Less than one year after its unsuccessful pursuit of Transatlantic Holdings, Validus Holdings says it has reached an agreement to buy Flagstone Reinsurance Holdings for about $623 million in cash and stock.
The purchase, expected to close in the fourth quarter, will allow the Bermuda-based specialty insurer to "further build upon our market-leading position in catastrophe risk," Validus Chairman & CEO Ed Noonan says in a statement.
The Validus brand, as well as its headquarters and executive management, will be used for the combined company.
Validus says it has obtained agreements from investment firms owning about 22.5 percent of Flagstone Re that they will vote in favor of the transaction. Flagstone shareholders will get $2 in cash as well as 0.1935 shares of Validus for each share of Flagstone.
"We believe this transaction offers a significant premium and immediate value for our shareholders and provides a more stable capital base with which to underwrite over the long term," Flagstone CEO David Brown says in a statement. Brown will be stepping down as part of the deal, and it is anticipated a number of Flagstone's existing offices will be closed.
Validus lost out on Transatlantic last year when Alleghany Corp. stepped in to buy the company for about $3.4 billion.
While Validus was in pursuit of Transatlantic, Luxembourg-based Flagstone was announcing a plan to realign its business to focus on lines with the highest return on equity—property, property-catastrophe and high-margin short-tail specialty reinsurance—and would sell its Lloyd's of London and Island Heritage operations.
Validus management has indicated that job cuts would be coming and will be "done quickly so employees know where they stand going forward," says Noonan.
Validus says the transaction's completion will propel it into position as Bermuda's largest property-catastrophe reinsurer, with total premiums of more than $1.19 billion, edging out Validus' nearest competitor, Renaissance Re, with $1.18 billion in premium.
Ratings agency Standard & Poor's credit analyst Jason Porter says that upon completion of the transaction Validus expects to strengthen Flagstone's reserves by $76 million, take $59 million of other charges and record a $58 million bargain-purchase gain.
The acquisition also will boost Validus' capital base by almost $800 million, says Porter, with additional shareholder equity and Flagstone's junior subordinated debt. "Although Validus could potentially have the largest property-catastrophe book in Bermuda, the overall business-mix shift will be modest," he adds.
RATINGS AGENCIES WEIGH IN
Ratings agencies agree that Validus should not see significant negative repercussions from its proposed acquisition of Flagstone, and Validus' ratings will remain unchanged.
Moody's Investors Service says it is affirming Validus' ratings while upgrading Flagstone's outlook to developing from negative. The agency says the rating action assumes "a successful closing of the transaction, which is subject to approval of regulators and Flagstone's shareholders."
Moody's says it believes Validus will receive "some financial and strategic benefit, albeit small," from its acquisition.
The ratings agency did raise a cautionary flag, however, saying that with the transaction, Validus' debt could rise modestly because of the cash outlay and the assumption of $250 million of Flagstone's debt.
Both A.M. Best and Fitch ratings also say Validus' ratings and outlook remain unchanged by the proposed deal. Both ratings agencies cite Validus' strong financial position and historically strong operating performance.
Fitch says Validus' financial leverage could increase modestly immediately following the transaction "but should remain well below median guidelines for Validus' current rating category."
As for Flagstone, A.M. Best put the company's A- financial strength rating under review with developing implications, reflecting "uncertainty around the future plans Validus may have for Flagstone, the possibility of the deal not closing due to risks beyond the parties' control and [the fact] this is occurring during the peak of wind season."
Best notes that Flagstone's ratings had been assigned a negative outlook in 2011 because of the group's "historically weak operating performance and concerns over their enterprise risk management (ERM) capability." But Best says the company made "significant progress" in strengthening its ERM program, which may have made the organization more appealing to Validus.
For its part, Fitch revised its Rating Watch for Flagstone to "evolving" from "negative." Fitch says this reflects expectations that it will bring Flagstone's ratings in line with Validus' ratings if the deal closes as expected.
While both companies are currently rated A-, Validus has a positive outlook.
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