Vote of confidence

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The past three weeks have seen a flurry of merger and acquisition activity in Lloyd's. Ralph Savage looks at the trends driving the most recent deal to buy out Cathedral

No one can accuse the 40-odd businesses in Lloyd's of resting on their laurels. The market's dynamism has been highlighted in recent weeks by Catlin's £591m offer for rival Wellington Underwriting; Canopius entering the top 10 underwriters on Lime Street through its acquisition of Creechurch; and now Cathedral, one of the newest managing agencies in the market, becoming the subject of a takeover by private equity house Alchemy.

Analysts and market commentators have mused over the significance of these deals, not least for the variety of investment vehicles and strategies being utilised to inject capital into the market. With the number of companies jetting off to more tax-friendly domiciles like Bermuda growing each year, Lloyd's' attractiveness to investors has been questioned; however, the teams behind the deal hoping to buy Cathedral, claimed this takeover was clear evidence of the market's appeal.

First of a kind

"This deal is yet more evidence of the attractiveness of the Lloyd's market to the investment community," commented Tim Matthews, the partner at Clyde and Co who acted for Cathedral Capital. "The investment by a private equity firm of Alchemy's size and reputation in a Lloyd's business is a substantial vote of confidence in the potential returns expected in the sector. This may be the first deal of its kind in the market but it is unlikely to be the last."

Alchemy is, of course, not the only private equity fund to have significant interest in Lloyd's - Canopius was itself backed to the tune of 80% by Engelfield Capital when it carried out a management buyout from previous owner, Trenwick, in 2003. Equity Insurance - known at the time as Cox - was itself provided with the necessary leverage by Duke Street and Engelfield Capital again, which took a 40% share each in the business last year.

Andrew Green, a partner at corporate adviser Mazars, claimed such deals were proof that private equity had long been interested in allocating investments to Lloyd's but he suggested the relatively small number of independent businesses remaining might leave opportunities a little scarce: "There are few independent managing agencies, by which I mean there are a limited number of players in the market of significant size, that are not aligned to listed entities in the US, UK or elsewhere.

"Private equity has been interested in the opportunities within Lloyd's for some time but it depends on when is the right time and in who to invest," he added.

Terms of agreement

The terms of the Cathedral deal differ from previous private equity investments in Lloyd's, whereby the entire share capital of the business is being acquired, rather than an equity-backed MBO.

Mr Green said: "It's significant in that it's the first private equity transaction like this, with Disciple Holdco (the newly incorporated company funded by Alchemy to make the offer) owning 100% of Cathedral's A shares if the offer is accepted. I think it is important to point out that the management itself will own a share of disciple too so the business will not in fact be 100% owned by Alchemy."

One of the newer businesses in Lloyd's, Cathedral, was created as a 'conversion vehicle' when a number of private investors (Names) were looking to convert their underwriting into a corporate phase during 2000. The senior management joined when this vehicle was established and the following year they established Syndicate 2010. However, capacity requirements for a vehicle capitalised entirely by private investment described as "diverse" by Mr Green, meant it was "not always easy to raise additional capital to grow the business".

Further capacity

Disciple Holdings confirmed this factor in its rationale for making the Cathedral offer: "Syndicate 2010 is pre-empting £50m of additional capacity for 2007 in order to take advantage of increased rates and higher levels of client retentions in non-marine and property books. However, pursuing these growth opportunities, coupled with other developments in the insurance market, means that in the future increasing amounts of capital are likely to be required by the Cathedral Capital Group,"

Of course, private equity investment is synonymous with the kind of high-risk, high-return strategies associated with many Lloyd's vehicles, and Disciple is clear that Cathedral's performance in recent years makes it a very attractive investment.

"Despite a difficult loss environment in the insurance market in the past few years, with 2005 being the third year in the past five claiming to be the costliest for the insurance industry, Syndicate 2010 has performed strongly, reporting a combined ratio of 93% in 2005 and 76.3% in 2004," it said.

Interestingly, Alchemy Partners has been in the news for reasons normally found on the other side of the strategic investment coin. As revealed in Post last month (19 October, p3), the company appointed Deloitte to advise it on a sale of its commercial broking business, Open and Direct.

Alchemy bought the majority share of Open and Direct in 2002 in a £128.4m MBO from Northern Irish conglomerate the Viridian Group, so if the investment horizon of this deal is anything to go by, perhaps Cathedral's future could be on the table once more.

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