You Paid a 50% Premium for What?

Submitted By Prudent Speculations

I am sure that those of you who saw the news that Liberty Mutual was paying a 50% premium to buy Safeco (NYSE: SAF) had to take a second look. After all, we are talking about the property and casualty business here, which is not exactly accustomed to monstrous premiums like say the biotech industry. An eventual buyout of Safeco was to be expected as the last several management teams have been preparing the company for a buyout and it has been a well known fact for sometime that the company was on the block. Liberty Mutual in purchasing Safeco is getting a regional insurance firm at a fair earnings multiple and at a slightly expensive book value but nonetheless they increases their regional diversity and they should be able to trim a fair amount of staff due their regional office's location in Portland, which will likely absorb much of Safeco’s employees.

The management of Safeco was without a doubt forced into this sale as they were simply running out of options to boost shareholder value. Over the last several years the management of the company has reduced the share count by well over 40 million shares (17 odd million coming in the last year) and significantly expanded the dividend. While these are all admirable accomplishments management undertook these actions without any growth in the company’s business and with an insurance company that can only mean a shrinkage of the firms assets and that is it exactly what Safeco did. This can be seen in the high single digit declines of the net earned premiums over that last 4+ years and the dramatic decrease in the firm’s investment portfolio. Safeco, while not levered to large amounts of debt, although they do have a fair amount, has significantly reduced the safety of its policy holders by its actions and I doubt that they could in the future continue with such large buybacks. Furthermore, the quarterly results they announced after the deal were absolutely terrible and I don’t think I quite by their excuse that the weather was returning to “normal,” there must have been other issues. For the first quarter of 2008, the company earned $1.57. This compares to a $1.71 a year ago quarter. It should be noted that this years results occurred even though the share count over the course of the year had declined from 106.7 million to less then 90 million after the repurchase of 17 million shares. If the share count had stayed the same over the course of the year the earnings fall off this quarter would have be massive and the stock would have likely been under extreme pressure. This is why I believe that the actions undertaken by management and the poor results soon to be announced left Safeco with only one alternative to boost shareholder value: to sell out to a bigger competitor, and that is what they have done. Executives of companies that are either facing negative revenue growth or are in declining/stagnate industries should only engage in massive share repurchases if they see their growth potential improving in the future otherwise they will surely leave themselves with little option but to sell out as soon as they have exhausted their capacity to buyback stock. Then again if you're going to sell out in the first place why not sell the company before you engage in the share repurchases, especially if there is a risk that your stock price will not appreciate significantly in the interim as happened with Safeco. Although maybe I'm just to old school about buying back stock as I don't think companies should do so unless their stock are trading near book value anytime else is just a waste of the firm's capital.