These are strange days in the economy and the financial markets, so perhaps it is fitting that the Transatlantic Holdings (NYSE:TRH) merger saga just got a little stranger. After all, it was odd enough that Transatlantic was the subject of competing bids that both undervalued this rare U.S.-domiciled reinsurance company. Now, Berkshire Hathaway (NYSE:BRK.A) is stepping in with a proposal when the company normally has preferred to act much more subtly in its acquisitions.
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The Latest Bid
Berkshire Hathaway, famously led by Warren Buffett, does not traditionally do hostile deals nor engage in public auctions. Typically Buffett's deal terms are "here's our deal, we expect a quick response and discretion". In this case, however, Berkshire's bid for Transatlantic does not seem to be the normal sort of arrangement where the deal is signed, sealed and delivered before the public even gets wind of it.
While the offer for Transatlantic is formally coming through National Indemnity and Ajit Jain, it seems inconceivable that Buffett is not fully aware of and involved in the deal. And as for the deal, Berkshire is offering $52 per share, or about $3.25 billion, in cash for Transatlantic. That is a little higher than the original "announced value" of Allied World Assurance's (NYSE:AWH) initial bid for Transatlantic, but lower than the $3.5 billion offer from Validus Holdings (NYSE:VR) that came later. In each of those cases, though, there was a large equity component to the offer, and the declines in the stock prices of the bidding companies means that Berkshire's bid is currently the largest (and would be guaranteed as an all-cash bid).
What is Transatlantic Holdings?
Global reinsurance is not a market that most investors consider often, if at all, so Transatlantic is likely to be an unfamiliar name to many readers. This is a case, though, where a lack of renown is not the same as a lack of value.
Transatlantic was once closely tied to AIG (NYSE:AIG), but it is now fully independent. It is one of the largest reinsurance companies in the world that works through brokers; third-largest in the U.S. and eighth-largest in the world. Split almost 50/50 between domestic and international business, Transatlantic writes considerably more casualty (more than 70%) than property insurance, and it tends to write long-tailed policies.
That exposure to long-tail casualty is a risk factor and perhaps part of the reason why Transatlantic is not attracting bids that fully value the business. Casualty insurance has not been a strong market for a few years now, and the problem with long-tail insurance is that mistakes in underwriting can haunt a company for a long, long time.
Speaking of those brokers, about one-quarter of Transatlantic's business goes through AON (NYSE:AON), and more than 15% goes through Marsh & McLennan (NYSE:MMC).
Transatlantic is a value asset. The company may not have the excellent capital position of Renaissance Re (NYSE:RNR) or PartnerRe (NYSE:PRE), but it is in good shape despite recently experiencing some of the worst casualty losses in its corporate history (due to natural disasters in Japan and New Zealand). Pricing is improving in its markets, and the company's relatively rare status as a U.S.-domiciled insurer could be invaluable.
Given that all of these bids for Transatlantic seem to be at least 15% below intrinsic value, this battle is probably not over yet. With that in mind, then, it seems unlikely that Berkshire Hathaway will walk away with this one. Berkshire is not famous for raising its bids, and while Buffett has done quite well for his shareholders by being a "capital provider of last resort" during this downturn - most famously, perhaps, with his dealings with Goldman Sachs (NYSE:GS) - it is not so clear that Transatlantic needs to take any bid, particularly a low one, just because it is in cash.
The Bottom Line
So what should investors do now? Transatlantic shareholders should sit tight, secure in the thesis that either Allied World or Validus will boost its offer, or that the company can ultimately sport a valuation in line with its intrinsic worth. At the same time, investors interested in the wider sector should check out names like ACE Limited (NYSE:ACE), Axis Capital (NYSE:AXS) and Arch Capital (Nasdaq:ACGL). With premiums finally on the way up in some markets, investors may be willing to pay more for well-run reinsurance and P&C franchises. (For additional reading, check out What Is Warren Buffett's Investing Style?)
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