the australian 3rd june

Very interesting article in the Australian 3rd June. should be read by those thinking about investing in IAG or QBE.



QBE and IAG a study in contrasts for growth and value
Paul Kerin | June 03, 2008

"In contrast, AMP never clearly articulated a compelling competitive advantage that its British adventure would leverage or create -- it only made motherhood statements about 'growth' and 'scale', two nouns that are often misused by executives seeking to rationalise what they want to do."

I WROTE these words five years ago when AMP rightly decided to exit Britain. Replace one acronym -- "AMP" with "IAG" -- and those words are equally apt today. The contrasts between these insurers' failed acquisition and international strategies and those of the enormously successful QBE -- IAG's frustrated suitor -- offer valuable lessons.

QBE is a statistical anomaly. Its acquisitions and international growth have created enormous value over three decades. Yet all the evidence shows that most acquisitions destroy shareholder value, and that international expansions -- particularly by Australian companies -- destroy even more. And those who succeed rarely sustain value-creation for a decade, let alone three.

QBE's success provides many tips for potential acquirers. Yes, they sound like motherhood statements -- but buyers frequently ignore them at their peril.

Here's five: don't confuse top-line growth with value-creation. Sanity-check whether your ability to add value is real. Ask whether your unique value-add is really greater than that of any other potential owners (including the current ones). Be disciplined on price: don't bid more than the value to the next-best potential owner. And don't bet the company.

Dow Jones just added QBE to its Global-30 Insurance Titans index. While this reflects QBE's top-line growth, size was never QBE's objective -- just a by-product of its focus on value.

QBE wasn't always a star. In the 1970s, it was as big a laughing stock as IAG is today. When current chairman John Cloney became CEO in 1981, QBE was losing money. He appointed current CEO Frank O'Halloran as CFO in 1982. Together, they've driven QBE's acquisition/international strategies for almost three decades (Cloney became chairman and O'Halloran CEO a decade ago).

They didn't have a grand international strategy mapped out in 1981. They learned over time. Local acquisitions were the entree. They did want to build local scale then -- size can matter, but only if it delivers clear benefits. An early bid for MMI failed, but QBE sold its stake at a tidy profit. The "never overbid" culture was taking hold. QBE also acquired the loss-making local operations of Legal & General -- the insurer it has now just replaced in the Global Titans index -- and turned them around.

In contrast, IAG pursued growth for growth's sake. Former CEO Michael Hawker argued that "to maintain our competitive position, we need to double the size of the company every five years". He noted that IAG was big in Australia and "as a result, we have sought growth opportunities offshore". IAG equated competitive position with size rather than ability to add value. Doubling size every five years was completely arbitrary.

It just happened to be what QBE had achieved for decades. And your current market's limited size doesn't make a case for entering new ones -- you need convincing reasons why this would create value. The best strategies are hard to replicate. Pale imitators trying to copy strategic outcomes -- like growth and foreign expansion -- without understanding how the strategies create value are doomed to fail. QBE's wisdom from more than 100 acquisitions over three decades can't be replicated overnight.

Cloney inherited a company in which international business already accounted for 25 per cent of premiums -- thanks to the long-existing international offices of the trade-oriented insurance companies that merged to form QBE in 1973. But he first rationalised them, closing the French operation and rationalised London business.

QBE made mistakes -- but learned from them. A pre-existing 1978 deal required QBE to cede control of a Malaysian JV in 1984 while retaining a 41 per cent stake. Five years later, it was forced into liquidation.

Careful sequencing and "bite-size" chunks are key components of QBE's acquisition mantra. They help ensure the benefits are real. 1986 marked QBE's first US acquisition (Sequoia). QBE's motivation wasn't scale per se but adding value. Cloney believed Sequoia could benefit from QBE's efficient automated systems and marketing ideas. QBE spent "almost three years researching the market". Careful due diligence is a QBE hallmark. While keen to make further US buys, the careful Cloney emphasised that "now comes about two years when we need to consolidate and build Sequoia" first.

Sequoia's $30 million price represented about 15 per cent of QBE's then capitalisation. Even the $3.5 billion combined total cost of QBE's two biggest acquisitions (Praetorian and Winthertur) 18 months ago accounted for only about 15 per cent of its market capitalisation -- and they were in a market it had operated in for two decades. QBE doesn't "bet the company".

By 1986, international represented 45 per cent of QBE's total business. Cloney said that "in the longer-run, it is quite possible the ratio will jump to 80 per cent". That's what it is today.

Picking the timing of market entry is also critical. QBE's first acquisitions in Britain came in the late 1980s to position itself to capitalise on the EU's planned 1992 deregulation of financial services markets, when opportunities to add value to companies previously coddled by regulation would abound. IAG entered Britain a dozen years after deregulation, when consolidation and competitive pressures drove costs and prices down a lot and created fierce competitors.

"Never overpay" is critically important.

Hawker claimed his 2007 British Equity Insurance purchase was an "ideal fit with our acquisition criteria -- a motor-led insurance business with consistently high margins in its markets and a strong management team". But many insurers with motor insurance could add value to Equity. And all buyers are willing to pay for high margins and management teams. Hawker added that the British acquisitions "provide a strong platform for further expansion in the UK". But if so, that platform is valuable to any buyer. IAG never made a compelling case as to why it could add more value than other bidders. Understanding your unique value-add -- and those of others -- is a key QBE skill that helps it draw the line in the sand on price.

Sometimes, that means losing deals -- but it also avoids destroying value. And sometimes you'll get it wrong in hindsight. But a senior industry consultant said: "O'Halloran trades off potential acquisition errors. He never pays too much -- occasionally this means he misses out on a good deal, like Promina. QBE offered $1.6 billion in the lead-up to the float -- if they'd gone to $1.7 billion, they would have got it. Promina floated at $2 billion." Four years later, Suncorp-Metway bought it for more than three times that. Drawing lines in the sand also helps capture value in future deals. A hard-arse reputation is a great negotiating asset. Walking away from deals -- as QBE just did by withdrawing its IAG offer -- tells future vendors they'd better be very careful about pushing too hard on price.

Paul Kerin is Professorial Fellow, Strategy, at Melbourne Business School