 |
 
 What is IAG really worth? ::
By Roger Montgomery
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| PORTFOLIO POINT: Expect any new bid from QBE to be lower than its last one. Even the share price is optimistic. |
A fortnight after QBE walked away from its takeover
bid for IAG, the insurance sector continues to analyse the way
ahead for insurance stocks, but for me the conclusion is
clear: the entire IAG board should be accountable for
rejecting OBE's bid. What's more, unless new chief executive
Mike Wilkins wants to go the same way has his predecessor,
Mike Hawker, he may be forced to accept another bid from QBE.
And if I was running QBE, I may be tempted to lob any new bid
at a lower price.
How can I
reach such conclusions? It’s simple, really and the answer
helps to explain why a valuation approach that is completely
independent of share price can be so powerful for investors
when the companies in which they own shares receive a bid.
The chart of business
performance as measured by Normalised Return on Equity reveals
declining returns to owners. Great businesses with great
management, by definition, don’t produce such charts. The
declining performance is a function in this case of falling
profits. The company has announced further downgrades and the
shares languish near five-year lows.
In Mike Hawker’s resignation statement, however, he
said: “I believe we are currently undervalued and our
underlying performance is improving …”
Such platitudes are
occasionally, if not often, out-of-step with the evidence. The
numbers provide no evidence of the stated “turn-around” and
perhaps more importantly, the value of the business is
substantially lower than even the current price.
I estimate the true
value of IAG at about $5.5 billion (1.853 billion shares @
$2.98). This is based on the company continuing to generate a
steady return on equity of 15.4%. If management could indeed
improve performance to, say 18%, then each share might be
worth $3.66, taking the company’s worth to $6.8 billion.
Of course, brand names are
worth something (management refer to this frequently in their
statements) and although some analysts may say that we should
be adding the value of these assets (which do not appear in
assets nor in equity on the balance sheet) I believe that they
are only worth what they are able to generate.
What is the value of a brand
name to a business that generates no revenue? The answer, of
course, is nothing. The assets, whether tangible or
intangible, combine to produce a profit and it is this
earnings power that should be valued. Alternatively, if you
argue that brand names should be included in the valuation,
then all that happens is the equity per share rises and return
on equity declines. The result is a similar valuation to that
which has already been estimated.
QBE bid more than $8.7 billion (0.145 QBE shares
plus 90˘ cash on May 19) for a business that is worth
somewhere less than that number. In rejecting the bid, the IAG
board, it could be argued, were not acting in the best
interests of shareholders. It would take many years to build
the value of the business to that level (if they could at all)
and, it can also be argued, were perhaps more concerned about
keeping their own jobs.
This
last point is a natural response when outsized remuneration
packages are at risk. Perhaps that is why the investment
director of fund manager, 452 Capital, Peter Morgan, lashed
out at IAG chairman James Strong with a letter which read:
“For God's sake, James, when is the board going to stop being
a mutual appreciation society and treat shareholders with the
respect they deserve?”
As it
stands today, IAG is worth substantially less than the price
QBE was willing to pay.
Questionable valuations abound and a recent example
of such valuations was reflected in the March 20007 actions of
some fund managers to block Airline Partners Australia’s $5.45
a share bid for Qantas. With Qantas shares today at $3.46 and
still well above their value, a lack of understanding about
how to value a business, even by the so-called experts, can
cost other shareholders dearly.
If QBE wants to pay $8.7 billion for IAG,
shareholders should hand it over and the IAG board should not
stand in their way.
Roger Montgomery is
managing director and founder of Clime Asset Management.
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