Buy into QBE

With the recent proposed and rejected merger/takeover the game is on between Insurance Australia Group (IAG) and QBE. The first offer was a salvo by QBE to see the reaction of investors and regulators. It was never meant to be the final offer and I think they will pay more to takeover QBE. I have written a number of times on both stocks and my preference is still QBE. I say this despite owning IAG shares, which have had a nice rise over the last week. IAG's stock closed at $4.38 yesterday compared with the $3.99 value of QBE's stock and cash takeover offer. So the market clearly expects a higher offer. I wouldn't be surprised if other local and overseas suitors are re-running the numbers over IAG, now that QBE has made its interest in the stock official.

Here's what the analysts are saying:

- QBE could pay as much as A$5 a share for Insurance Australia, Credit Suisse Group analyst Arjan van Veen said in a note to clients today. Citigroup Inc.'s Nigel Pittaway estimated a price of A$4.50, and Ryan Fisher at Goldman Sachs JBWere Pty said an offer in the ``mid-A$4s'' was possible.

- Merrill Lynch, meanwhile, believes QBE will come back with another bid and could offer up to $5.10 per IAG share and still make the deal cash earnings break-even.

- According to broker Credit Suisse, QBE's offer is greater than four times IAG's net tangible asset (NTA) value compared to recent QBE transactions at 1.5 to 1.75 times NTA.

- Analysts are unsure if the mega-merger will eventuate, with some musing that QBE, with its conservative approach to valuing targets, could find cheaper buys elsewhere. With or without IAG, analysts agreed with the assertion that QBE still has a decent pipeline of offshore deal opportunities.

- Goldman Sachs JBWere (GSJBW) believes that while QBE has room to increase its offer, it is unlikely to stump up enough capital to satisfy the IAG board, which is adamant IAG's shares are undervalued in a tough market.

What the companies are saying:

- IAG chairman James Strong acknowledged on Tuesday the merits of a tie-up between the two insurers, but only at the right price.

- In a sign the price might never be right, QBE indicated that it would not deviate from its usual deal requirement of achieving earnings accretion in year one.

How to profit from this merger

For short term investors the best way to make some money from this merger is to buy IAG shares. There is between 10-20% upside based on the average analyst recommendation. QBE's offer of $4, provides the floor for the stock, so at most you will lost 10% if QBE pulls out of the
merger/takeover tomorrow.

For longer term investors, like me, invest in QBE. It is a quality company that has taken a hit of late due to the global credit crisis. It is far better run than IAG from all reports. If it takes over/merges with IAG it will likely take some time to realize the synergies from the merger, but once it does it will probably add another $5 - $10 to the stock price in the medium term. Even if the takeover doesn't go ahead, QBE will find other options for growth and I see the share price going back to $30 by next year (assuming no major natural or man made catastrophes).

The rise of the US markets overnight should buoy both stock prices today, but stay tuned as there is a way to go with this deal.