The Inoculated Investor http://inoculatedinvestor.blogspot.com

IPCR: Scuttled Deal Provides an Opportunity

Over the last few days the strange love triangle between IPC Holdings (IPCR), Max Capital (MXGL) andValidus Holdings (VR) has gotten even more convoluted. For those of you who have not been followingthis story, here is a brief timeline of the recent dramatic and even Desperate Housewives-worthy events:

March 2nd, 2009:

IPCR and MXGL agreed to combine forces. The original agreement was for the groupto maintain the Max Capital name under the following terms:1. Holders of MXGL shares would receive .6429 shares of IPCR in a tax free, stock for stock merger 2. IPCR shareholders would then control 58% of the combined entity with MXGL shareholders holding theremaining 42%3. The deal was set to close sometime in the 3rd quarter 2009.MXGL closed at $16.20 on 3/2 and proceeded to drop all the way down to $14.47 by the end of the day on3/3. IPCR closed at $24.69 on 3/3 and then also dropped the next day to $22.28. Based on the closing prices at the end of the day on 3/3, the deal valued MXGL at $14.32 per share (.6429* $22.28).

March 31st, 2009:

IPCR acknowledged the receipt of an unsolicited letter from VR outlining a proposedtransaction. The company stated that it would review the letter but would not comment further until havingdone so. The offer from VR would have provided 1.2037 VR shares for each share of IPCR. Based on theclosing prices on 3/30 the offer valued IPCR at $29.98 (about $1.68B) and offered an 18% premium to theclosing price of $25.41. In the letter to IPCR, VR and its advisers highlighted a number of reasons its offer was superior to the MXGL-IPCR tie up, including low leverage ratios, a stable investment portfolio withfew investments in “alternative assets”, and a global underwriting platform.

April 7th, 2009:

The IPCR board unanimously approved the deal with MXGL and reaffirmed itsrecommendation that shareholders approve the deal. In the press release IPCR Chairman Ken Hammondstressed the benefits of the deal with MXGL and suggested that the fact that the MXGL would close faster also made it preferable to the VR offer. Also, in a letter to VR Chairman and CEO Ed Noonan, Hammondoutlined some additional reasons for rejecting the offer:1. The VR offer failed to meet IPCR's diversification goals that include moving into less correlated risks2. The fact that VR's stock price at the time was near the high end of the 52 week range could lead todownside for IPCR shareholders.3. IPCR was concerned about VR's exposure to catastrophe losses and the subsequent impact on earnings per share and the share price4. The MXGL deal would have to be rejected by IPCR shareholders before the Board could conductsufficient due diligence on the VR offer

April 15th, 2009:

IPCR and MXGL announced that the Federal Trade Commission and Antitrust Divisionof the US Department of Justice had reviewed the transaction and granted an early termination of a requiredwaiting period. As a result IPCR stated that the deal should close in June with all the necessary regulatoryapprovals.

April 30th, 2009:

VR decides to take its hostile bid directly to IPCR shareholders after the IPCR Boardhad rejected the deal. VR also took the occasion to urge IPCR shareholders to reject the MXGL deal.

April 12th, 2009:

VR commences an exchange offer for all of the outstanding common shares of IPCR,continuing to offer 1.203 shares of its own stock. At this point VR was trading at $23.68 (on 4/13),implying a $28.49 value for IPCR. IPCR closed on 4/13 at $27.41.

May 18, 2009:

After filing an application with the Supreme Court of Bermuda on 5/12 to allow a meetingof IPCR common shareholders, VR increased its offer on 5/18. Under the revised terms, VR offered $3 incash and 1.1234 shares of VR for each share of IPCR. Based on the closing price of VR on May 15th, thenew offer provided IPCR shareholders with $30.14 of compensation for each share, a 13.2% premium tothe 5/15 closing price of IPCR and a 21.9% premium to the closing price on 3/30.

The Inoculated Investor http://inoculatedinvestor.blogspot.com

May 22nd, 2009:

IPCR's Board indicated that it still did not feel VR's offer represented a superior proposalto the MXGL deal. VR then issued a press release stating that it was both surprised and disappointed bythat conclusion. Along with re-affirming the belief that its offer provided IPCR shareholders significantlymore value than a merger between IPCR and MXGL, VR continued its assault on both IPCR and MXGLfor what it deemed as false, inconsistent, and misleading statements regarding its offer.

June 10th, 2009:

VR announced that RiskMetrics, an independent proxy voting group, had recommendedthat IPCR shareholders reject the MXGL merger. Also, VR took this opportunity to revise the deal onceagain, this time increasing the cash portion to $3.75 per share from $3. The total consideration at this pointwas $30.36, a 12.5% premium to IPCR's closing price.

June 12th, 2009:

After IPCR's shareholders voted down the merger with MXGL, MXGL terminated theagreement for the two companies to merge.So, after all of the dancing, name calling, and deal revising, where are we today? According to today’s press releasefrom IPCR, after entering into a confidentiality agreement over the weekend, IPCR ChairmanHammond sent VR a letter outlining the necessary criteria for its Board to be willing to consider a tie upwith VR. Apparently even after all the acrimony (but only after the MXGL deal got summarily voted down —72% voted against it), IPCR is now willing to enter negotiations with VR.“We reached out to Validus last Friday, June 12, to discuss terms for a negotiated transaction at a price acceptable to IPC. As the primary consideration offered to IPC shareholders is Validus stock IPC needs to perform due diligence on Validus. Over the weekend, IPC and Validus entered into aconfidentiality agreement. IPC provided Validus with our initial due diligence request, retainedadvisors to assist us in the due diligence process and began work.”“Even though Validus has twice revised its offer in light of the fact that its stock has dropped 9%since its March 31 offer, Validus’s current offer continues to be at a significant discount to IPC’s book value. Our unaudited book value per share is approximately $35 at the end of May and theimplied value of Validus’s present offer as of June 12, 2009 represents a 16% discount to thatvalue. Validus can now expedite the process by negotiating a transaction at a price that adequatelyreflects IPC’s value. We would require that any negotiated transaction with Validus would giveIPC the right to perform a proactive market check between signing and closing.”Mr. Hammond also indicated in the letter that he expects VR to be willing to pay the $50M break up feeassociated with the failed MXGL merger. Not to be outdone, today VR issued a press release indicating itswillingness to replace portions of the IPCR Board if it is unwilling to agree to the current offer. The proposal is to solicit IPCR shareholders to call a special meeting in which they could elect three of VR’snominees to the Board. The nominees include Fuqua Professor Raymond Groth, former Ontario MunicipalEmployees Retirement System CEO Paul Haggis, and Senior Advisor to Irving Place Capital Partners(formerly Bear Stearns Merchant Banking LLC) Thomas Wajnert.Ok, you got all of that? Now you ask, since I am not a merger-arb specialist and not a person whospeculates on potential deals, why am I interested? The reason IPCR at the current stock price is intriguingto me is based on the quality of the company and not the potential buyout. IPCR is trading at .85x tangible book value despite having $122M in net cash (no debt) on the balance sheet, an attractive 3.15% dividendyield, a consistently low combined ratio, a conservative investment portfolio, and substantial grossredundancies when it comes to loss projections.

The Inoculated Investor http://inoculatedinvestor.blogspot.com

Below I have included an updated chart from myoriginal article on the insurers/re-insurers:

Company NameTickerStock Price Current P/TBV2003-2008 AVG. P/TBV

Axis Cap HoldingsAXS$25.69 0.87x1.44xAce LimitedACE$43.77 1.34x1.95xAspen Insurance HoldingsAHL$22.73 0.72x1.32xAllied World Assurance CompanyAWH$39.29 1.00x1.16xEndurance Specialty HoldingsENH$28.07 0.87x1.30xMontpelier Re HoldingsMRH$13.74 0.84x1.31xEverest Re GroupRE$70.09 0.92x1.41xWhite Mountain InsuranceWTM$207.01 0.72x1.51x

Group Average

0.91x1.42xIPC Holdings IPCR$27.80 0.85x1.04x

As the chart indicates, IPCR is trading at a discount to the current group average and to its 5 year average price to tangible book. This is despite being the company that I identified as being the best in class out of all of the ones I looked at. I believe the stock has not traded up closer to tangible book value due to theobviously very unpopular proposed merger with Max Capital. Now that the MXGL deal is not weighing onthe stock, regardless of what happens with VR, there could be some upside in the near term. However, asalways my focus is on the longer term and the valuation and solid historical performance are the reasonsthat I would be comfortable owning the stock at the current levels.My view is that for 85% of tangible book value investors can purchase a very formidable insurancecompany that will continue to grow book value through its profitable underwriting. Aside from a very badyear in 2005 in which IPCR sustained substantial losses from Hurricane Katrina (an unheard of 251%combined ratio), the company has had a combined ratio that is the envy of many of the firms in theindustry. If the past performance is any indication of the way IPCR will perform in non-major catastropheyears, it is hard to argue that the current valuation is justified, especially in comparison to peer valuations.(For those of you who want some more detail on why I believe IPCR is the best in class check out thisScribd document that includes more extensive charts and data)In addition, I believe the current valuation gives investors a free call on an accelerated realization of valuewhen it comes to the VR acquisition offer. As it stands right now, with VR trading at $22.52, the deal on thetable values IPCR at $29.05 versus the current share price of $27.90. Since it only offer a 4.1% premium tothe current price and IPCR management has vehemently stated that it would not agree to be bought out below book value, there is no question VR may be forced to increase its bid once again. Now that thecompanies are in more formal negotiations, it is possible that they can end the contentious nature of the pastdiscussions and work towards a mutually beneficial agreement. As an example, if VR were to offer Q12009 book value of $33.09 (keep in mind that IPCR management indicated that un-audited BV for May2009 had increased to $35 a share) for each IPCR share, that would imply a 18.6% premium to the current price. Since the companies are already in negotiations and VR continues to make it very obvious that it isinterested in a tie up, it would not be a surprise to see a deal agreed upon sooner rather than later. In thatevent the annualized rate of return based on buying today could be quite substantial.I would be remiss not to mention that there are some risks here. I happen to believe that the entire market issomewhat overvalued so there is certainly some market risk inherent in shares of IPCR and VR. The goodnews is that there is an offer for IPCR on the table that could mitigate a fall in the share price. That beingsaid, the fact that the offer includes a large component of VR shares means that the price goes down asshares of VR go down. Also, any deal could fall through due to all of the previous acrimony, combinedwith the uncertainty in the economy today and the potential that IPCR is looking for too rich a price.Therefore, investors should be prepared for some volatility in the stock price of IPCR in the casenegotiations with VR fall apart and should be comfortable owning the shares at this valuation without anyexpectation of a buyout. Finally, I believe there is some legitimate reason to be concerned about the