Private equity suitors are not proceeding with a proposal to acquire AUB (ASX: AUB) for $45 per share. With no binding proposal forthcoming since due diligence began in early October, discussions are terminated. Shares dived 17%, now lower than before the nonbinding proposal was announced.

Why it matters: No reason for why the deal fizzled is provided, but the statement that the AUB board believes $45 per share appropriately values the firm might imply the private equity suitors were wanting to negotiate the price down.

  • Since EQT and CVC Asia Pacific entered discussions with AUB, its larger Australian competitor Steadfast has seen its shares slide over 15%. The S&P/ASX 200 is also down around 3% over that period. Maybe the buyer figured they could pick up another great business at a better price.
  • Steadfast currently trades on a forward P/E of around 15 times, below the 17 times AUB was trading on before the due diligence period commenced. Steadfast was on a P/E of 18 times before it announced its CEO was on the receiving end of workplace complaints in late October.

The bottom line: We revert to our stand-alone fair value for narrow-moat AUB of $37.50, down from $43.00, which incorporated a 75% chance of the takeover completing.

  • Shares are materially undervalued. We view AUB as an above-average company with a positive earnings outlook, which means shareholders who bought in recent weeks likely just need to wait longer to be repaid. Private equity suitors not proceeding does not mean they found red flags.

Big picture: We see growth from higher insurance premiums over the medium term. Climate change increases the uncertainty of future claims, warranting higher premiums, and AUB gets a slice. Also, bolt-on acquisitions and margin expansion with scale should benefit earnings.

  • We expect the general insurance pie to expand with single-digit premium increases and for AUB to take share of the intermediated general insurance market.

AUB primed for future growth

AUB Group operates the second-largest general insurance broker network in Australia and New Zealand. AUB brokers derive revenue from commissions paid by insurers, based on gross written premiums, plus fees. AUB owns or has equity stakes in each broking business within the network. Around half of group profit is delivered by the Australian and New Zealand broker network, around 30% from Tysers in the United Kingdom, and the remainder from underwriting agencies.

A key value proposition over smaller brokers is AUB’s ability to negotiate more favorable policy wording and pricing. Scale also provides the capacity to spend more on technology, which helps facilitate greater analytical and processing capabilities, and marketing to help attract and retain customers. Other services such as claims support and premium funding support the value proposition.

AUB Group’s underwriting agencies distribute insurance products but take no underwriting risk. Underwriting agencies act on behalf of insurers to design, develop, and provide specialized insurance products and services.

The earnings outlook is positive. We expect further insurance price rises over the medium term, albeit not at double-digit levels recently experienced, as insurers seek to cover claims inflation and higher reinsurance costs.

We expect insurance brokers to make modest market share gains of the general insurance market. Technology should allow a greater number of policies per client—for example, adding personal motor/home on top of a business client’s insurance needs. AUB’s investment in BizCover, a self-service insurance platform targeting small SMEs, and partnership with accounting firm Kelly+Partners to act as a lead generator should see AUB take share of the small SME end of the market. This share will most likely come from the direct channel.

The acquisition of Tysers was material for AUB Group. We are optimistic that cost and revenue synergy benefits, as well as insurers lifting prices, will lead to solid earnings growth for the business over the long-term.

Bulls say

  • AUB’s scale and expertise in insurance products and services leave it well placed to benefit from the essential nature of insurance.
  • Ownership in BizCover leaves AUB placed to take share in the smaller end of the SME market.
  • The firm’s acquisition strategy, of both new investments and increased equity stakes, likely boosts EPS growth

Bears say

  • Insurance volumes and prices are closely tied to the insurance cycle and general economic conditions. Downside risk could increase in a recession.
  • The insurance pricing cycle could weaken if excess capacity and competition in the global reinsurance market increases.
  • The acquisition of Tysers could fail to deliver earnings growth over the medium term and prove a distraction of company resources.Get Morningstar insights in your inbox

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.