Stockwatch: is this a transformative deal for UK small-cap?

Is an insurance partnership with Ageas financially transformative enough to help get shares in Saga (LSE:SAGA) out of the 100p to 150p range that they have traded in over the last 18 months? Considering also that the cruise holiday side is enjoying “strong momentum”?

Despite negotiations with Ageas SA/ NV (EURONEXT:AGS) being confirmed in October, Saga shares drifted from 140p to 110p by mid-November then joined a “risk-on” party in small-caps. The market price managed an 8% rise to 133p in response to the news, easing to 131p today.

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On the face of it, a lot of money is changing hands where inflows over the next year or so quite look as if more than £200 million is coming Saga’s way – relative to a £190 million market value. If ever there was a need to unpack a company news item.

Does this deal radically alter Saga’s financial risk?

Part of the reason for share price weakness lately was an October downgrading by credit rating agency Moody’s – from stable to negative – “reflecting Saga’s constrained liquidity and material refinancing risk over the next 12 to 18 months”. This was based on medium-term payments near £148 million as guided for then, but did not include a £60 million performance-based payment (quite whether that materialises anyway).

The 31 July balance sheet had £615 million net debt versus £116 million net assets albeit where the extent of goodwill/intangibles meant a net tangible assets’ deficit of £154 million. This generated nearly £24 million finance costs in the first half-year alone, mitigated this time (but not in 2023) by £9 million investment income. 

Saga’s situation is currently supported by a £75 million drawdown on a loan from the chair (who is the son of Saga’s founder), which matures in April 2026 ahead of a £250 million bond due July 2026. Since he owns 26% of Saga’s equity, it is hardly likely that he would get tough to the extent of forcing a restructuring in debt-holders’ interests; hence this may backstop other shareholders too.

Refinancing this £250 million debt ought to be possible given Saga’s marketing pitch for “boutique-liner” cruises looks like a sweet spot among affluent pensioners. Yet Moody’s takes a rigorous view noting that “a potential amend-and-extend of the bond we may view as a distressed exchange”.

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The new partnership shifts Saga’s motor and home insurance to an “affinity” model, customised to Ageas, which is acquiring Saga’s underwriting business. After Ageas failed to buy Direct Line Insurance Group (LSE:DLG) earlier this year, it offers the Belgian insurer some recompense.

Yet the £67.5 million headlined to be paid up front for the underwriter still involves a £22 million payback to Ageas regarding a property site. The £43 million remaining then looks liable to go out on £25 million transaction costs cited in the announcement.

Ageas will then pay £80 million when the partnership goes live at the end of 2025; the performance element involving a possible further £30 million paid in 2026 and up to £30 million in 2032. There will also be commission payments based on policies sold.

Moody’s, however, expects the defined cash elements above will be “fully consumed by unwinding negative capital as the insurance-broking business transitions to an affinity model”, moreover it will not be available for repaying the chair. The agency also cautions how £376 million ship loans (due 2031 and 2032, and which take total debt to £770 million) consume a significant proportion of annual cash flow by way of amortisation.

Quite whether speculative buyers of Saga lately took any of this on board, a possible silver lining is credit rating agencies’ tendency to lag underlying change. So, if the insurance partnership does stabilise and commission payments prove good, then the shares can at least potentially “climb a wall of worry”.

Group complexities make forecasting tricky

Saga guides for insurance profit to fall in the next financial year and recover steadily thereafter. One key reason for uncertainty in projections is affinity insurance, meaning Saga will no longer receive payments for policies (or “premiums”), as we have no sense what levels of commission will arise in this partnership arrangement, despite it reducing costs.

At the half-year 2024 stage, underlying group revenue rose 11% and underlying pre-tax profit trebled over £27 million as cruising saw an “excellent” start to the year. This business seems relatively UK recession-resilient compared with travel oriented towards younger families (and even that has outperformed lately).

Consensus expectations on net profit have anyway been for a sharp turnaround from recent years’ red ink, to £37 million in respect of the current year to 31 January and £56 million to early 2026. This has implied normalised earnings per share (EPS), with plenty of scope for adjustments, of 27p rising near 38p, which implies a forward price/earnings (PE) multiple of around four times, which is attractive to speculators.

Saga - financial summary
Year end 31 Jan

Source: historic company REFS and company accounts

The course of the UK economy is some influence: quite whether insurance is exposed to online discounters such as Dial Direct and Urban Jungle; which significantly depends on whether consumers opt for the lowest cost or want reliable service. I would expect Saga’s cruising only to be affected if a recession compromises marginal travellers affecting load factors recently 86% for river and 90% ocean.

Management pitches how the Ageas partnership will leverage Saga’s brand given that the two companies share marketing to the over-50s, and also help reduce capital employed. Certainly the story on insurance has needed improving – having spoiled the group narrative – albeit partly due to challenging industry conditions.

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Underwriting has appeared a near-marginal business: an £11 million profit in the January 2022 year becoming a £1.4 million loss in 2023. Broking profit had also fallen from £71.5 million to £40 million. Industry consolidation, as implied by this partnership, looks a sensible step forwards.

What behavioural economics behind an end-game for Saga?

As we have recently seen with clothing retailer Brown (N) Group (LSE:BWNG), where Lord Alliance is a 44% shareholder, events can be significantly influenced by a founder-type shareholder tidying matters up. In this case, the business is being taken off-market under the stewardship of a son.

One wonders what may be Sir Roger De Haan’s intentions – also respecting limitations, due to Saga’s debt – in holding 26% of Saga equity at the age of 76. That puts him capable of continuing as chair for a good few years yet, and I imagine his motivation is to see the group best sorted out – in terms of his legacy – than crystallise major cash.

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A previous element to Saga’s story had, however, been speculation of a break-up, with insurance and travel finding separate owners. Has that effectively been thwarted by the Ageas partnership or under full ownership might it still be doable? Supposedly, the cruise ships’ value offset their loans.

Yet a key aspect to both businesses’ prosperity is meant to be a trusted service linking to the Saga brand, the expansion of which was a key selling point of the 2014 flotation. Can it be separated to prosper under different owners?

The most likely scenario seems Saga remaining a listed group, its shares remaining volatile due to debt – possibly overall upwards.

At least interest rates may decline further and, arguably, you can lower existing projections still to derive a modest P/E. It remains highly speculative to derive any “buy” case given the uncertainties for debt management as Moody’s describes. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.