Your client, REA, is a reinsurance company.
REA recently acquired another reinsurance company (approximatively same size): the choice of this company was notably based on its product portfolio as well as its market presence which appeared complement with REA.
However, the acquisition is not well received by the market. The acquisition price is considered too high and the transaction has not been well graded. REA management asks you to evaluate the transaction.
This is an interviewer-led case. It is split into two parts.
The first part describes more qualitative problems and includes open questions to force the interviewee into thinking about the problem and possible solutions.
The second part deals with quantitative calculations based on the previous part. The interviewee should conduct his own calculations and solve the questions.
Short Solution (Expand) (Collapse)
This is an interviewer-led case. Please share the questions outlined here with the interviewee at the given moment.
I. What is reinsurance?
The interviewee should understand the market and ask questions to get a good grasp of the client problem. Possible questions:
Insure insurance companies
What are the revenue streams?
Number of clients * premiums (%) * price of original contracts
Why this acquisition?
Ensure revenues, growth, presence in Asia, complementarity of firms
II. If asked by a key player in the market, how would you describe the transaction?
The interviewee should come up with a structured answer covering the main issues at stake. The idea is to give an overview of the companies and the interest of the transaction between them. It also tests the abilities of the interviewee to create excitement and interest for the topic at hand to a third person.
A possible answer would be:
- Performance? Both companies are performing well on their respective markets
- Complementarity of products? Very good
- Complementarity of market penetration globally? Our client is present in Europe and USA. The acquired company is present in Europe and Asia
- Growth? Flourishing market
- Competitors? The transaction should give REA a better competitive position in the market
- Market Shares? New clients in Asia
- Financing of acquisition? Cash reserves + debt
- Occurring costs? Acquisition price, transactional costs
III. What benefits could REA expect from the transaction?
The interviewee should come up with a structured answer, which shows a good understanding of the context.
Benefits revenue side:
- Increase in revenues (Sales REA + Sales acquired company + Cross-selling)
- Volume effect (offers better diversification of risks)
- Higher market share (allows for better prices/margins through leadership position in the market)
Benefits cost side:
- Economies of scale (imagine for example product design and research)
- Overhead costs synergies (through elimination of redundancies)
IV. Which cost related synergies could this transaction allow?
The first step should be the identification of the companies’ costs, relevant to the reinsurance industry.
- Staff costs
- Real estate
- Marketing & distribution
- IT costs
- Travel and entertainment
- Administration and logistics
It is now interesting, how the cost structures of the two companies compare. On interviewee’s request you will provide him/her with the following information:
With these numbers the interviewee can start his/her calculations in the next section.
V. How much could our client benefit from costs synergies?
Eligible for synergies: Yes!
REA: 10% * 4,000,000 = $400,000
Acquired company: 20% * $3,600,000 = $720,000
Total = $1,120,000 (30% = $336,000 for simplification: $350,000)
Staff costs (excludes HQ)
Eligible for synergies: Rather not.
Eligible for synergies: Arguable, assume - due to little regional overlap - not.
Eligible for synergies: Yes!
REA: 90% * $4,000,000 * 10% = $360,000 (costs in regions * total cost * share of IT costs)
Acquired Company: 80% * $3,600,000 * 10% = $288,000
Total = $650,000 (30% = $195,000 for simplification: $200,000)
Eligible for synergies: rather not.
The transaction does indeed allow cost savings due to synergies. Since there is no information given on the acquisition price, at this point no evaluation can be made regarding the potentially high acquisition costs.
Total costs to be saved due to synergies: $350,000 + $ 200,000 = $550,000
$550,000 / 7,600,000 = 7% of total cost reduction.
Q: Please describe a potential way to determine whether the trancaction price was reasonable or not!
More questions to be added by you, interviewer!