The savvy team over at Argonaut Group (NASDAQ:AGII) agreed to a reverse merger with reinsurer PXRE Group (NYSE:PXT). Although achieving merger synergies is as rare as finding a pot of gold at the end of a rainbow, this is definitely a merger where it's not hard to see that 2 plus 2 is more than 4.
Deal mechanics
In the deal, technically Argonaut will be merged into PXRE, with each Argonaut shareholder receiving 6.4672 PXRE shares -- plus a $60 million dividend that will be paid to Argonaut shareholders to try to alleviate any taxes that result from the merger. Following the merger, current Argonaut shareholders will own about 73% of the combined company, and PXRE shareholders will own 27%.
Why it makes sense
In the conference call, Argonaut management mentioned they've been doing due diligence on this deal for more than year.
As a primer, PXRE was forced into runoff -- it is currently winding down its reinsurance business and not writing new premiums (besides mandatory renewals) -- after Katrina saddled the company with huge losses.
What Argonaut gets out of the deal is PXRE's Bermuda operations and reinsurance infrastructure, and a significant amount of capital (because PXRE is in runoff and not writing new business, its stock currently trades at roughly 75% of book value). This gives Argonaut an entry into Bermuda and the international markets, which are uncorrelated with Argonaut's other risks. It also ups its reinsurance business mix from about 8% of premiums to a projected 15% of premiums. Argonaut management mentioned it believes pricing and returns on capital are often better in reinsurance compared to their main primary insurance business.
The deal makes sense for PXRE because by merging with a bigger player, it can regain a decent rating from A.M. Best, which allows it to start writing new business through Peleus, the newly formed reinsurance segment. Without the merger, PXRE would be stuck in runoff and would not be able to create excess shareholder return by writing new premiums. The merger also allows the combined entity to manage PXRE's excess capital better by having more outlets to allocate it to. In addition, there will be a small amount of cost cutting -- such as leveraging public company costs. All in all, I think the deal makes a whole lot of sense and that the combined company will be worth more than the sum of the parts.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.
