The Trials of Industry Mergers Acquisitions

Under-performing capital markets and the corporate trend to globalization were two factors expected to drive further heated merger and acquisition (M&As) deals in Canada for 1999. The market, however, failed to react, leaving industry analysts wondering whether this lack of activity on the consolidation front will set the tone for at least the opening years of this century.

Looking ahead it is difficult to say whether the Canadian market will regain steam on the M&A front. Several factors, for and against, appear on the horizon. In the neighbouring U.S. market, senior executives polled in surveys believe that M&A activity will build on that country’s record US$1.6 trillion in financial service deals of last year. In addition to which, the recent enactment of the U.S. Financial

Services Modernization Act (S-900), which allows for cross-ownership between financial institutions, is expected to add spice to M&As in 2000. In turn, some analysts expect events south of the border will drive the need for deals in Canada.

But, on the local front, current signs are that the calm will remain in place for at least 12 months, as large companies put Y2K firmly behind them. “Things run in waves,” explains Wayne Snider, a partner with Deloitte Consulting, heading up the Canadian financial services practice. “A lot of things that happened or didn’t happen in 1999 were probably related to the year-2000. Everybody had to get their Y2K issues out of the way before taking on an acquisition that would mean the integration of another data-base.”

The Y2K twist

Interestingly, the possibility of heavy liabilities linked to the Y2K computer problem may turn out to be the trigger accelerating global M&As, as companies compensate for the bleeding of capital caused by millennium bug claims.

Demutualization in Canada has also had a hand in curbing the industry’s appetite for acquisitions. “Five of the top life insurers were demutualizing,” Snider adds. “The last thing they would want is to confuse that process with an acquisition.” Snider predicts that once the dust settles on demutualization and Y2K issues, insurers will return to implementing their growth strategies — buttressed on the life side by a “boatload” of cash through recent initial paper offerings (IPOs). They will need the money if acquisitions are in the cards, points out Paul Kovacs, vice president of the Insurance Bureau of Canada (IBC). “Because of the large increase in acquisitions over the last few years, the price of taking over a company is much higher than it was, so acquisitions are not as attractive.”

Kovacs points out that the situation in Canada mirrors what is happening in both the U.S. and Europe, where companies once recognized as a good fit have already come together at good prices.

“I don’t think mergers and acquisitions have come to an end. But it has slowed down from the very strong pace of the last three years, and it will continue at a slower pace for the next few years,” he comments.

Bill Weiland, a consultant at Eckler Partners, a firm which specializes in financial institution M&As, is not convinced that surplus cash sloshing around in the tanks of life insurers will automatically lead to acquisitions within the industry. “The issue of what you do with the surplus is not obvious and is going to be quite a searching question for various stakeholders, including the regulators.”

In the Canadian market at least, it is entirely possible that M&As have slowed down because it is harder to find a suitable fit following the last round of consolidations. “Most of the top [companies] on the premium level have made acquisitions and are now reasonably picky about what they are prepared to take on,” Weiland says. “There is still an interest in acquisitions, but they are waiting for the right thing to come along.”

Finding opportunities

Ted Belton, director of research at RBC Underwriting Management Services Inc., confirms that a lack of opportunities has dampened the climate for M&As. He also points to an emerging trend for the next wave of consolidations. “We haven’t reached the end of the line. The difference between what is happening now compared with what happened a few years ago is that mergers and acquisitions are taking place over the entire financial sector.”

Belton predicts more alliances such as the Equisure partnership with ING, although he is quick to point out that Canadians banks have been slow to pick up on the trend. Likely because they are still prevented from retailing insurance products on the branch level. “If there’s any truth at all to the relationship/management theory, by the time the banks receive permission to sell insurance through their branches, those relationships are going to be sown up by a nationwide retail network of complete financial services,” he adds.

A.M. Best predicts that up to one-third of property & casualty companies could be absorbed or withdraw from the market by 2005. Kovacs argues that Canadian-owned property and casualty companies are in very good shape, and that mutual ownership is a barrier to take-over. Nevertheless, further consolidation of Canada’s most competitive financial sector is expected.

“Sustained economics and small companies do not make sense,” Snider points out in response, suggesting that the next round of acquisitions could take several players out of the Canadian market entirely. “Some of the foreign companies who play here will decide whether Canada is strategic enough to continue in the marketplace. The players who dabble in the market will start to ease out.”

A recent decision by the Federation Group to put itself on the block may be a harbinger of things to come. The biggest negative in the Canadian market will continue to be in property and casualty, where, despite a burst of consolidation, over 200 companies continue to chase a wafer-thin 3% of Canada’s financial sector assets. But the life insurance industry cannot be excluded. “When it comes to life, a lot of insurance protection products are commoditized,” Snider explains. “Nobody is buying whole or permanent insurance. Universal insurance is hot, but it is an investment product. Life insurers are competing in the asset and investment business.” That includes banks, which have remained quiet recently, at least on the property and casualty front.

Less jest

“Part of the change we’ve noticed is that the banks were acquiring a few years ago. Now they’re not,” Kovacs says, noting that the only activity discussed lately is CIBC pulling out of property and casualty.

For his part, Belton believes that mid-sized property and casualty is the most vulnerable for take-over because this is the category that is going to find it increasingly difficult to occupy the middle ground between Canada’s top five insurers on the one hand and niche or speciality service providers on the other. A shake-up in mid-sized companies appears inevitable, in no small part because of the financial services reforms taking place in the U.S. U.S. analysts appear to be divided on the outcome of such reforms: will there be a stampede of banks taking over insurance companies, or will insurance companies (many which are larger than banks) participate in a reverse take-over?

What is certain according to Belton is that a large degree of consolidation will take place in the U.S. with the potential to spill over into Canada. “It creates an interesting situation,” he says. “We have Ottawa trying to encourage more foreign banks to come into Canada. That might be the way to do it, through their insurance subsidiary.”

Players in the next round of M&As may also have to take a closer look at the human element according to Jim Shaffer, leader of management consultant for Towers Perrin’s business communications practice in New York. “Few events in the corporate life cycle jolt the people of an organization as much as a merger or acquisition,” Shaffer says.

Shaffer argues that from a people perspective, many mergers and acquisitions aren’t managed very well. A study of Fortune-500 chief financial officers who had recently merged
or had acquired another company reported that “people problems” represented the top failure factor, with problems related to communication topping the list. “They found that the whole people side of the merger/acquisition effort was largely responsible for some of the failures,” Shaffer says. “I find that interesting coming from the chief financial people, who have a proclivity to be looking at financial reasons why a merger would not work.”

In response, Kovacs says it is hard to apply global observations to recent M&As in the Canadian property and casualty sector. “It’s not as straight forward as it would be in other circumstances,” he explains. “Success might be evident in terms of the stock price going up or failure may be measured with the stock price going down. But in some cases, there is no Canadian stock price. In other cases, Canada is one component of an international operation. What happened here was only a small part of the transition.”

Success or not

In Canadian property and casualty at least, recent mergers have been marked by no open discussion of success or failure either way. Still, it is difficult to imagine merged companies in Canada escaping the types of transitional problems that have plagued other M&As particularly when treatment of personal remains a consistently low priority. Smoothing out the transition will probably become more important in the next round of deals, particularly if it is mid-sized companies coming together for strategic reasons other than size.

“You’re not necessarily looking for compatible cultures in any acquisition,” Shaffer points out. “It is often the different culture you are looking for. A slow cumbersome organization looking to improve speed to market may go to a small dot.com company in an acquisition because it can move faster into e-commerce. So you have to be able to manage the two parts properly.”

What different cultures are going to be brought together in the next round of insurance M&As is difficult to predict. One thing is clear, competition, especially in P&C and the need to create greater economies of scale will continue to drive M&As over the next five years, even if it becomes more difficult for predators to root out likely targets. “The market will continue to get smaller,” says Weiland. “The rate which this will occur is hard to say.”

Just as hard to predict will be the shape of things to come. “When you analyze each of the companies that might be a take-over target all sorts of interesting things come up,” Belton admits. “The bottom-line is, nobody knows what is going to happen over the next few years because what has happened was unimaginable just a few years ago. The rule book has been thrown out.” cu