European stock markets responded well today to reports that Greek Prime Minister Alexis Tsipras has capitulated to the demands of his nation's creditor institutions, and U.S. stocks are doing the same. The Dow Jones Industrial Average (DJINDICES:^DJI) and the broader S&P 500 (SNPINDEX:^GSPC) were up 0.58% and 0.49%, respectively, at 12:20 p.m. EDT. The technology-heavy Nasdaq Composite was up 0.4%.
The market might also be taking a cue from the M&A locomotive, with today's announcement of the largest transaction in the insurance sector this year, as ACE Ltd. (NYSE:ACE) is acquiring Chubb Corp. (NYSE:CB) for $28.3 billion (more on this story below).
It's worth keeping in mind that Greece is not out of the woods: banks remain closed, its bailout expired yesterday, and a formal proposal to extend the bailout is no longer on the table. Furthermore, although its eurozone partners are highly motivated to keep Greece in the single currency, new negotiations are unlikely to begin before Sunday's Greek referendum (on whether to accept the terms of a creditor proposal that no longer exists!).
M&A: ACE pays up for Chubb
Zurich-base property and casualty insurer ACE is acquiring "venerable" insurer Chubb. ACE actually used this adjective in its press release, and I think it's appropriate here: In this instance, the combined company will operate under the target company's name, reflecting the quality and value of the Chubb brand. Chubb shareholders will receive cash and ACE shares valued at approximately $124.13 per Chubb share, a 30% premium to the company's closing price on Monday. ACE shareholders will own 70% of the combined company, and Chubb shareholders 30%, but who is getting the better deal?
ACE expects to realize $650 million in pre-tax cost savings by the third year of the merger. At a 17.7% tax rate (the company's average rate over the past decade), that translates into an annual earnings bump of $535 million. Applying Chubb's 10.4 price-to-earnings multiple (of 2018 estimated earnings), the announced savings are worth $5.5 billion in incremental value.
Comparing that to the $8.8 billion increase in ACE and Chubb's combined market value this morning suggests investors are looking for significant revenue synergies as well. Thankfully, ACE is forecasting just that ("The company also expects to achieve meaningful growth that will result in substantial additional revenue").
Furthermore, the lopsided increase in the respective companies' market value indicates the market believes Chubb shareholders are capturing most of the value in this transaction (Chubb has gained $7 billion, compared to ACE's $1.8 billion increase). In a merger/ acquisition, it's not unusual for the acquired company's shareholders to make off with the lion's share of the value that is created.
ACE is paying what looks like a full price for Chubb. That's not a problem in itself -- Chubb is a high-quality franchise, so picking it up on the cheap would be highly unlikely. The bigger issue is that ACE is paying for part of the transaction using shares that look undervalued; on a price-to-earnings basis, ACE trades at a 27% discount to the median multiple of its peer group, according to data from Bloomberg. All told, this looks like a decent transaction for ACE -- and the market is validating it -- but ACE shareholders ought to be glad that only half the deal consideration will be paid in their precious scrip.