Looking At Potential Outcomes for the Future of The Hartford

This is going to be a challenging one to write. As you all probably know, Chubb has made an offer to acquire Hartford. I have a lot of history with, and respect for, both companies and have been a significant shareholder of both at times.

I actually predicted this exact path years ago, but I’m not going to share all that inside baseball. Suffice it to say, while I was surprised when it happened, I wasn’t surprised that it eventually happened.

You should also all know that Hartford is one of my bigger personal holdings precisely because I anticipated this outcome (to be crystal clear I never discussed the possibility with a potential buyer…I figured out on my own that somebody would decide it was worth going hostile for a number of reasons which I will keep private).

Therefore, you should assume my goal in this post is to talk up the takeout price as much as possible. That’s not my actual goal, but you shouldn’t trust me on this one because I have a conflict.

I will do my best to remain objective, just like in any other post, but you should know I have thought for many years that the takeout price for Hartford could be much higher than the market believed. I should also make clear, as always, these are my own thoughts and I’m not trying to get any of you to buy or sell either stock.

So with those constraints, what do I think I can write about? First, I’m not going to provide any target prices for Hartford or tell you how likely I think it is that an acquisition happens or who will win if it does. What I think I can do is provide you the tools to evaluate those things and let the reader come up with their own answer if he or she is so motivated.

Why did Chubb publicize its offer?

The simple reason is because Hartford declined the offer. The lengthier reason is because Chubb realized Hartford doesn’t want to sell, period. Hartford has made it very clear they intend to remain independent. While there is obviously a price where they would change their mind, $65 surely isn’t it.

So there was little reason to try to bid against themselves, knowing it would take a significantly higher offer to bring Hartford to the table willingly.

However, by going public they do a few things. First, they force Hartford to respond. Now, they might say “no thank you” and ignore Chubb and just deal with the incessant investor questions and assume Chubb can’t get enough support to justify a proxy fight. That may or may not work.

Second, as mentioned, they can solicit investors to support their bid and try to start a proxy fight. We have seen this tactic employed by Validus in the past, as well as Endurance with Aspen, to mixed effect.

It’s harder to do that on a bigger company where you have more large institutions as shareholders, who are less likely to get involved, and the risk arbs can have more influence on a smaller company where it is easier to get a big stake.

While it may seem a free option by Chubb to put Hartford in play, the big risk is it does just that…it puts Hartford in play! This means all the other competitors who have thought about buying Hartford in the past now have the all clear to come forward with their own offers.

Chubb obviously had to consider this risk and I’m sure they are confident in their approach, but there is very much a Pandora’s Box element to this tactic. Once you try to pin the “For Sale” sign on Hartford, you lose control of the process because you don’t know who else will come to the party.

The Bidding War Potential

So let’s talk about the other potential parties. Hartford’s neighbor, Travelers, has long been speculated as a buyer for Hartford. There are some potential hurdles (job cuts in CT) but I’m sure they have been preparing for this scenario and know what they want to do.

Allianz may seem like an unlikely bidder, but don’t forget they took a significant stake in Hartford years ago and have some inside knowledge of the company. Zurich would have a lot of overlap and has been speculated about before.

You also can’t discount Berkshire. While Buffett would be unlikely to get in a bidding war, he could position himself as a white knight. While we don’t know his specific thoughts about Hartford, he has hinted he looked to buy Chubb previously and is obviously looking for large acquisitions.

There’s one other important aspect to the outcome. Hartford is the last chance for a buyer to acquire a national small commercial platform. That’s a very important sentence.

Not only does it suggest that a buyer would be willing to “overpay” vs. a typical acquisition, but it also means each bidder will fear its rival winning.

Chubb will have made a major strategic misstep if it puts Hartford in play, only for it to wind up with Travelers or Zurich. Travelers and especially Zurich would be weakened competitively by a Chubb-Hartford combo which would have leading positions from small commercial all the way to large account.

Basic game theory suggests, when there is only one outcome where you win (make the acquisition) and many where you lose (any of the other buyers are successful) AND there is no chance to play the game again (because Hartford is the last piece on the board), that the players will overbid. Remember, I have an incentive to tell you that, but that doesn’t make it less true.

Why Did Chubb Start at $65?

I’ll admit I was a little puzzled by this for some of the reasons stated above. Chubb’s CEO Evan Greenberg had to know this would be summarily rejected.

While he was obviously looking for that response to let him go public, a low offer does not block other bidders. And, as mentioned, inviting other bidders without confidence you will prevail can lead to a bad outcome (either overpaying or letting one of your competitors improve their market position relative to you).

I’m sure Greenberg has considered all this chess and has a plan for if other bidders emerge, but I think he would have been better served making a stronger opening bid. A bear hug offer (i.e. significantly higher than the market price) would have made it harder for others to compete. It would have forced Hartford to take it seriously and reduced the risk of a bidding war where, once others are in, they feel they can’t back down.

If I’m Hartford, I’m secretly thrilled by the low offer (assuming they have resigned themselves to sell and not resist) because the more bidders who participate, the greater the odds of egos getting involved and fear of losing emerging to produce irrational bids.

Now, Evan is a brilliant guy and he has a fantastic M&A team, so I’m sure they have their reasons for starting low, but I would have tried to end the competition before it started. Perhaps they think as soon as other offers emerge, they have the power to top them every time and break their will, but I don’t think it will be that easy.

Chubb might think the other bidders don’t have the financial firepower to compete with them, so all my theories are nice on paper, but irrelevant in practice. That’s certainly possible as Chubb enters this process with tons of excess capital, plenty of debt capacity, a larger market cap, and less potential for revenue loss (though also less expense savings). However, that may not matter if other bidders are willing to take more dilution or can get creative with their bid.

Splitting the Baby

Which brings us to our next consideration. Hartford has three main businesses. By far, the largest is the commercial which is primarily small commercial. They also have a very large group benefits business as well a small personal lines business that is largely the AARP book (direct auto for seniors). The latter two can be sold independently of the commercial P&C business. (There is also a small mutual funds business that can be sold as well.)

This is hugely important because not all the bidders will want all three businesses. It’s not even clear that Chubb plans to keep all three. Furthermore, group benefits books have sold for premiums to P&C companies and the AARP business, given its uniqueness, potentially would go for a higher multiple than the commercial book.

It is also worth nothing that these two businesses also have some scarcity value to competitors in those segments. Every major auto player would love to have the AARP book. The same could be said for the benefits business, which is a market leader, though the competitors tend to be owned by life companies without the currencies to outbid others.

Why does all this matter? Because I’m not sure the ultimate deal will have only one buyer. It is very possible the group business is sold separately or even the AARP. Given these could trade at higher multiples, these units are a cheap source of financing assistance for the buyer of the main commercial business.

The Blocking Manuever

Similarly, Hartford could try to sell one of these businesses on its own, as a way to block a bid for the whole company. If Hartford truly doesn’t want to sell, the obvious path to take is to offer a “competing vision” to shareholders where they agree to sell (or spin) group and auto and focus on the core commercial.

This would help Hartford get revalued by monetizing their more valuable businesses and “unlock” the cheapness of the core P&C. I wouldn’t underestimate the probability of this outcome.

But, if Hartford does commit to a full sale where they maximize the price in a bidding war, it would make sense for the bidders to find partners to take the benefits and/or AARP.

The Club Deal Option

It would be easy to see Allstate, Progressive, or Liberty bidding on the AARP book. Allstate could also have interest in the benefits business (they have an existing worksite book they are fond of). SunLife or Aflac could be potential bidders for group. While Unum, MetLife, or Lincoln would certainly be interested, as mentioned, they may not have the currency to get involved.

Could Travelers team up with Allstate for a joint bid? Why not? Chubb even could, although I suspect they would like to keep the group business. If they want to keep the AARP, there are plenty of partner options for just the group piece.

Zurich could have Farmers partner up with Zurich North America on its bid, especially with Farmers recently buying the Met direct book. AARP would be a natural fit for Farmers and would let Zurich corporate use two of its balance sheets for the deal while bringing in an outside partner for the benefits.

The big benefit to bringing in partners is it reduces the check size a bidder needs for the commercial which allows smaller bidders to compete. I’m going to use purposely round numbers so don’t take these as projections, but if you look at past takeout multiples, you can get up to $10B for group and up to $5B for AARP.

I’m not going to debate the exact valuations, but hopefully it gives enough of a sense of why a club deal would make a lot of sense for the parties interested in the core commercial. If the P&C companies are trading at lower multiples than what a benefits business can be sold for, it doesn’t make sense to issue your equity for the group piece. Let someone else buy it and keep the piece you really want.

What Happens Next?

We wait. This is not going to be a quick process. It is possible the other bidders wait to see how much progress Chubb makes before getting involved. If Hartford’s plan is “Just Say No“, then the others will wait to see if Chubb is able to force Hartford to engage.

If Hartford realizes what the likely end game is, then they have probably already called other potential bidders and told them to start preparing their moves. I doubt Chubb is Hartford’s preferred buyer. While there would be fewer layoffs than other bidders, they are vastly different cultures.

So my guess is the other bidders will stay patient for now. They know there is plenty of room left between $65 and their walk away price, that they don’t need to show their cards yet. Let Chubb bid against itself for now and see how shareholders, insurance regulators, and the proxy firms react.

There is another element of game theory where, if one of the other potential buyers feels Hartford has successfully fended off Chubb, they may want to force Hartford’s hand by topping the Chubb bid to put more pressure on Hartford to commit to selling. This would obviously be a risky play for the reasons mentioned earlier…you better win or you have made yourself worse off.

Or perhaps the other bidders decide this deal is too complicated or too big a distraction and let Chubb win. However, even in that situation, one of the competitors would be smart to fake a bid (e.g. higher bid with contingencies that lets them walk) to try to drive the price up for Chubb.

So for now, the burden lies on Chubb to force Hartford to negotiate. Once that occurs, then the others will all dive in and try to steal the prize away.

Until then, Hartford is likely to focus its energies on fighting for its freedom. And, at $65, they have a pretty good case for it. I don’t think it is a certainty that Hartford gets sold, especially if there is no bidding war.

The likelihood of a sale goes up with the offer price. If Chubb makes clear they are willing to pay for the scarcity value, the odds of a sale increase. Then, we’ll see if the others decide to engage in a bidding war to prevent their opponent from getting the equivalent of the last Infinity Stone to control commercial insurance.