesfarmers’ mostly West Coast insurance assets would marry well with IAG’s dominance on the East Coast. It’s more of a question of the sensitivity surrounding IAG, its massive retail shareholder base and origins as in NRMA the privatised mutual.
A tie-up between Wesfarmers and IAG would make Australia even more of a duopoly nation. Perhaps if Coles took IAG, Woolworths could snaffle Suncorp and we could turn two big duopolies into one mega-duopoly! Consumers would hardly win.
Financially, given the sheer size of Wesfarmers and the rising cash generation of Coles, a deal could be done – scrip and cash perhaps. And ever since serial takeover merchant Frank O’Halloran’s QBE came knocking with a $4.20 a share informal offer three years ago, IAG stock has languished.
QBE, thanks to its foundering share price, is effectively out of the picture as a counter bidder although there could be bidding tension from one of the big banks. The Commonwealth Bank, as reported here earlier this year, has had a sniff around.
IAG looks undervalued, at least until this week when the shares took off. Today, IAG shares rose 5 cents, or 1.6 per cent, to $3.18, posting their seventh straight day of gains. But a Wesfarmers spokesman this afternoon said he had no knowledge of any deal.
Since late November, IAG has outperformed the broader market by 4.4 per cent and its peers by 3-4 per cent. Why? The Wesfarmers rumour, said one broker’s note to a client today who labelled it “an oldie but a goodie … that perennial rumour suggesting WES is about to bid for IAG has resurfaced.
The Citigroup broker said there was no denying that insurance was a scale business “hence adding IAG to its existing WFI/Lumley portfolio has appeal”.
“However, I question Wesfarmers’ commitment to insurance – it was only a few years ago that industry players suggested Lumley was up for sale. I also wonder if the board and management has enough on its plate what with the Coles turnaround (still has years to play out), problems with Kmart, defending Bunnings from new entrant Masters etc. Does it really make sense to take on more at this time?”
The broker may well be right. Perhaps adding mystique to the rumour, BusinessDay can add that Wesfarmers’ CEO Richard Goyder was scheduled to be in Sydney today at the offices of Wesfarmer’s merchant banking subsidiary, Gresham Partners.
But what of the financial considerations asked the Citigroup broker? “It’s not like IAG offers a lot of cost-out opportunities or revenue synergy potential. Its expense ratio is currently sitting at 27 per cent, consistent with global peers. Surely, there would be head office and listing fee savings but these would be hardly significant.
“IAG’s average ROE since listing in 2000 has only been 9.6 per cent. That is, it barely covers Wesfarmers’ cost of equity at 10 per cent. Adding in a takeover premium Wesfarmers’ could be paying a multiple of 12x earnings for IAG at present prices versus its own 13x multiple,” said the broker.