Market murmurings that conglomerate Wesfarmers (ASX: WES) will offload its Insurance division are getting louder with the Australian Financial Review not only reporting that recent talks between global insurer Zurich Insurance and Wesfarmers have broken down but also that leading domestic insurer Insurance Australia Group (ASX: IAG) is considering making a $2 billion offer for the division.
The Wesfarmers Insurance division recorded earnings before interest and tax of $205 million in the 12 months to 30 June 2013 on revenue of nearly $2.1 billion. According to the AFR, should IAG purchase the division, IAG would move past QBE Insurance (ASX: QBE) to become the largest commercial underwriter in Australia, accounting for around 21% of the market.
A combined IAG-Wesfarmers Insurance would also have around 38% of the motor vehicle underwriting market, which some analysts are speculating would attract the attention of the Australian Competition and Consumer Commission (ACCC). One solution could be for IAG to jointly bid for Wesfarmers with another insurer such as Suncorp (ASX: SUN) and let the partner take the motor insurance business so as to not raise ACCC concerns, however this would presumably not be a particularly desirable outcome for IAG.
Foolish takeaway
For Wesfarmers shareholders, the opportunity to sell the sub-scale, non-core insurance business and utilise the sales proceeds for more shareholder value enhancing opportunities is highly appealing.
Likewise for IAG shareholders, the opportunity to swallow up a competitor in what would be akin to a bolt-on acquisition is highly appealing given the synergies it would create including the benefits of scale and leveraging the fixed cost base across a wider revenue stream.
However, as investors in companies including McMillan Shakespeare (ASX: MMS) and GrainCorp (ASX: GNC) have seen recently, betting on regulatory outcomes is fraught with unknowns. For this reason while IAG would no doubt benefit from a purchase of Wesfarmers Insurance, investors trying to second guess whether the ACCC would allow the acquisition to proceed is complex and risky.
