Bedding Down Gio

The Age

Saturday July 20, 2002

LEON GETTLER

One year after Suncorp-Metway acquired GIO, the banking and insurance group is touted as a merger partner for St George. Leon Gettler asks Macquarie's Tony Jackson what the future holds for the group.

Q Since January, Suncorp-Metway has underperformed the Financial Services Index by 9 per cent. What's the problem - exposure to equity markets, or questions about it meeting synergy targets and, by implication, its management?

A There are three key factors. One is exposure to equity markets, and on that basis you shouldn't benchmark its performance against the banking index. You should probably benchmark it against the insurance index, and the insurers are down (by) more than that, year to date. Second, there is definitely scepticism in the market about Suncorp's ability to achieve the promised GIO integration synergies, and scepticism about the quality of the underlying GIO business. Third is concern about a potential deterioration in average claims costs in the Queensland compulsory third-party market, where Suncorp has a 56 per cent market share, and that could hold adverse implications in terms of a one-off reserving charge and potential ongoing profitability. I remain quite confident about the GIO integration and believe that fears on the Queensland CTP issue are overdone. However, the market clearly remains concerned on these fronts.

Q On the first factor, then, Steve Jones has been quoted saying that the $240 million of GIO integration synergies are on track to be delivered. He's had a good track record on integration by bringing Suncorp and Metway together. Is there any risk this integration will be different?

A There are always risks with acquisitions, particularly of general insurance businesses. Suncorp took a $25 million reserving charge for the GIO book in the last half. No doubt it would have preferred not to have incurred that but, as best as I can tell, the integration is on track in terms of timing and the quantum of promised synergies. Some of the riskier integration steps, such as bringing the IT platform in-house, have already been completed without any significant hiccups and this should deliver significant cost savings. My only real concern has been the extent to which the attainment of the integration synergies could damage the GIO franchise; that is, in service levels. But there are examples of where Suncorp has already improved service levels within the GIO business, so I am increasingly relaxed on this front. The best example is that call abandonment rates have been reduced from as high as 30 per cent to 3 per cent following the transfer of GIO's inbound call functions to Suncorp's centralised call-centre platform. So, Suncorp has a track record of successfully integrating businesses not only in terms of removing costs but also in terms of maintaining, if not improving, service levels.

Q If Jones does deliver, what's the impact on your valuation?

A We have a valuation of $14.50 and the stock is trading at sub-$12. We're assuming that three-quarters of the synergies will be achieved. Some portion of the $240 million synergy target will have to be reinvested, so not all of that will necessarily hit the bottom line. During the process, and over the next year or 18 months, the company will no doubt pursue additional projects to drive further value from the acquisition, but such initiatives will cost money. Notwithstanding the potential for project reinvestments, Suncorp appears on track to deliver.

Q Still, wouldn't you expect that a potential erosion in the Queensland general insurance margins would eat away at some of those synergies?

A That's certainly a possibility but, having said that, I've never seen the local general insurance pricing environment as attractive as it is at the moment, and underlying profitability will improve even further with higher interest rates through interest income on premium investments. Suncorp is a very strong franchise in Queensland and it is not at all easy for other parties to get into that market. In the last result, the Suncorp portfolio recorded an insurance margin of 10 per cent, reflecting a combination of regional (Queensland) scale efficiencies, pricing power and the fact that it is so conservatively reserved.

Q There's been talk around the traps about a joint bid between Westpac and Suncorp for St George as a way of circumventing competition concerns. Your comments?

A There's been lots of speculation involving St George, but the bottom line is that NAB has a 10 per cent stake and is therefore in the driving seat. The rumour perhaps started in recognition of Westpac's weak positioning in the master trust sphere and public comments that it was actively looking at its options in this regard. St George owns Asgard, the No. 2 master trust platform, and therefore the rumour emerged that Westpac would assist Suncorp to acquire St George, and Westpac would acquire Asgard. I do not place much merit on this rumour because, after all, NAB still has a blocking stake and I would be surprised if Suncorp did anything on the M&A side until it has delivered on the GIO integration and as a consequence greatly enhanced its share price.

VERDICT
Macquarie               outperform
Merrill Lynch           buy
BNP Paribas             outperform
ABN Amro                buy
J.P. Morgan             buy
JBWere                  buy
Deutsche Bank           buy
Salomon Smith Barney    outperform
CSFB                    hold
Goldman Sachs           market perform
UBS Warburg             hold

© 2002 The Age

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