Something in reserve
Zurich Insurance Group can justify going the extra mile if it really wants RSA. Disappointing results from the Swiss insurer on Aug. 6 – and expectation-beating ones from the UK-based rival it says it might bid for – make it harder for Zurich to offer less than the 515 pence at which RSA has been trading since a deal was first mooted. Fortunately, it could offer up to 600 pence without destroying value.
Zurich boss Martin Senn reiterated on Thursday his reluctance to make a formal approach unless an RSA deal could hit his return requirements of around 10 percent. If he offered 600 pence a share – a 36 percent premium to RSA’s undisturbed share price on July 27 – Zurich’s return would just sneak over that level.
The maths works thus. At 600p, RSA’s market capitalisation plus borrowings amounts to 7.4 billion pounds. Suppose RSA can increase the 483 million pounds in operating profit it made in the second half of last year and the first half of 2015 by 15 percent annually. Then assume 200 million pounds of pre-tax cost synergies, pushing operating profit in three years to 748 million pounds. Zurich’s return that year would be 10.2 percent.
Those assumptions don’t look too taxing. Consensus operating profit figures from 11 analysts on RSA’s own website imply 16 percent growth this year. And 200 million pounds of synergies implies 15 percent of operational cost savings in RSA’s main markets like the UK and Canada, according to Deutsche Bank analysis.
That doesn’t mean Zurich will come charging in at 600p. RSA’s pension deficit of at least 600 million pounds could reduce the headroom. And RSA Chief Executive Stephen Hester is already hacking back group costs unaided. Any cross-border deal will have execution risks.
Still, Zurich’s all-important combined ratio – the extent to which premiums covered claims – slipped back in the first half to 98 percent, while RSA’s improved to 97 percent. With RSA seemingly heading in the right direction, Senn may have to offer more. The good thing for Zurich shareholders is that it looks like he can.