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