How Inspired Timely Decisions Can Bring Spectacular Rewards
The Age
Wednesday August 20, 2003
Every night, before he goes to sleep, Frank O'Halloran should say a quiet thank-you to Deutsche Bank and Capital Group. The two fund managers - QBE Insurances' biggest shareholders - convinced O'Halloran, against his instincts, to raise capital in the wake of the September 11 attacks.
Until Deutsche and Capital made their case, O'Halloran had been adamant that QBE didn't need more capital and wouldn't raise it at a point where its share price had nearly halved as a result of the attacks and the $250 million of losses QBE had sustained.
The investors, however, weren't urging him to raise capital to shore up his balance sheet; they had faith in QBE's initial estimates of its September 11 losses and wanted him to have a war chest for expansion. QBE eventually raised about $1 billion and was one of the first of the big insurers to do so.
The decision turned out to be an inspired one. Last month the chairman and CEO of global insurer AON, Dennis Mahoney, told the local insurance industry that the combination of insurance and investment losses over the past two years had ripped $US250 billion ($A380 billion) from the industry. Only $US30 billion of new capital had been raised over that period.
Not surprisingly, that had resulted in premium rates ``hardening" significantly and left some risks uninsurable. The global industry is under pressure and what had been, before September 11, a market that was over-capitalised and characterised by irrational pricing is now undercapitalised and thus less competitive.
QBE, however, has plenty of capital and the only pressure it is under is to maintain its underwriting discipline, which it appears to be doing.
Yesterday's interim profit statement was remarkable, with almost every metric by which insurers are assessed moving strongly in the right direction.
Apart from the obvious - the 110 per cent increase in profit to $241 million - gross written premium was up 11 per cent to $4.8 billion, net earned premium was up 15 per cent to $3.1 billion, cash flows surged 60 per cent to $726 million, its combined operation ratio improved from 99 per cent to 96 per cent, claims and expense ratios reduced and insurance margins expanded.
The capital raised after September 11 was the key to the results now flowing. It enabled QBE to write a lot more business on attractive terms and, with premium rates still rising, to continue to do so.
QBE said yesterday it expected an average increase in premium rates of more than 10 per cent this year and a further increase of 5 per cent in 2004. It expected gross written premium growth of 10 per cent this year and net earned premium growth of 13 per cent. With the turnaround in investment markets - despite having only an 8 per cent exposure to equities in its portfolio, QBE's investment income rose 95 per cent to $189 million - the group is in an extraordinarily strong position relative to many of its global peers.
The unusual opportunity available to QBE as a healthy group within a stressed sector is the ability to drive both volume and margin gains while simultaneously improving the quality of the business it is writing and its own balance sheet.
QBE has reduced its maximum risk retention from disasters by more than 40 per cent since June last year, improved its prudential margins, has a capital adequacy of about twice the minimum regulatory requirement and has reduced its exposure to reinsurers.
Had O'Halloran maintained his initial attitude towards a raising after September 11, QBE would still be in good shape. It would, however, have missed the opportunity to super-charge its growth and performance statistics.
Burns Philp's first result since the acquisition of Goodman Fielder earlier this year didn't provide any great insight into the prospects of the now highly leveraged group. With hindsight, however, Graeme Hart's audacious debt-funded $2.5 billion deal couldn't have been more perfectly timed.
The day in mid-March that Burns won Goodman's support for the bid with a token 2 per share increase in its offer, the sharemarket hit a four-year low of 2700 points, triggering a condition in the offer that could have enabled Burns to withdraw. Since then the market has risen 17 per cent - Burns bought Goodman at the bottom of the market at a point where investors were exceptionally nervous and attracted to cash.
Raising the debt for a highly leveraged transaction in the lead-up to the war in Iraq was ambitious. It was, however, another fortuitously timed exercise that delivered cheap long-term funding and, because $US1 billion of it was raised in the US, the windfall of currency gains. The Australian dollar has risen 10 per cent since the funding was arranged.
With Burns's CEO, Tom Degnan, saying yesterday that he has already made annualised savings/revenue enhancements of $70 million and expects more, the acquisition is on track.
The bid was more akin to a leveraged buy-out than a conventional takeover. For Hart's strategy to work Goodman's performance doesn't have to improve dramatically, although it is critical that its strong cash flows hold up. Degnan said yesterday there had been no operational surprises in Goodman.
The leverage in the group - $4.6 billion of assets sitting on only $758 million of equity - and the hoard of unused tax losses within Burns means that relatively modest improvements in Goodman's performance and value will translate to large gains for Burns shareholders.
By seizing the moment to attack a much larger company at a low point for the sharemarket and when credit was available at cheap rates, Hart minimised his costs and maximised his potential returns in what was and is - until the debt levels are substantially lowered - a high-risk play.
bartho@theage.com.au
© 2003 The Age