Insurance Australia Group (ASX: IAG) is the largest home and car insurer in Australia. The company recently announced that it plans to buy Wesfarmers' (ASX: WES) WFI and Lumley Insurance brands. It also agreed a 10-year distribution deal with Coles. As a result, IAG decided to raise $1.4 million in capital by selling shares at a discount to the prevailing market price.
$1.2 billion worth of shares were allocated to institutions at the price of $5.47, a 5.8% discount to the current price of $5.81. The sheer volume of shares available to institutions means that they can make a quick profit if they wish. Only $200 million worth of shares will be sold to retail investors at the discounted price of $5.47, via a share purchase plan (SPP). As Fool contributor Andrew Mudie points out, retail investors will receive a disproportionately small amount of discounted shares, given they make up over 30% of the share register.
Shareholders may apply for a parcel of $1,000, $2,500, $5,000, $7,500, $10,000 or $15,000 shares. However, the company reserves the right to scale back applications at its absolute discretion.
Will there be a scale back?
There are well over 750,000 eligible retail shareholders, but just $200 million worth of shares on offer. Even if only 200,000 retail shareholders apply for shares, on average each shareholder would be entitled to just $1000 worth of shares. Given that $1000 is the smallest amount of shares available, it is almost certain that there will be a heavy scale back.
The current offer is reminiscent of the 2012 SPP of insurance giant QBE (ASX: QBE). Just like IAG, QBE sold a disproportionate amount of discounted shares to institutional shareholders. QBE ended up drastically scaling back retail shareholders, limiting them to 8.34% of their existing shareholding (I was allotted less than 10 shares and received no interest on my money for almost a month).
The IAG SPP offer document states that: "IAG may take into account, among other factors, the size of an applicant's shareholding in determining the amount (if any) by which to scale back that applicant's application." The company also states that it expects to direct credit refunds on 6 February 2014, should a scale back be applied.
Foolish takeaway
A heavy scale back is highly likely. In my opinion existing shareholders should not apply for more than about 20% of their existing holding. This is because they are very unlikely to receive more than that. For small shareholders (with less than $4000 worth of shares), I think it's highly unlikely participation in the SPP would be worth the effort.
Finally, shareholders and non-shareholders alike should consider whether IAG is really worth buying at all. The insurance company had a good run in 2013, as Mother Nature permitted a hefty insurance margin of over 17%. In my opinion the time to buy insurance company stock is after the company has announced losses stemming from a rare adverse event, not after a stellar year when luck may have shined on the company. If I had a large enough holding of IAG, I'd apply for about 10-15% of that holding under the SPP, via BPAY, on 20 January. That is assuming the IAG share price was still above $5.75.
