Did Allstate Just Blunder?

If you think "you're in good hands" with Allstate (NYSE: ALL  ) , consider this.

Allstate has agreed to acquire White Mountains Insurance's (NYSE: WTM  ) Esurance and Answer Financial businesses in a deal that is valued at about $1 billion, or roughly three times tangible book value. The deal is expected to be completed by late 2011.

The first impression
Given that Allstate is the second largest auto insurer in the country, acquiring Esurance, which provides auto insurance quotes online, could prove to be a positive move. Esurance is the third-largest provider of such quotes, and is well-recognized as a consumer-facing brand, while Answer Financial helps customers in choosing insurance from 20 companies, through comparison of quotes. The combination looks like a valuable proposition for the company, and should ideally translate into better advertising, customer reach, and sales for Allstate.

The insurer recently added a feather to its cap by receiving the highest recognition in the collision repair industry. Add to this the current deal, and it shows Allstate's focus on the auto sector. But does this mean the company is all set to zoom ahead of its peers?

Competition in the industry is already stiff and getting stiffer. Progressive (NYSE: PGR  ) and Berkshire's (NYSE: BRK-A  ) (NYSE: BRK-B  ) Geico unit already have a hold in the online auto insurance business, with Geico having more than 10 million auto policyholders on its own.

For the quarter ended March 31, Esurance had 892,000 policies, and $247 million in gross premiums written. Post the deal's completion, these new properties will add significantly to Allstate's portfolio. With Answer Financial's technology, Allstate should be able to tap wider markets. But even if the deal looks impressive at first, it does not give us the freedom to ignore the associated costs and challenges.

A challenging proposition
How insurance companies perform depends on several external factors, and it's difficult to project costs associated with catastrophes like earthquakes and tornadoes -- especially this year.

Allstate reported a huge catastrophe loss of $1.4 billion for the month of April, which is bound to have an impact on its margins. This month may prove worse.

Progressive incurred losses of around $55 million in the same month. Allstate can diversify its portfolio by selling policies in newer areas and protect itself by purchasing reinsurance, but these are just some of the risks involved in building scale in the insurance business.

Can Allstate now stand tall? Or will it fall?
The company says "the transaction is anticipated to be non-dilutive to Allstate's earnings in the second full year of ownership." Foolish investors can read between the lines: Dilution of earnings in the first year after the acquisition is completed appears likely. Analysts suggest the move was expensive and won't be accretive to earnings until the second full year of ownership, but that Allstate didn't have much of a choice if it wanted to grow.

Naturally, White Mountains, which expects its adjusted book value to increase by around $80 per share, called the deal a "win-win." By selling the Esurance segment, it seems to be shifting focus to its global reinsurance and specialty insurance businesses. Investors reacted positively, sending White Mountains' stock sharply higher on the day the deal was announced. 

The Foolish bottom line
If you're a shareholder of Allstate, you need to think over this deal carefully. The move is a strategic one and is certainly relevant to current trends. In the short run though, the stock might not be a grab, as there is still time for the deal to be completed, and we need to see how the company capitalizes on its acquisition. I would prefer to remain on the sidelines in the near term.

To stay up to speed on Allstate or any other company that interests you, click here to add it to your watchlist.

Neha Chamaria does not own shares of any of the companies mentioned. The Motley Fool owns shares of Berkshire Hathaway and White Mountains Insurance Group. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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