Prudential makes a classic investment error buying AIG
Posted on 02 March 2010 with no comments from readers
Buying a company too early in the aftermath of a financial crash, and overpaying for it is a classic investment error.
One might have expected more from the Prudential, Britain’s largest insurance company. But the appetite for debt in the UK knows no bounds.
AIG Asia
The Man for the Pru is paying $35.5 billion for the Asian life insurance business of AIG, the US insurance giant smashed to pieces by the financial crisis, and making a $21 billion rights issue and borrowing $5 billion to foot the bill.
The warning signs are obvious. AIG has only gone for a trade sale because IPOs are difficult now in Asian markets – probably because investors sense a further downturn is close.
Beware CEOs offering ‘transformational deals’ and forgetting their market timing. How can the Prudential be so imprudent, and issue its good paper to pay for something so unknown?
What if the transformation proves to be of a different kind: from a financially strong and well managed business to one carrying too much debt and with 60 per cent of its business in Asia just as that region goes into another downturn?
Prudential shareholders are not impressed and its shares lost 11.5 per cent after the announcement yesterday. History is littered with examples of big takeovers in the aftermath of market crises that went badly wrong.
From the early 90s in the UK there was Beazer’s $1 billion takeover of Koppers in the US; or UK house builder Raine Industries only too early acquisition of rival Walter Lawrence. Both proved fatal mistakes.
Investment king
It is particularly ironic that the Prudential should fall into this trap and make such a classic investment error. For the Pru is a real stickler as an investor itself and you have to ask whether it would back such a deal if it was proposed by one of the companies whose shares it holds.
Usually the root cause of such mistakes is the ego of businessmen with an urge to top long and successful careers with one really big deal. This blinds them to the obvious reality of exchanging a sound financial position for a very risky one.
Markets then take their revenge in the extended downturn, and rivals end up buying those assets now regarded as a prize for a far cheaper price.
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Of course the alternative view is that AIG is selling its legitimate components for a song after having its CDS counter-parties bailed out whilst shareholders were wiped out.
Far from being a clear cut example of overzealous management, the transaction seems to be more a reflection of Washington’s irrational behaviour during the 2008 bailout fever.
Fannie Mae just received a new $15bn injection and had its capital requirements relaxed during the crisis. GM isn’t being forced to liquidate to foreigners. These are corrupt and arbitrary decisions being made with no relation to the free market or any normal MA cycle.