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Allied World is latest insurer selling for scale

Capabilities and scale were two of the factors the CEO of Allied World Assurance Co. Holdings AG cited as benefits of selling to Fairfax Financial Holdings Ltd.

With the pressure from falling insurance rates, smaller property and casualty insurers might be drawn, as Allied World was, to sell ownership for the ability to do more and attain a global reach, Keefe Bruyette & Woods analyst Meyer Shields said in an interview.

"If you're a smaller company that's a little less relevant on the global stage, I think that there's more pressure as these deals get done," he said.

Shields compared the proposed merger to Endurance Specialty Holdings Ltd.'s sale to Sompo Holdings Inc. and PartnerRe Ltd.'s sale to Exor SpA. The buyers did not seek integration savings and looked past the current rate environment with its soft pricing, he said.

"There's still more long-term value to insurance companies than what some companies are likely to produce during the worst part of the pricing cycle," Shields said. The sellers get the value of monetizing their companies at an acceptable valuation during tough business conditions that are not likely to abate soon, he said.

RBC Capital Markets analyst Mark Dwelle said Fairfax has historically been a reasonable buyer and is offering Allied World a fair price with a longer-range perspective.

"They think they can make decent [returns on equity] at that valuation over time," Dwelle said in an interview.

The $4.9 billion deal is proposed as a mix of cash and stock offering Allied World's shareholders a total of $54 per share, including $10 in cash.

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Fairfax is replicating an acquisition model it has employed previously, making an offer price and soliciting an investor to fund part of the price for a minority stake. For the Allied World deal, Fairfax is looking for a partner to finance $30 per share of the buyout offer, which the company would give Allied World stockholders in cash as a substitute for an equivalent portion of the $44-per-share stock consideration. Fairfax used a similar tack to fund its 2012 acquisition of Brit Insurance Ltd. and its recently closed purchase of a controlling interest in Eurolife ERB Insurance Group Holdings SA.

"I expect they'll be able to find a partner that's interested in being involved in at least some of it," Dwelle said of the Allied World deal. Fairfax has 75 days from Dec. 19 to substitute a portion of its equity offering with third-party financing, which could bring the cash part of the deal to as much as $40 per share.

The deal includes a provision to allow Allied World to shop for another offer, but BMO Capital Markets analyst Charles Sebaski does not think a takeout bid is likely.

"While it is not without precedent in recent P&C mergers, we would not expect to see a second bidder step in to bid up this deal given the premium valuation implied in the transaction," Sebaski wrote in a note to clients.

Approval of the deal would make Fairfax the seventh-largest P&C-focused North American insurer by market capitalization, according to a presentation accompanying the company's conference call on the merger agreement. The combined company would become the fifth-largest excess-and-surplus lines writer in the U.S., based on 2015 direct premiums written. Fairfax on its own is 11th in U.S. excess-and-surplus business.

Approval of the deal would grow the North American portion of Fairfax's business to 75% from 73% at a time when Prem Watsa, the company's chairman and CEO, is optimistic about the outlook for the U.S. business environment. The acquisition would increase the insurer's investment portfolio to about $40 billion from nearly $30 billion, Watsa said. A more business-friendly environment in the U.S., which he anticipates with the election of Donald Trump to the presidency, would make the market a more value-oriented, stock-pickers market, Watsa said.

"This is a market we have excelled in for 40 years," Watsa said.