Posted on 31 Aug 2012 by Neilson
Two former rivals who vied with one another to buy a property-catastrophe reinsurance company target back in 2009—Validus Holdings and Flagstone Reinsurance Holdings—announced they will merge to form a $4 billion property-catastrophe-focused reinsurer yesterday.
Validus is paying $623.2 million in a cash and stock deal for Luxembourg-based Flagstone that will boost Validus’ shareholders’ equity roughly 14 percent from $3.5 billion (at June 30) to $4.0 billion if the deal closes. The transaction is subject to approval from Flagstone shareholders and regulators, and is expected to close in the fourth quarter.
On a conference call, Ed Noonan, chair and chief executive of Bermuda-based Validus said the combined operations write roughly $1.19 billion in gross property- catastrophe reinsurance premiums (using 2011 figures), ranking the merged entity as the largest property-catastrophe reinsurer by Validus’ calculations. A slide presentation released in conjunction with the conference call shows Validus-Flagstone combination just edging out RenaissanceRe, the next largest competitor with $1.18 billion in premiums.
Exactly how those first and second-place rankings will actually play out in 2013 is an open question, Noonan suggested in answer to a different question—how much of Flagstone’s $514 million in gross premiums for all classes of business (57 percent in property-cat and the remainder in short-tail casualty, specialty and other property) will be renewed going forward?
“If you can tell me what the market conditions are going to look like at Jan. 1, I can give you a really good estimate of what that is going to look like,” he said, responding to the analyst who posed the query, adding that property-catastrophe is pricing is “good broadly at this moment around the world.
“It’s not great. We’re not in a hard market, but pricing is good and we would look to retain the lion’s share of the business,” subject to market conditions and how Flagstone’s business fits within the aggregate portfolio, he said.
As for the rationale behind the deal, Noonan opened the call saying, “We think scale matters in the global catastrophe reinsurance market and we think this only adds to our already considerable advantages in that regard.”
“Our business plan since the beginning has been to focus on short-tail lines because that’s where we believe the best-priced classes of business exist, he said.
Both Validus and Flagstone started life in Bermuda as reinsurers focused on short-tail business in the wake of Hurricanes Katrina, Rita and Wilma in 2005. Neither strayed significantly from those roots, and both pursued global growth strategies in the years that followed. But Validus grew faster and bigger, allowing it to earn a profit even in the face of last year’s record global catastrophes, while those same events produced a bottom-line loss for Flagstone, which announced divestures and a strategic realignment of some of its businesses late in 2011 and earlier this year.
In a press statement announcing the merger transaction, Noonan said the deal “allows Validus to further build upon our market leading position in catastrophe risk,” echoing similar comments he made back in 2009, when Validus battled Max Capital (now Alterra) and last-minute suitor Flagstone in a competition to acquire IPC Re.
“We think we see the opportunity to create a market leader,” Noonan said back then, stepping into a four-month bidding war that culminated with Validus taking the spoils for $1.6 billion in the summer of 2009.
Validus’ pursuit of Flagstone this year played out very differently, according to Noonan.
“We were aware that Flagstone was having discussions with other parties early in the year, [but] we declined to participate in the process…because it felt like it would turn into an auction, and that’s not a place the really fits well in our approach to things,” he said during yesterday’s conference call.
Validus’ decision to step back stands in stark contrast to the previous dog-fights for acquisition targets, of which attentive listeners to yesterday’s conference call were reminded when Noonan at one point mistakenly referred to Flagstone as Transatlantic. Last year, Validus tried to outbid Allied World in an aggressive fight to acquire Transatlantic Holdings, which ended with a third-contestant—Alleghany Holdings—winning the sole Validus target that had a good chunk of casualty reinsurance business.
(At the time, Noonan explained the attraction to this reporter by pointing the fact that a lot of the Transatlantic’s casualty business was actually short-tail specialty, and that Validus was seizing the opportunity to pick up a global franchise at a fair valuation.)
On the yesterday’ call, Validus President and Chief Financial Officer Joseph Consolino said that some of Validus’ lack of early interest in the Flagstone acquisition was explained by the fact that the Validus management team was preoccupied with work on a separate deal—the capitalization of a sidecar known as AlphaCat Re 2012 with several other investors. Launched at June 1, the special purpose reinsurer was formed to write collateralized reinsurance with a particular focus on windstorm risks for Florida-domiciled insurance companies.
Throughout the conference Noonan fielded questions about whether Flagstone’s accounts might end up on the books of Validus Re—the Bermuda reinsurance operation of Validus Holdings—or such third-party vehicles by referencing the fact that Flagstone’s business has already been loaded into the firm’s capital-allocation risk management and pricing system known as VCAPS in order to decide.
In addition to state-of-the-art property-cat risk management systems, Noonan touted his company’s “track record of integration” of acquired entities as a benefit to Flagstone shareholders during the call.
Asked about the specifics of this in integration in terms of employees and office locations, Noonan and Consolino said that Flagstone’s CEO David Brown will step down, and that Validus’ efficient and scalable business model points to the likelihood of office closures in some locations. “I feel a great obligation to the Flagstone employees to make sure that that’s done thoughtfully—with consideration and compassion—and quickly,” Noonan said.
Although Validus has remained domiciled in Bermuda since inception, Flagstone redomiciled to Luxembourg in 2010.
“We’re a Bermudian company,” Noonan said. “We’re proud of being a Bermudian company. We’re proud of bringing a company back to Bermuda….This is home,” he said.
Noonan added that while Validus has “looked at every domicile in the world” to meet its obligations to shareholders, Bermuda “is the global center of catastrophe risk. [And] that is our core business.” Every domicile has costs and taxes associated with it, he added.
While Flagstone holds A-minus ratings from A.M. Best and Fitch Ratings and an A3 from Moody’s, Validus, which holds the same Fitch and Moody’s ratings, is rated A by A.M. Best and saw its A-minus from Standard & Poor’s hiked to an A just last week. With the merged entity being “90 percent Validus,” Consolino speculated that Validus’ ratings would prevail, and S&P actually did affirm the rating late yesterday.
Although the executives responses did not make it entirely clear whether S&P knew about the pending deal when it pushed up the rating last week, Noonan said the rating agencies understand that if there’s an attractive acquisition opportunity, then Validus will pursue that as part of its model. “Two-thirds of acquisitions destroy value, [but Validus’] acquisitions have been absolute value generators in the extreme,” Noonan said.