Analysts divided on combo and whether it will jump-start more consolidation

Lincoln National Corp.’s $7.5 billion offer to buy Jefferson-Pilot Corp. was met with mixed reviews by industry analysts. While many saw promise for the combined company in the deal, one team called it a merger of “desperate housewives.”

The combined companies would operate under the name Lincoln Financial Group, offering life insurance, annuities, and retirement and investment products and services as well as an array of group benefits.

A few days before the deal was announced, Andrew Kligerman of UBS Securities LLC, New York, forecast an LNC-JP combination as one of several mergers and acquisitions possible in the life insurance industry in the year ahead.

Following the announcement, Kligerman said the merger would be a plus for LNC because of long-term cost savings and improvement to its market value. He said management’s projected earnings increase of 6% to 7% was “reasonable.”

Still, costs of the merger would dilute profits for at least three years, he said.

Jason Zucker and John Nadel, analysts for Fox-Pitt Kelton Group Inc., New York, called the deal a merger of “desperate housewives” because “these companies combined out of weakness, as growth has been stalled.”

The new company would face growth problems stemming from excessive reliance on universal life insurance and fixed annuities, products that make them vulnerable in a low-interest-rate environment, they stated in a report.

Zucker and Nadel calculated the new company would have an estimated 31% of its earnings from equity-sensitive products, down from 50% for LNC currently.

They projected 45% of the combined companies’ business would come from life insurance, primarily UL; 28% from annuities; 7% from Benefit Partners, a J-P unit; 2% from Delaware Investment Management; 4% from J-P’s communications businesses; and 4% from LNC U.K.

Neither LNC nor J-P had strong earnings growth in the past couple of years, the analysts observed.

Kligerman, however, predicted earnings growth of 10% annually in 2007 and 2008 for the combined firms.

Standard & Poor’s Ratings Services, New York, was upbeat on LNC. However, it said the planned merger could undermine J-P’s creditworthiness.

S&P analysts thought the merger would enhance LNC’s ability to execute its operating plans, improve cash flow, advance its financial leverage and build market position.

The S&P analysts did express reservations about the companies’ ability to integrate operations and about the adverse impact of current low interest rates. They also anticipated a need for LNC to increase reserves for its UL products.

“Nevertheless, Standard & Poor’s believes that upon successful completion of the merger, the ratings on LNC and its life insurance operating companies will be raised,” albeit slightly, the analysts said.

Fitch Ratings Services, Chicago, said integrating the firms would pose challenges but believed it promised significant strategic benefits for both firms.

In a statement, Fitch said “the merger will strengthen the combined company’s competitive position in the individual life insurance business and expand and diversify distribution capabilities.”

Brad Ellis, a Fitch director, said he was “a little surprised” by the merger, noting he had viewed both companies more as targets for acquisitions by others rather than with each other.

He said he didn’t believe the merger would touch off acquisition activity in the life insurance business but added there are a number of midsized players that could be targets.

As for who the acquirers might be, he speculated that MetLife and Prudential Financial might be contenders. AIG might be out of the running for a while due to its preoccupation with investigations by the SEC, he added, while LNC itself “would probably be tied up for a while” with the details of its acquisition.

UBS’s Kligerman broached the possibility the merger could be overturned if another company came along and bid to take over either firm–particularly if LNC’s stock price falls. (It dropped 3% the day of the announcement.)

But he thought that was unlikely to happen, especially in view of a $300 million break-up fee that, he noted, is part of the merger agreement.

If there were a counterbid, however, Kligerman speculated the most likely competitors for either company would be the AXA Group, Paris; Manufacturers Life Insurance Company, Toronto; or Sun Life Financial Inc., Toronto.

The merger announcement still leaves a few likely candidates for future M&A deals in the U.S. life market, Kligerman noted. Among them: Nationwide Financial Services, Columbus, Ohio; Principal Financial Group Inc., Des Moines, Iowa; and Protective Life Corp., Birmingham, Ala.

Zucker and Nadel of Fox-Pitt doubt there is much chance of a deal being scuttled by a new bidder. For one thing, they said, hostile bids in the life insurance business are rare.

“In addition, we believe J-P has sought a suitor for some time, and nothing was forthcoming,” they said.

LNC would finance the deal with about $5.7 billion in stock and $1.8 billion in cash.

Based on closing prices for both companies on the day of the announcement, LNC, Philadelphia, would pay a premium of about 9% for J-P, Greensboro, N.C.

Lincoln National Corp. has assets of $119 billion and reported revenues of $5.4 billion in 2004. Jefferson-Pilot has $29.5 billion in assets and produced $4.1 billion in revenue in the same period.

The combined company would be ranked first in the industry for UL product sales and would be a significant presence in the life insurance market.

In group benefits, the company would be No. 8 in group disability sales, No. 13 in group life sales and No. 6 among publicly traded insurers in defined contribution and retirement plan assets.

LNC is a holding company for various businesses, including life insurance, annuities, and 401(k) and 403(b) plans.

Company subsidiaries include Lincoln U.K. and Delaware Investments, its investment management organization,

J-P would bring to the alliance considerable strength in UL and variable UL insurance and in fixed annuities, including equity indexed annuities. It also is strong in group benefits, including life, disability and dental insurance.

J-P businesses include Jefferson-Pilot Communications, which owns and operates 3 television stations, 18 radio stations, and the Jefferson Pilot Sports production and syndication business.

The companies said they expect to achieve total annual cost savings of around $180 million, with 50% of those savings within a year of closing, 80% within 24 months and the balance by the end of 2008.

Jon Boscia, chairman and CEO of Lincoln, would be chairman and CEO of the combined firms, while Dennis Glass, Jefferson Pilot’s president and CEO, would be president and chief operating officer.

The merged company would maintain corporate offices in Philadelphia, while Greensboro would be the main center of operations for life insurance and Fort Wayne, Ind., would be the center for annuity operations, according to the announcement.

The new company would maintain “significant operations” in the companies’ existing locations in Concord, N.H., and Hartford. J-P’s group insurance would remain in Omaha, Neb., the companies said.

If approved by shareholders, the companies expect to close the deal in first quarter 2006.