Combined IPC, Validus has cons: Analysts

HAMILTON, Bermuda—The proposed merger between Bermuda-based rivals IPC Holdings Ltd. and Validus Holdings Ltd. is expected to create a financially stronger global reinsurer with a major presence in the property catastrophe market, observers say.

The deal has raised concerns with analysts, however, about the combined entity's large concentration of catastrophe-exposed business as the U.S. hurricane season ramps up.

Under terms of the agreement announced July 9, Validus would purchase IPC for $1.65 billion in cash and stock. IPC shareholders would receive 0.9727 of a Validus share and $7.50 in cash for each of their shares of IPC. The deal values IPC at $29.48 per share, the firms said.

The agreement ends a months-long bidding war between rival Bermuda-based insurers, which prompted Validus to revise its offer three times and significantly boost its cash component in an attempt to outbid offers from Max Capital Group Ltd. and Flagstone Reinsurance Holdings Ltd. Berkshire Hathaway Inc. also reportedly made a $1.7 billion cash offer for IPC earlier this month but was ultimately rejected.

IPC Chairman Kenneth L. Hammond cited the “significantly higher cash component” of Validus' revised offer and said the agreement “represents the best outcome for our shareholders,” in a statement. Last month, IPC shareholders rejected a planned merger with Max Capital (BI, June 15/22).

Combined, IPC and Validus would have roughly $3.7 billion in total capital and will be well positioned to compete with larger peers, analysts said.

Brokers say the stronger balance sheet will be more attractive to buyers who are “increasingly concerned about the quality of counterparties” after the steep financial losses of 2008. “Clients are much more interested in sitting down with firms that have heartier balance sheets, in the $3 billion to $5 billion range,” one market source said.

“All things being equal, it is better to be larger than it was a few years ago,” said Steven K. Bolland, president of New York-based reinsurance intermediary Gill & Roeser Inc.

Validus Chairman and Chief Executive Officer Ed Noonan said in a statement “this is a compelling strategic combination.” Mr. Noonan is expected to run the company after the merger.

Market observers' concerns persist, though, over the heightened risk profile of the combined company due to the amount of property cat business both companies write.

“There is significant catastrophe exposure in the middle of the storm season,” said Dean Evans, an analyst with Keefe, Bruyette & Woods Inc. in New York.

As part of its revised deal, Validus has given up termination rights in the event of catastrophe losses, meaning that if a large event occurred before the deal closes, Validus could not back out of the deal, Mr. Evans said. The provision provides IPC shareholders with additional security, but “it's extremely risky for Validus because they could be exposed if a loss occurs,” Mr. Evans said.

Rating agencies A.M. Best Co. Inc. and Standard & Poor's Corp. also expressed concern over the timing of the deal in the middle of the hurricane season. A.M. Best cut IPC's financial strength rating to A-, from A; and put Validus' A- rating under review with negative implications. Meanwhile, S&P affirmed Validus' BBB- counterparty credit rating on the holding company, but revised its outlook to positive from stable. S&P put IPC's A- financial strength rating on watch for a downgrade.

IPC, which was formed in 1993 in the wake of Hurricane Andrew, specializes in short-tail property catastrophe reinsurance.

Validus is 2005 startup formed after Hurricane Katrina. The firm specializes in short-tail lines of reinsurance including property catastrophe, property pro rata, marine, energy and other specialty lines. In 2007, Validus acquired Talbot Holdings Ltd., which operates syndicate 1183 at Lloyd's of London.

“In the end, this offer gives the most amount of cash back to IPC shareholders,” and IPC's management believes this is the deal that will get shareholder approval,” said Joshua Shanker, an analyst with Citigroup Global Markets in New York.

The deal has approval from both boards, and is expected to close in September pending shareholder approval.