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Pacific Specialty's $300mn deal meets a clouded end

Biglari Holdings has pulled out of a $300mn deal to acquire Pacific Specialty Insurance, the firm said in a late December regulatory filing that came a few months after a deterioration in the target's financial results.

The statement offered no reason for the termination of the acquisition of privately held Western Contract Service Corporation, its A-rated Pacific Specialty operating unit based in Palo Alto, California, and the related McGraw Insurance Agency.

The transaction, announced in May 2017, included a $100mn bequest to the University of Notre Dame.

But the collapse was foreshadowed in a statement filed with the Securities and Exchange Commission on 15 September. In it, San Antonio-based Biglari suggested the terms of the deal might change.

One of the most significant alterations would have essentially cut in half the $24mn up-front cash payment Biglari had initially agreed to. The September disclosure also omitted any mention of the $100mn earmarked for the storied Catholic university.

In addition, the new terms being discussed reduced the total of deferred payments to $138mn over 10 years, down 21 percent from $175mn in the original agreement.

The $100mn bequest to the University of Notre Dame was to be in the form of a promissory note that would have matured upon the death of Michael McGraw, one of the owners of the insurance group.

Michael McGraw and his brother, John McGraw, became shareholders after their father and group founder Jack McGraw transferred ownership to them and their sister, Ann Morrical, in the 1990s.

After a dispute over control of the company arose, Morrical sold her one-third stake for $100mn in 2014, which left her brothers each with a 50 percent interest.

Efforts to reach Michael McGraw for comment were unsuccessful, as were attempts to contact executives running Western Service, Pacific Specialty and the McGraw agency. Biglari officials did not respond to requests for comment.

Reached by telephone, John McGraw refused to comment.

"I'm not going to say anything about it," he said. "It's a private company."

So while it remains unclear why the deal fell apart, the recent performance of the insurer may hold some clues.

For the first nine months of last year, Pacific Specialty posted a pre-tax operating loss of $5.3mn while net income came in at $506,000, according to S&P Global data.

The company posted an underwriting loss of $10.9mn in that period as its combined ratio deteriorated to 110.3 percent.

For full-year 2016, the insurer's net underwriting gain plunged by 92 percent to just $397,000 from $5.2mn in 2015.

Pacific Specialty appears to have suffered a significant loss involving commercial and fire risks, which represented about 5 percent and 7 percent of its premiums, respectively, in 2016. The S&P data shows the insurer's loss and loss adjustment expense ratio jumped to 111.5 percent for commercial lines and 193.7 percent for fire and allied lines that year.

The insurer nonetheless produced net income of $17.5mn in 2016, while its combined ratio stood at 99.5 percent. But its pre-tax operating income fell by 37 percent to $8.5mn compared with its 2015 results.

Net premiums earned rose 7.9 percent to $186mn in 2016, however, and came to $133.4mn for the nine months through September of last year.

In 2016, the insurer had reinsurance agreements with more than a dozen carriers, with the largest amount ceded to Paraline Syndicate 4242 ($11.6mn), Munich Re ($6.2mn), Scor ($5.7mn) and Swiss Re ($4.5mn), the S&P data shows.

The bulk of the carrier's business came from homeowners' and farm owners' policies, and most premium was written in California, according to S&P. But Pacific Specialty built its reputation covering motorcycles and watercraft.

In his annual letter to shareholders last month, Biglari CEO Sardar Biglari noted the importance of acquisitions to the company. In 2014, it acquired commercial trucking direct underwriter First Guard, which produced a $4.5mn 2017 operating profit with $24.2mn in net written premium, drawing the CEO's praise.

But the executive added that Biglari Holdings had not made any significant acquisitions in the past several years, without noting the abandoned agreement to buy Pacific Specialty. Biglari draws most of its revenue from restaurant chains.

"Most potential acquisitions do not come close to passing our threshold of acceptability," Biglari said in the letter.

"We readily acknowledge that acquisitions are an easy way to lose money - finding masterpieces and not overpaying for them is the trick of the trade," he said. "Biglari Holdings' ascendency will depend on sidestepping folly yet seizing strong cash-flow generators."

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