The Other Brit

[twacowfca]

While some have been investing in toxic waste and buying puts on tar ball futures, guess what’s been happening with the other Brit?  The other Brit?  It’s Brit Insurance Holdings.  BRE:LN .  Apollo made an offer of £10.00 for them a few weeks ago, and has since raised the offer to £10.50.  Mr. Market has priced the probability of the deal’s closing at 50:50 with about equal upside to downside, based on the current price of about £9.00 compared to a likely acceptance of a sweetened offer at £11.00 or greater.  BRE was selling at £7.30 before Apollo’s offer.  

 

Using de Mesqueta’s methodology, I’ve estimated that the probability of the deal’s closing at £10.50 or higher is more like 5:1 or 10:1.  In the meantime, I get to hold one of the better Lloyd’s insurers with substantial reserve redundancies that’s priced around 86% of tangible book value, paying a VERY nice annual dividend of 6.6%.  

 

Am I overly optimistic in my estimate of the odds of the deal’s closing?

 

Comments?

 

[beerbaron]

Never heard about the Mesqueta’s methodology can you give me a book or reference?

 

I remember reading that about 97% of the mergers go trough. My approach has always been to use plain dumb odds before even looking at an arbitrage.

It looks like the following:

(0.97 * 1) - (0.03 * 1.5) = 0.925 Pounds statistical profit

 

There are very very few arbitrage that offer any profits when you apply a simple statistical analysis. Therefore, I have never made one. The spread are so thin that the margin of safety is inexistent. When the spreads are good there is an evident reason, so what's the catch with this one?

 

BeerBaron

[twacowfca]

I don't understand the calculation.  There's no monetary value on the left hand side of the equation as there is on the right hand side.

 

The probability of eventual acceptance after a cash offer has been made public can sometimes be as high as .97 ,but only in the most favorable market conditions like the mid noughties when money was cheap and businesses were often selling far below intrinsic value.  This may be the situation with the current offer for BRE, but I would think it prudent to discount that probability as overly optimistic because current market conditions are uncertain.  Also, offers by private equity companies are not accepted at as high a rate as offers from strategic buyers.  :)

 

Bruce Bueno de Mesqueta's book, The Predictioneer's Game, is the most interesting book about the practical uses of game theory.  His models have a good track record, predicting the outcome of M&A's.

[beerbaron]

The calculation gives the statistical dollar (or pound on this one) return.

 

That means I have 97% chance of winning 1 pound versus a 3% chance of losing 1.7 pounds (return to the original price). The result would give you your gains if you took this bet many times, the more often the bet is taken the more it will converge to the statistical gain. I red fast previously, I tough the pre-merger price was 7.5.

 

3% is the only number I found, I usually add an extra 6% as a margin of safety, it's like any other investment. You take what you think is going to happen and you discount it to get some margin. As I said earlier, I spent many hours seeking for good arbitrage and could never come with a single opportunity that was worth it. It's probably because my knowledge of mergers requires me to put a much higher margin then other knowledgeable participants.

 

Your catch seems good, I wish I could investigate further but my broker does not let me order in LSE (no point being teased on this one).

 

BeerBaron

[elltel]

on 2nd July...

 

1018 GMT [Dow Jones] Brit Insurance (BRE.LN) risks seeing Apollo Global Management walk away from buying Brit, says Collins Stewart analyst Ben Cohen. This comes after Brit rejected a GBP10.50-a-share indicative offer from Apollo. Cohen says an offer of GBP10.50 to GBP11 would be a fair basis for discussion. Says: "We are surprised and disappointed that Brit's board does not consider GBP10.50 a reasonable basis for discussions, especially in current market conditions. We think there is a real risk now that Apollo walks away." Adds that there is a lack of other bidders and Brit shares could fall to around the GBP8 level if Apollo walks away. Cuts rating to hold from buy, and price target to 1000p from 1075p. Brit shares +4.6% at 929p.

[twacowfca]

Yes, there is always the risk that a prospective buyer who makes an offer will walk away.  That's what makes game theory interesting.  However, this sort of jockeying is normal in these situations.  Prospects look good IMO, although not certain.  There is a willing buyer and a willing seller.  They are talking quietly behind the scenes and not conducting a PR war. Apollo hasn't even engaged a PR Firm.  The executive directors of Brit will get a huge payday if a deal goes through because many options they are entitled to will vest upon a change of control.  The small number of funds who own most of Brit's shares would like to sell if the price is right.  If Apollo walked away from a willing seller simply because the owners were not keen to accept a lowball offer, Apollo might become unwelcome among the brokers in the industry.  If Apollo hangs in there and no other buyer appears, Apollo should be able to pick up a very good business for very little premium to BV, a company that likely might be able to dividend out twice their current annual payout in special dividends, as they have been passing on business that isn't likely to be substantially profitable on underwriting.

[twacowfca]

Apollo sweetened its public offer to 1075 pence yesterday after Brit reached deeply into it's cookie jar and pulled out a giant cookie of reserves, reporting H 1 income ~@ 8% of BV, even after big losses from the Chile earthquake.  BV is now up above 11 pounds and Brit has opened their books to Apollo.

 

My back of the envelope estimate of the probability that the deal goes through is now the 97% probability that occurs in very favorable conditions.  However, I'm adjusting the probability to a range of 90% to 95% to compensate for overconfidence bias.  It seems that Apollo is going to be able to steal a very good insurance co with redundant reserves for a takeout at little more than BV if no other buyer appears.