The dust has now settled on the deal announced two weeks ago where Warren Buffett's Berkshire Hathaway investment conglomerate purchased a 3.7% stake in Australia and New-Zealand focussed Insurance Australia Group Ltd (ASX: IAG).
The investment was made via a $500 million placement of new shares and was accompanied by the announcement of a strategic partnership between the two companies in which Berkshire will receive 20% of IAG's consolidated gross written premiums and pay 20% of claims.
At the time of the deal I questioned the value for existing shareholders, especially in the next two years, as the deal appears to be earnings per share dilutive. I summarised analyst findings by saying that: "Citi Group estimates that IAG's 2015 earnings per share will be 3% lower and 2016 earnings per share will be 10% lower, while JP Morgan estimates that 2016 earnings will be 6.5% lower. If IAG maintains its stated dividend payout ratio target of between 60% and 70% of earnings, it can be expected that the dividend will fall by a similar amount."
Where are we now?
The investment community appears content that the deal WILL be earnings per share dilutive for existing shareholders. Consensus earnings per share for the 2016 financial year (noting the arrangement commences from 1 July) now sits at 39.91 cents, down from 42.69 cents a month ago, and 43.39 cents two months ago.
2017 earnings per share is down to 40.70 cents, from 43.40 cents a month ago and 44.56 cents two month ago. Dividend forecasts have also fallen.
This isn't great news for investors, however we at the Motley Fool prefer to look over the long term and a number of positives have emerged from further analysis:
- Analysts see an opportunity for IAG to pursue investments in Asia, reducing Australia-specific risks and potentially lowering earnings volatility due to floods, cyclones and fires.
- IAG's earnings volatility should decrease as 20% of any gap between insurance income and expense will be covered by Berkshire.
- Closer ties with Berkshire can only be a good thing, especially seeing as Berkshire's presence in Australia is growing.
The final word?
I mentioned in another article today that investors in IAG today are paying for the dividend yield and not for growth. For this reason I can't help but feel that Berskhire's prime motivation for doing the deal with IAG is simply to further its business in Australia, rather than invest in a real Buffett-worthy company.
IAG doesn't have a competitive advantage over peers, generates profit based on the severity and frequency of uncontrollable events, and appears to be at the peak of its earnings cycle.
Geoff Wilson from Wilson Asset Management said it well: "Basically, you are paying $1 billion for $2.5 billion of value. For me, it seems it's a cracking deal for Buffett but not for investors".
