On Jul 10, we issued an updated research report on Tower Group International, Ltd. (TWGP).
Tower Group was trapped in a muddle of accounting fallacy about a year and half ago. The hale and hearty company was diagnosed with a huge reserve shortfall in Jun 2013. In a soft insurance market, when the insurance rates were very low, the company tried an inorganic way to grow through acquisitions, paying little heed to maintaining adequate reserve in long-tailed products for the accident years 2008–2011.
The company ended up with a serious reserve shortfall in workers’ compensation, commercial liability and commercial auto business lines. Significant losses and reduction of statutory surplus in its insurance subsidiaries ensued, leaving the company paralyzed to run its business.
Faced with the inability to repay debt and continue normal operations, in Jan 2014, Tower Group opted to merge itself with ACP Re Ltd., a Bermuda-based reinsurance company, as a strategic end game to save itself. We believe the merger makes perfect sense as it will not only pay off the current shareholders handsomely, but will also shape a brighter future for the company as an entity.
Recently, the terms of the deal were amended to reduce the cash payment per share to $2.50 from $3.00 agreed to earlier. The time limit for closure of the deal has also been extended to Nov 2014 from the summer of 2014.
There remains a high degree of uncertainty about the deal. As a backup to rescue itself from the debt holders, in May 2014, Tower Group hired Greenhill & Co. to seek advice on repaying debt (due in Sep 2014), if the merger fails to materialize.
Tower Group has seen multi-notch rating downgrades from rating agencies Fitch and A.M. Best for a number of times in recent months.
While we prefer to avoid Tower Group with carries a Zacks Rank #4 (Sell), better-ranked stocks in the insurance sector include AmTrust Financial Services, Inc. (AFSI), Endurance Specialty Holdings Ltd. (ENH) and W.R. Berkley Corp. (WRB). All these stocks sport a Zacks Rank #1 (Strong Buy).
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