To inattentive observers, the recent announcement that the British insurance company Prudential PLC (NYSE ADR: PUK) would pay $35.5 billion for American International Group Inc.'s (NYSE: AIG) Asian insurance operation, AIA, might seem like just another belated expansion of the old British Empire - a strange contrast to the sale of the premier British chocolate company Cadbury PLC (NYSE ADR: CBY) to Kraft Foods Inc. (NYSE: KFT) last month.
Yet in reality both deals are examples of Empire-building that for shareholders is much more dangerous than the benign British variety - Empire-building by corporate management that runs contrary to capitalist ideals.
The British Prudential was founded in 1848, beating its U.S. counterpart by 27 years. It was a very similar company in its business, providing insurance policies to working people.
When I was a child, the man from the Pru used to call weekly on my grandmother to collect her two shillings and six pennies premium (about 50 cents) on a whole life policy. I used to deal with Prudential in my early days in the City of London; when visiting them you could always rely on a good cup of tea around 3:30 in the afternoon as the lady with the trolley made her way round the office doling out biscuits and gossip. (That early period in my career was the only time I was any good at office politics - Mary the tea lady at Hill Samuel, where I worked, would provide me with a cuppa just after she'd been to the boss's office, and mutter to me what reorganizations were being planned!)
Needless to say the Pru has changed since the 1970s - but not necessarily for the better. The new chief executive officer (CEO), Tidjane Thiam, is a management consultant from the Ivory Coast, with no particular ties to Britain and few to the insurance business - he had spent a few years as "Strategy Director" of another insurance company after being headhunted from McKinsey & Co. Needless to say, Thiam wanted to make a splash, and not leave the venerable British company looking the same as when he found it.
At first sight, buying a huge Asian operation looks strategically sensible - it makes Prudential a major player in the Asian market and a substantial one in - gasp - China. There are rumors that in order to buy it, Prudential may divest itself of its U.K. operations, thereby losing a low growth business and moving into a high growth business. All very consultantish and clever.
That's until you look at the question of price. Prudential is paying $35 billion for AIA, which is $15 billion more than the $20 billion AIA was thought to be worth as a stand-alone business. To buy it, Prudential is going to issue shares to AIG, as well as undertaking a $20 billion share issue that will double its capital and dilute the hell out of existing shareholders.
And, of course, if Prudential sells its British business it won't get much for it. After all, British insurance is a "low growth" business, so it won't be worth very much in a sale. In other words, it's just about as bad a deal as possible for existing Prudential shareholders.
Rather than follow the classic axiom of "buy low and sell high," Thiam is buying high and selling low.
That's not all.
In spite of its new whizz-bang CEO, Prudential is a slow-moving but very reliable organization with a level of integrity that is trusted by policyholders. Frankly, that's what you want in an insurance company. I have had a modest U.K. pension with one of its competitors since 1980, and I am constantly worried that some leveraged buyout (LBO) artist will step in, take it over, change the computer system so that information gets lost, outsource customer service, and drive the company into bankruptcy. If you're buying life insurance or pension services, you want a company that's not going to disappear in the next 30 years, and doesn't change its address or computer system too often. Avoid a company like the plague if it is run by whiz kids.
However, that's what AIG was like. We know how AIG operated; a guy who thought betting the ranch on the credit default swap market was a good idea ran it. Its Asian operation is no doubt full of similarly clever ideas. Even in the unlikely event that everything there is on the level, the cultural clash with an old-fashioned British insurance company is huge.
And why would you pay a PREMIUM for an AIG operation?
Like the Kraft/Cadbury deal, Prudential's takeover of AIA is value-destroying. Also like Kraft/Cadbury, it looks likely to destroy a valuable part of the British economy that millions of people have relied upon for generations - only this time the destruction will be caused by the buyer rather than the target.
As shareholders we need a new form of corporate governance. Those in management are hired hands. In the old days, large shareholders used to treat management as they would have treated their butler - and management was equally deferential to the owners of substantial percentages of the company's capital. That's how capitalism is supposed to work - with resources deployed in the interests of the owners of capital.
We know that system works; economics shows us why it works. The alternative, with resources deployed to satisfy the egos and fill the pockets of the hired hands, has no theoretical justification and little practicality - just as a big country house run in the interests of the butler would be a mess.
As capitalists, we must work together to restore capitalism!
News and Related Story Links:
- Money Morning:
With His Rebuke of Kraft, Buffett Reminds Wall Street That Shareholders Come First - Money Morning:
Battle for Cadbury Gets Sticky as Hershey & Italy's Ferrero Mull Offer - Money Morning:
Kraft Launches Hostile Bid for Cadbury - Money Morning:
The Credit Crisis and the Real Story Behind the Collapse of AIG
Great article on values of Capitalism, especailly about how HIRED HANDS…should, no, MUST work for, and in the shareholders interest……and not mal-utilising their positions to further their personal careers and aligning their pockets with hefty commissions/bonuses.
It is the shareholder who loses out as, as hired hands come in and out of a company, with no particular interest in the company, except their own gain. Today one comapny, tomorrow another.
And it carries on and on and on……….
I couldnt agree more but whilst you are reffering to big business this problem is playing out in the huge world of modern day politics Apathy and disinterest coupled with the dumbing down of the populace has enabled our elected politicians to rule the west purely for their own gain. The USA and the UK need a revolution to revert back to where we should be. The clock is ticking and we have little time left
As anyone in Life Insurance knows. It is easy to write a policy. It is the tail (tale) that makes you or kills you.
Great observation and well stated. I cannot agree with you more, nor can I add to what you have just said. The new style of going for immediate gratification taught at the Universities is killing the traditional style of management. This of course make investors lose confidence in these unscrupulous Corporations.
ktnyo
Author is right in his comments. It appears in general we have become too greedy. Earlier respect for continuity has lost the value.New norm is stay for one or two years,make mess ;show higher profits by jugglery & leave by the time it is noticed.
Western countries have lost premium to honesty & integrity.India is falling in the same line very fast.Every one wants to get rich fast by hook or crook.
Remedy lies in giving premium to honesty & integrity.Respect to experience;It is a big question mark whether one hears it or likes it.
Hi Martin:
Great article on the negative consequences for Capitalism as giant corporations merge reducing competition, and reducing payrolls.
Where are the anti-trust politicians when we need them?
This Pru-AIG deal which is all smoke and mirrors, reminds me of the merger of Time/Warner and AOL, which was great for the egos of senior management and the Investment Banks, but lousy in the long run for the real shareholders.
Maybe, it was the announcement of this deal that set off the panic selling of the pound in world currency markets.
Regards.
Steve
"Why would you pay a premium for an AIG company?"
Because it is AIG, and because it is an Asian insurance company.
What needs to be investigated is the link between the respective government agencies and Prudential's move. An insurance company holds a lot of strategic military information about a country's infrastructure, such as bridges and factories, storage facilities, etc.
Corporations and the government are one and the same: a corporation is granted its limited liability status at the behest of the government in a quid-pro-quo exchange that implies perpetual growth of that government's country and economy. They are forever linked.
When 'whiz kids' are making the moves, you can bet they will be looking for a video game to play, like "Medal of Honor" or some other nonsense that makes them feel like "killer" apps, and when MI6 comes knocking on their door, they get more thrills than they could ever imagine.
Why do you think AIG U.S. was bailed out so quickly? You don't really buy that crap about "too big to fail", do you?
Conspiracy? Sure. That's the only way anything actually GETS done in the government.
Take it with a grain of salt, then make up your own recipe. I like mine a little spicier than most.
To true, most large companies act like workers cooperatives for the benefit of the workers .
The shareholders are A inconvieniance to be humoured at the agm and then ignored
Very good article. It is a fact that effective and good management practices are missing in some big companies. Hiring practices and management rules have been changing a lot during the last 10 years and now we see a lot of value-destroying practices as very common management practices. The sad part of the story is that those practices are being copied by medium and small companies and are setting the "example to follow" in developing countries such as Latin America. That only makes the crisis worse for companies, shareholders and at the end, for the society where those companies operate.
SELL antishareholder corporate stocks – the ultimate solution .
Most of this article is wishful nonsense based on some deluded sense of nostalgic grandeur. Since when has "capitalism" had anything to do with "responsibility" to anyone or anything, other than making profits? When a corporation dumps its US workers after decades and moves its plants to China to drastically lower labor costs and then two years later moves to another smaller Chinese city to cut their labors costs from 68 cents an hour down to 45 cents, do shareholders call that "irresponsible"? Not if the stock price is going up. Trading a slow growth, reputable business for a fast track new market opportunity at a loss may be a good or bad, short or long term business strategy, but it has nothing to do with "capitalism" as a system. Anyone who thinks their investment in any company is anything other a gambling bet is a deluded fool who will likely be sheared like a sheep. If you want integrity and responsibility in business then you need serious regulations and real watchdogs who aren't in the pockets of the corporations and markets they police. According to today's political climate that's spelled s-o-c-i-a-l-i-s-m. The irony is, of course, is that we've got corporate socialism where public monies are supporting giant corporations like AIG and Goldman-Sachs (with their shamefull access to Fed money as a so-called "bank") propping or providing endless capital no matter how good or bad their investment judgements may be.
Ronnie, I completely agree with you and recently sold all my equity stocks, because i was truly tired of supporting this upside down system. I'm getting ready for the revolution that is coming to take care of the similar government problems.
Bravo Martin. You hit the nail on the head. Both in the U.S. and in Britain and somewhat throughout the world, corporate executives (who are actually thieves) get control of a company, fill its board of directors with buddies who control other companies and swap director's seats ("You do what I say in my company and I'll do what you say in yours"). The directors of companies are increasingly "mushroom" directors and shareholders are almost always "mushroom" owners. (To grow mushrooms you need to keep them in the dark and through a lot of fertilizer on them.) "The shareholders be damned while I build my personal empire and my own compensation." Capitalism works, but we really don't have it in much of the western world. We need to hold directors accountable to the shareholders. Companies have grown so large with share ownership of the company so diffuse and with so much institutional ownership (pension funds, etc.) that shareholder meetings are infrequent and the meetings are management's rubber stamps 99% of the time. We need to outlaw the trading of director's seats and the buddy system. We need to require shareholder approval of major deals like the one described in your article and have an independent CPA firm or equivalent, a firm not chosen by corporate management or even by the existing directors, evaluate for the share holders the true economics of deals like the ones in your article. Shareholders will act in their own interests (true capitalism) if we take them out of the dark and stop throwing fertilizer on them. We also need to directly tie management's compensation to corporate earnings and share value and have it done by other than corporate management itself (because they are adept at playing games with these formulas so that tails I win, heads you lose). I speak from personal experience. I was a senior executive in a seven billion dollar NYSE company for sixteen years. I watched management at all levels totally devoted to personal empire building at almost all levels of management, not giving a damn for the shareholders. The Chairman, who was as unqualified an executive as they come fostered a cult of personal ambition, putting his golfing buddies and other California Club (CEOs and top executives' lunch club in Los Angeles) cronies on his board and driven (stupidly) to expand the company into areas where the company had no expertise and no business getting into, all for absurdly high acquisition prices, until this company, the parent company of a very profitable utility, could no longer service the dividend it had paid and increased for nearly a hundred years. Absurd acquisition prices, stupid investments (one in a oil company with no oil reserves) and personal greed rather than protecting the shareholders eventually brought the company to disaster so that it dissolved, pretty much destroying seven billion dollars of equity and screwing over pensioners and other investors who bought the company stock mainly to receive that sold, strong, growing dividend stream. Capitalism? No. We have Cronieism, and Corporate Imperialism instead, and it will continue until we do something like create a set of corporate rules equivalent to FASB in the accounting world, rules that puts checks and balances in place to prevent these type of clear shareholder abuses. Keep up the good reporting.
Jay Curtis (author of THE CODE)
In response to that last comment — I believe the other name for "corporate socialism" is Fascism. George Orwell is alive and well.
I think the parallels to the Kraft/Cadbury deal here are pretty telling. Not only does the value of the brand get hurt, but everyone seems to agree that shareholdings will be diluted as well. Best of luck, Pru and AIG. This one's gonna have far reaching implications on all sides of the globe.
The top toads salivate while ordering their poindexters to crank out "growth platforms". Computer proformas based on unproven assumptions tweaked with delusional multiples that they call "models".
That Wall St hoods round up the $ for, taking a top cut of cash plus stock for themselves, and then bet on the demise of the deal they jigged by selling credit default swaps, which they feast from on the way up and down. This is what the whiz bang CEO's have mastered and peddle to saps of all stripes. Enron Finance 101.
The derivatives market is $595 TRILLION at last count. Almost 10 times global GDP. Their game is too big to fail and getting bigger by the month. The new world order is whoever owes the most wields the most power. Only a revolution will stop these hoods and banksters. The politicians are bought and paid for with the dance card a constantly moving target.
Martin, great article. You wonder what the present day Business Schools are teaching about Corporate Governance. The tail is wagging the dog, rather than the dog wags the tail. This is the kind of Corporate Culture that contributed to the present Financial collapse in America and consequently,other parts of the World.It should be legislated that sizable Corporations should adopt a two tier type of Management system where the decision making process must be approved by the Shareholders,before any decision is implemented by management.
This society is standing on its head and we will continue to reap what we sow.
As a former KPMG Consulting Insurance Partner, with over 25 years consulting experience, I hope the theory can be put into practice to deliver the anticipated shareholder value creation.
Nothing will change until people realise good values and morals are important for sustainability.
We will always have greed, dishonesty and lack of respect for others but it doesn't need to come from 90% of population. Me,me,me,me,me. What about the team? If children had parents that put time into them, instead of both working (I realsie there a a lot of single parents), it would save them money and responsibility in the long term and install values and decent morals in the kilds for life. Obviously this is not the only issue! I am not a guru in business but I am learning fast who I want to do business with, and the type of person I don't. Good values make it so much easier and sustainable.
Martin, a great insight, thank you. And the comments by other readers were very interesting.
The scary part is shareholders' stock is diluted and dividends reduced, but saying that there is still a board of directors who can sack an overzealous CEO. It should be contemplated that the board of directors (who would want to protect their own investments) would keep an eye on the CEO. If the board does not do its job, shareholders can vote to change directors at the AGM. Has every one forgotten about their proxy?
In America, you can be sure that there will be no support from the Administration to back the SEC if it wants to more stringently regulate corporations. Most attempts over the past 30 years to implement reform of the financial services market have been scuttled due to lobby groups and Wall Street's influence within the Administration or Treasury.
"Its Asian operation is no doubt full of similarly clever ideas."
Gosh, you really are clever, aren't you? Painting the entire picture black along with the rest of the background. Genuis. Or pure idiot.
The tale continues. It is now the tail that is wagging the "dog" Let the saga develop and like all good consulting project look forward not back at the boulevard of broken dreams – that are yet to be defined with blame where ever it can be laid.
Ross Wrigley
Pure Genius. Thanks for the real view