January 25, 2018

Update on the A-Team of Extended Warranties:

In a new burst of merger and acquisition activity, two of the top players in the extended warranty and service contract industry are moving things around. Assurant is buying The Warranty Group, AmTrust is taking itself private, and it's selling half of Warrantech to private equity investors.

Way back in September 2017, we published a newsletter with a title of "The A-Team of Extended Warranties." In the four months that have gone by since, so much has changed that we thought it time to publish an update. And given the way these mergers and acquisitions seem to come in bunches, we have a feeling that more news will be on the way soon.

When we were putting the A-Team list together, the biggest regret we had was the fact that one of the biggest players in the industry -- The Warranty Group -- did not have a name that started with the letter A. Had they instead called themselves A Warranty Group, or had they retained some vestige of the name of their former parent company Aon Corp., we would have been all set.

As it was, we estimated that the ten members of the A-Team controlled at least 57% of the $40 billion U.S.-based and consumer-facing service contract industry. That doesn't mean they get their hands on all that money, but simply that the name of one of their insurance, obligor, or protection plan administration subsidiaries is in the fine print of the service contracts they sell to consumers.

But as we get deeper into the new year, it's becoming highly likely that the A-Team is going to add as much as 6% to its market share, as Assurant Inc. prepares to complete its acquisition of The Warranty Group during the first half of 2018. However, some deductions may also be in order, as AmTrust Financial Services Inc. prepares to sell off a controlling interest in its extended warranty administration business to a private equity firm whose name begins with M. Although, if an AmTrust entity remains the insurance underwriter for service contracts sold by Warrantech, they might still remain on the A-Team.

Assurant Reorganizes


In 2016, Assurant exited the health insurance market and the employee benefits business to instead focus on extended warranties, renters insurance, funeral insurance, and mortgage-related insurance services. The extended warranty operations, which used to be part of what was once called Assurant Solutions, became part of Assurant's Global Lifestyle segment.

That segment accounted for $3.7 billion in revenue in 2016, including $2.57 billion in mobile phone protection plans and consumer product service contracts, and $716 million in net earned premiums and fees derived from the sale of vehicle service contracts and other protection services. The mobile/consumer business grew slowly year-over-year, but the vehicle business was up by nearly 18%, compared to 2015.

In terms of market control, Warranty Week estimated that Assurant was in third place behind Asurion and AIG in the mobile/consumer business, and was in second place behind The Warranty Group on the vehicle side of the business. The Warranty Group's reach has declined significantly on the mobile/consumer side in recent years, but it remains the U.S. market leader on the vehicle side of the extended warranty business. Now, if the merger proceeds as planned, Assurant will be the undisputed market leader on the vehicle side, far ahead of Allstate and other A-Team members.

When the merger was first announced in October, the deal anticipated that Assurant Inc. would become a wholly owned subsidiary of TWG Holdings Limited, a Bermuda-based company whose name would have been changed to Assurant Ltd. Shares of Assurant Inc. would have been swapped for shares of Assurant Ltd., a Bermuda-based company, but the ticker symbol on the New York Stock Exchange was to remain AIZ.

However, things changed in the interim. Most notably, the U.S. Congress passed the Tax Cuts and Jobs Act in December, which reduced corporate tax rates and made it more attractive to be a U.S.-based company. Therefore, on January 9, Assurant announced that it would instead acquire TWG Holdings Limited and its subsidiaries, and would remain a Delaware corporation instead of moving to Bermuda. In addition to allowing Assurant to take advantage of the newly lowered corporate tax rates in the U.S., that change had the added benefit of making the transaction no longer taxable to Assurant's current shareholders.

Other Changes

There were several other changes announced as well. Originally, TPG Capital, the private equity firm that owns The Warranty Group, was to receive 16 million Assurant shares and $372 million in cash. Now, they will receive 10.4 million Assurant shares and $850 million in cash. Originally, Assurant planned to add three seats to its 12-member board of directors. Now, it will add just two new seats for TPG Capital representatives.

When the deal was first announced in October, shares of AIZ were trading for approximately $96 apiece. Afterwards, they rose to nearly $102 per share, and remained in a trading range of $98 to $102 for the rest of the year. When the revised terms were announced, however, shares dropped back down to a range of $93 to $96. It closed today at $95.03 per share. This recent pullback happened in spite of Assurant's decision to raise its quarterly dividend by three cents to 56 cents per share, which gives it a 2.36% yield at current prices.

The insurance ratings agency A.M. Best said the financial strength rating of Assurant's extended warranty insurance underwriting entities such as American Bankers Insurance Company of Florida and American Security Insurance Company will retain their "A" ratings, with a stable outlook. Meanwhile, A.M. Best said that Virginia Surety Company Inc., The Warranty Group's primary extended warranty insurance underwriter, would retain its "A-" rating, with positive implications, pending the completion of the merger.

"From a strategic standpoint," A.M. Best stated at the time, the merger "will enable Assurant to strengthen its position in the vehicle protection business in addition to enhancing its distribution platform. The merger provides [Virginia Surety] with strategic synergies as well as the backing of an owner with a history of commitment to providing similar products and services."

A.M. Best also placed the "A-" financial strength rating of The Warranty Group's other main extended warranty insurance underwriting entity, London General Insurance Company Ltd, under review with developing implications. This slightly more uncertain outlook, A.M. Best said, reflects the fact that the impact of the transaction on the UK-based underwriter "is at present unknown."

After the merger is completed, Assurant and The Warranty Group will operate in a total of 35 countries, up from Assurant's current 16-country reach. With the addition of The Warranty Group's VSC administrators, including Resource Automotive and First Extended Service Corp., as well as Virginia Surety's numerous underwriting relationships with third-party VSC administrators, Assurant will enjoy a market-leading position on the vehicle side of the extended warranty business, having its name on upwards of 25% of the vehicle service contracts sold in the U.S. And the ten-member A-Team will expand its control of the entire business to over 63%.

AmTrust Changes Structure


Coincidentally, on the same day that Assurant announced its modified merger terms, AmTrust Financial Services Inc. received an offer from Stone Point Capital LLC, together with AmTrust chairman and CEO Barry Zyskind, AmTrust director George Karfunkel, and AmTrust director Leah Karfunkel, to acquire all outstanding shares of the company that they do not already own or control at a price of $12.25 per share in cash. That would effectively take the company private, returning AmTrust to its initial status as a family-controlled enterprise.

AmTrust was founded in 1998 by brothers George Karfunkel and Michael Karfunkel. Michael passed away in April 2016. Leah Karfunkel is his widow, and Barry Zyskind is his son-in-law (having married his daughter Esther). Press reports say the families together control 43% of AmTrust's shares, but a January 9 SEC filing placed their collective holdings at 50.6%. Either way, the point is that the families already own a significant share of the company's stock.

Last week, AmTrust Financial Services announced that a special committee of its board of directors retained Deutsche Bank Securities Inc. as its financial advisor, and Willkie Farr & Gallagher LLP as its legal advisor. The special committee said it is evaluating the proposal to take the company private, with the assistance of its financial advisor and legal advisor. And it added that there can be no assurance that any agreement will be executed or that a transaction will be approved or consummated.

The problem, as we see it, is that while the company's outstanding shares were trading hands at prices slightly above $10 a share before the offer was made, they've traded at prices up to $13.18 a share in the weeks since. Today's closing price was $13.10, up 10 cents for the day (Ticker: AFSI).

Usually, when a founding family of a closely-held decides to take a public company private, it's because the stock appears to be underpriced, and the prospects for the future look promising from an insider's point of view. Dell Inc. is an excellent example of this. In AmTrust's case, there's the added benefit of escaping from the onslaught of short-sellers, who have done an incredible job of talking the company's stock down from its $34+ highs of mid-2015. That's a 62% decline in 30 months.

Because the founding families control such a high percentage of the company's shares, a higher bid from a different entity is unlikely to succeed. And the window for value investors is quickly closing. However, millions of shares have already traded at prices above $12.25 a share, so the open market is effectively voting for a higher bid. Will it come from the founding families?

Selling Half of Warrantech

Meanwhile, AmTrust also recently agreed to sell a 51% stake in Warrantech and other fee-based businesses to Madison Dearborn Partners LLC, a private equity firm based in Chicago.

AmTrust will retain a 49% equity interest in the business, which the transaction values at $1.15 billion. Stuart Hollander, who is currently the president of Specialty Risk North America for AmTrust, will become the CEO of the new company, for which a new name will be announced in the coming months. The deal is expected to close during the first half of 2018.

AmTrust completed its acquisition of Warrantech Corp. in 2010, buying a 73% stake in the extended warranty administrator from the private equity firm H.I.G. Capital LLC, and adding that to the 27% stake it already owned. Warrantech, which was founded in 1983, was for several years a public company on its own, until it was taken private by H.I.G. and AmTrust in early 2007. H.I.G., based in Miami, has also been an investor in Service Net Solutions, Safe-Guard Products International, and Dent Wizard, among other extended warranty-related entities.

According to a filing with the Federal Trade Commission, this transaction between AmTrust and Madison Dearborn Partners includes numerous subsidiaries that will be familiar to people in the extended warranty business: AMT Agency Holdings Inc.; AMT Road Services Corp.; AMT Warranty Corp.; AMT Warranty Corp. of Canada ULC; AMT Warranty Solutions Inc.; Canada Warranty Solutions LLC; Heritage Mechanical Breakdown Corp.; OwnerGuard Agency; OwnerGuard Corp.; OwnerGuard University; TMI Solutions LLC; Warrantech Automotive of Canada Inc.; Warrantech Automotive of Florida Inc.; Warrantech Automotive Inc.; Warrantech Caribbean Ltd.; Warrantech Consumer Product Services Inc.; Warrantech Corp.; Warrantech Direct Inc.; Warrantech Home Assurance Co.; Warrantech Home Service Co.; Warrantech Management Co.; Warranty Solutions Administrative Services Inc.; Warranty Solutions Management Corp.; WCPS of Florida Inc.; and WS Aftermarket Service Corp.

Together, these companies comprise the bulk of AmTrust's interests in the extended warranty administration industry, on both the vehicle and consumer products side of the business. Under terms of the agreement, AmTrust will have an opportunity to continue to be the insurance underwriter for the extended warranties and service contract programs administered by these entities.

After the transaction with Madison Dearborn Partners was announced in November, the insurance ratings agency A.M. Best placed the credit ratings of AmTrust and its operating insurance companies under review with negative implications. When the additional move to go private was announced two weeks ago, A.M. Best said the ratings would remain under review until the Madison Dearborn Partners transaction closed, and until AmTrust filed its annual report for 2017. For the moment, however, AmTrust's extended warranty insurance underwriting entities such as Technology Insurance Company Inc. and Wesco Insurance Company retain their "A" rating.

Merger Frenzy Resumes

Assuming that these three transactions close as expected in 2018, this will mark one of the busiest years for merger and acquisition activity in the extended warranty industry in a decade. It was back in 2008 when Asurion LLC put the finishing touches on its ascendance with the purchase of NEW Customer Services Company Inc., having acquired both lock\line LLC and Warranty Corp. of America in 2006.

Other big moves by A-Team members in the past decade include AIG's acquisition of Service Net Solutions in 2012, the Ontario Teachers' Pension Plan purchase of a majority interest of APCO Holdings Inc. in 2015, and Allstate's acquisition of SquareTrade Inc. in early 2017. And, not to get too pedantic, but Ally Financial Inc. was bought and sold by the U.S. government following the financial panic of 2008.

That leaves slim pickings in terms of top extended warranty companies not on the A-Team. On the vehicle side, we have Protective Life Corp., JM Family Enterprises Inc., and CNA Financial Corp. (which also underwrites for Asurion on the consumer side). Outside of those three, Fortegra Financial Corp., Centricity (formerly Bankers Warranty Group), and New Leaf Service Contracts LLC lead the players on the B-Team roster.

With these most recent moves, though, the members of the A-Team are beginning to show some distinct personalities. Think of it as an industry that shifts on three axes: insurance vs. administration, vehicle vs. consumer goods, and U.S. vs. international. Acquisitions can be viewed by which direction they pull the acquiring company towards.

For instance, Allstate's acquisition of SquareTrade pulled it into consumer goods and deeper into administration, where before it had been primarily a vehicle service contract administrator and underwriter. AIG's acquisition of Service Net pulled it much deeper into consumer goods, and gave it a stake in administration that it didn't have previously.

Conversely, by their relative lack of recent acquisitiveness, Ally Financial seems content to remain focused on vehicles for both insurance and administration, APCO remains focused on vehicles and administration, and Asurion remains focused on consumer goods and administration. Any of these would be good acquisition targets for an insurance company, particularly an international carrier looking to bolster its U.S. presence.

Viewed in that light, Assurant's acquisition of The Warranty Group combined with both parties' recent setbacks in consumer goods leave it with a primary focus on vehicles, a strong presence in both insurance and administration, a leading position in the U.S., and a reinforced focus on international. AmTrust seems to be taking half a giant step away from administration, leaving it with an insurance focus. The move to take it private looks like a shrewd move to invest in a company the market has underpriced, especially given its current 5.2% dividend yield.

Editor's Note: Neither Warranty Week nor any of its employees or family members hold any positions in an A-Team stock, bond, or other investment. However, several A-Team members or their subsidiaries have in the past been sponsors of the newsletter, though none are at the present time.

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