IAG’s brutal poison pill

Every year there's a rumour that Insurance Australia Group will receive a takeover offer, but given it possesses Australia's most powerful poison pill, a buyout is highly unlikely.

For the last few years – almost without exception – an inexperienced merchant banker will try and drum up takeover business by flogging around the market the idea of someone acquiring Insurance Australia Group.

On each occasion they also sell the idea to an equally inexperienced journalist. Last year followed past years with one deviation – Wesfarmers was named as the likely acquirer.

There is one simple problem that the inexperienced merchant bankers and journalists always forget – IAG has Australia’s best poison pill. Anyone trying to acquire IAG could suffer big losses if the poison pill is activated. And it is almost certain that it will be.

This is how the poison pills works.

IAG owns 70 per cent of the Insurance Manufacturers of Australia (IMA) operation, which produces car, house and other insurance products for New South Wales and Victoria, plus some other markets. It is the jewel in the IAG crown.

The Royal Automotive Club of Victoria, which has members’ funds of over $2 billion and is close to Australia’s largest mutual, owns the remaining 30 per cent.

The IMA joint venture was formed in 1999 and ended an insurance price war between the NRMA and RACV.

RACV not only has a 30 per cent stake in IMA but it has the right to buy out the IAG 70 per cent stake at a "fair” price should there be a control change at IAG.

Anyone buying IAG runs the risk of the RACV purchasing 70 per cent of the most profitable IAG asset at a price below the value that the bidder placed on the asset in the takeover.

Since QBE made an unsuccessful bid for IAG in 2008, the RACV has always been on red alert to bring in a partner and snap up the 70 per cent IAG stake, should there be an IAG control change. Not surprisingly, RACV wants to leave the current arrangement as it is, but it remains ready to act. In 2010, IAG tried to buy RACV out, but the offer was at the ludicrously low price of $1.5 billion. But even if they had offered a more realistic price of, say, $3 billion, it is unlikely RACV would sell.

The 30 per cent joint venture stake has now been totally embedded into the RACV operation and has funded the purchase or constriction of a series of tourism-related investments at depressed prices in Victoria and Queensland. RACV has no debt apart from its finance company debentures.

Unfortunately for IAG shareholders, the company has used many of the rewards from its 70 per cent stake in IMA to fund unprofitable ventures offshore. If Wesfarmers or anyone else wants to buy IAG they have to first find a way of dealing with the poison pill and the RACV.

Note: I am a member of the RACV and the RACV city club.