Go for a SCOR

[dropcap]B[/dropcap]ecoming a possible target in a rich industry contemplating consolidations is good news for shareholders and seemingly less so for Scor’s management. The insurer has a healthy in-force portfolio and is on the right track to achieve all its strategic targets. Its €7bn market is within reach for most of the bigger players and at 1.1x book this is not excessive.

The odds are high that the ball has started rolling as Scor starts disclosing its hitherto lesser-known strengths.

Covéa, a mutual French primary insurers that sees itself as a domestic force, made a late August offer for Scor. The generous proposition of €43 per share should become a reference price for the reinsurer.

Covéa prefers a friendly transaction but seems able to be hostile if the French establishment does not act as a brake to their surprising ambitions. Other re-insurers will have a look at Scor.

An industry where excess capacity weighs on pricing

To understand the strategy of Covéa and probably that of Partner Re (part of Exor), a quick word about the reinsurance industry situation may not hurt. Currently, reinsurers post strong balance sheets after years of restructuring and recapitalisations. Even after the bad 2017 US hurricane season and its impact on the sector’s earnings, capital adequacy remained solid.

The industry is benefiting from abundant capacity, which explains the continued weak pricing conditions in 2018. The disappointing pricing during the 2018 mid-year policy renewal period confirmed that the upward trend observed in January campaign has lost momentum.

Another reason for the soft pricing environment is alternative capital vehicles (third-party reinsurance capital), which have a cheaper cost of capital than full-fledged regulated reinsurers and continue to challenge reinsurers’ business models. According to Aon, the volume of alternative capital in the reinsurance industry reached a record $98bn by June 2018.

Some reinsurers, which have excess capital and are not keen on acquisitions, are developing their own alternative instruments to improve their overall competitive position and to stay connected to what could be a distinct competitive advantage in the future.

Why is Scor a natural target?

Major operators are bound to be looking for more scale and diversification to improve profitability through capital efficiencies and cost reduction. Scor, which should theoretically be in acquisition mode has been exposed as a highly visible target by the Covéa bid. The French reinsurer is the fourth global operator with a market capitalisation at only at €7.2bn.

The offer of Covéa (which already has 8%) valued the company at €8.3bn, which is within reach for most players. Scor’s rediscovered attractions include a large geographical footprint, a strong position in the all-important US market and a balanced portfolio between the P&C and Life businesses.

The company enjoys a comfortable solvency position and has been a respected dividend payer (about €300m a year leaving the option of some gearing for a 100% acquirer). The reinsurer is benefiting from an excellent credit risk profile according to all rating agencies.

Are major European reinsurers interested in bidding? Swiss Re or Partner Re/Exor would certainly have a look while the dominant position of Munich Re might be an issue. Swiss Re seems to be a natural buyer. In terms of geographic presence, the French company could improve the presence of the Zurich-based reinsurer in Asia. Recall that in January 2018, Swiss Re opened its Asian headquarters in Singapore, confirming its interest in this region.

Even in Europe, Swiss Re can increase significantly it market position. In terms of sales, it would reduce the gap with Munich Re. It would have the highest profit in the sector (€3.3bn) and the largest market capitalisation in the world (c.€35bn). Moreover, the most important point would be the access to the operating cash of Scor allowing it to bring its operating cash to c.€3.5bn.

Concerning other potential pretenders, Hannover Re would need to get a free hand from Talanx (50.2% owner of Hannover Re) whose own legal status as a mutual company (Versicherungsverein auf Gegenseitigkeit) is a brake. The Talanx–Hannover Re tandem may have inspired Covéa in its courting of Scor.

Scor is no easy prey

Scor’s management is focusing on the importance of being independent. During the last Investors Day, Denis Kessler, the CEO of the last 16 years who extracted Scor from its strategic quagmire through multiple acquisitions, has repeated many times that being an independent reinsurer is a success factor.

This was an implicit answer to the latest events. The 66 year-old CEO has strong historical relations with BNP Paribas where he has been an administrator since 2000 and the bank can help it defend its independence, if it sees a point at all. Alternatively Scor may just accelerate its external growth plans with a degree of borrowing as a way to escape a bidder’s clutch.

That could be effective to fend off Covéa which would find it difficult to put at risk its own solvency ratios for the purpose of overpaying for Scor. Mr Kessler is a fighter so that his shareholders are likely to enjoy the ride. They include Allianz, Alecta and another mutual insurer (Malakoff) which may want to raise the ante.

Then, there is the not so minor issue of whether Covéa should be allowed by market authorities to bid for Scor. As a mutual company, Covéa does not play by market rules and is itself protected from any inquisitive questioning from its shareholders who also happen to be its clients.

This is not suitable as market forces are skewed and there is an asymmetric risk at Scor’s expense. Covéa has theoretical deep pockets (€14.3bn of equity) but it is not proven that it can tap its clients/shareholders if it were to book massive reinsurance losses in the future.

A listed Scor can tap markets as long as it respects its shareholders and pays back decent dividends. Covéa posted a comfortable capital position with a Solvency margin of 372% by the end of 2017, but its Solvency II compliance is still under review. Controlling the solid Scor is more than useful from this point of view. We would expect the insurance regulator to make its opinion known rather rapidly on the Covéa bid.

We have revised our valuation by attributing a premium to Scor compared to its peers. This premium is justified by Scor’s scarcity, being at the same time a major global player but a fairly easy prey. The financial solidity of the company would justify top money.

Full research study available on www.alphavalue.com