Brian Gaynor: Uphill struggle, downstream benefits

Investors should consider two important issues when looking at an initial public offering (IPO) - the company and the state of the sharemarket.

In buoyant sharemarket conditions most IPOs will list above their issue price, regardless of quality. The 1980s boom in New Zealand and Nasdaq technology bubble were good examples of this.

In depressed market conditions blue-chip companies will struggle to list at a premium unless the issue price is extremely low.

Promina fits into the latter category. Its timing is dreadful, it is a blue-chip company being floated at the wrong time. Depressed sharemarket conditions in Australia and New Zealand are likely to have a bigger influence on the issue than the company's outlook.

Retail investors are at a huge disadvantage because most major brokers have a formal involvement with the IPO and there will be little independent analysis and advice on the issue.

Promina is the Australasian operation of the troubled UK general insurance giant Royal & SunAlliance. The new company is the second largest general insurer in New Zealand and the third biggest in Australia.

European insurance companies have gone through a dreadful period and Royal & SunAlliance is no exception. The European insurance sharemarket index fell 51 per cent last year and Royal & SunAlliance's share price has plunged from £8 to just £0.86 since April 1998.

The sector's woes are caused by several factors including poorly performing US acquisitions, over-investment in equities, major court decisions in favour of asbestos-related claimants and increased weather and accident-related claims.

Royal & SunAlliance reported a group operating loss of £655 million ($1.87 billion) for the December 2002 year compared with a loss of £293 million for the previous year. The loss included goodwill write-offs and investment losses.

The London-based insurer is selling assets, including its Australasian operations, in an effort to lift its dreadful earnings and share price performance.

Royal & SunAlliance is offering up to 1,057 million Promina shares (including any shares that may be issued or sold under the over-allotment option but excluding any employee gift offer shares) in the following manner:

* Institutions will buy their shares through a bookbuilding process (an auction) with an indicative price range between A$1.50 and A$2 ($1.64 to $2.15). This exercise will determine the final issue price for institutional investors and retail investors (who will pay A$0.10 less than the institutional price).

* Brokers may pool bids on behalf of retail investors in the bookbuilding process. These retail investors will pay the final issue price converted to New Zealand dollars excluding the A$0.10 retail discount.

* New Zealand retail investors will pay $2.15 per share on application. Their final price will be the lesser of $2.15 or the NZ dollar equivalent of the retail price for Australian applicants (which includes the A$0.10 discount). Thus the indicative price for retail investors is between $2.15 and $1.53. If the final price is below $2.15 the difference will be returned to applicants.

The broker pool for retail investors is a welcome innovation but it has limited appeal because it does not attract the A$0.10 discount.

The direct retail offer has two drawbacks. Retail investors who participate in this process will have no influence over the final price and they will not know what they will have to pay until after they send in their application money.

Brokers in Australia and New Zealand will receive total fees of up to $60 million, based on the retail application price. As most of them are struggling at present they have a huge incentive to push the issue even if it is not in the best interest of their clients.

Promina is smaller, in sharemarket terms, than three large Australian general insurance companies - Insurance Australia Group (IAG), QBE Insurance, and Suncorp Metway (AMP, AXA and Tower are primarily life insurance companies).

General insurance is usually less risky than life because operators can rewrite their policies each year whereas life insurers have long-term commitments that are difficult to reprice if market conditions turn negative (for example, if there is a prolonged bear market in equities). Nevertheless, general insurers are still exposed to adverse developments including bushfires, floods, earthquakes, leaky buildings and poor investment markets.

Australia's largest general insurer, IAG, which owns NRMA in Australia and State Insurance and NZI in New Zealand, reported a net loss of A$25 million for the June 2002 year. This included a pre-tax loss on its investment portfolio of $98 million compared with a profit of $358 million in the previous year. Analysts are expecting a much better result for the current year because of improved industry fundamentals, lower claims and a more conservative investment portfolio.

QBE, Australia's fourth-largest general insurer and a major player in the Lloyd's insurance market, recently announced a net profit of A$279 million for the December year compared with a loss of $25 million for the previous year. The group has only 7.9 per cent of its investment portfolio in listed equities and expects insurance industry conditions to remain favourable in the current year.

Suncorp Metway, which is Australia's second largest general insurer and sixth largest bank, reported net earnings of A$155 million for the six months to December compared with $154 million for the same period in the previous year. Analysts expect a better second half even though Canberra bushfire claims could be in the order of A$30 million and there are some concerns over the quality of its bank loan book.

Promina, which operates under several brand names including AAMI, AA Insurance, SIS Insurance, Guardian Trust and Tyndall, had a pro forma loss of A$291 million for the December 2002 year. The result included a $129 million increase in reserves for prior year claims, mainly asbestos related, and a $425 million writedown in the value of its financial services business.

The directors are forecasting net earnings of A$188 million for the December 2003 year. The forecasts are reasonable although there is always the possibility of unexpected claims with the leaky buildings phenomena in Auckland being a potential problem.

Promina also has an extremely low exposure to equities as all of its general insurance technical assets and shareholder funds are held in cash and fixed interest.

Promina looks reasonably attractive on a price/earnings and dividend yield basis compared with its industry peers but the timing of the IPO is dreadful, at least as far as short-term traders are concerned.

A recent report in the Australian Financial Review showed only 15 of the 37 IPOs in the past 12 months are trading above their issue price and the average return on the 37 companies is a negative 9.1 per cent. New Zealand floats have also done poorly with Skellmax and Vertex trading below their issue price.

Another problem is that investors are withdrawing money from equity funds and institutional managers may not have the resources to invest in Promina.

Poor sharemarket conditions are expected to have a bigger influence on the issue than the company's fundamentals and it is reasonable to assume that the final price will be near the bottom of the indicate range, A$1.50 ($1.64) for institutions and A$1.40 ($1.53) for retail investors.

If the final price is at the lower end of the indicative price range then the issue should be attractive for long-term holders.

But the big disadvantages of the IPO are that retail investors will not know the final price when they send in their money and the issue has limited appeal from a short-term perspective.

* Email Brian Gaynor