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Travelers May Be Heavy Baggage


When MetLife Inc. (MET) announced in January that it would buy the last vestiges of the insurance giant Travelers Inc. from Citigroup (C) for $11.5 billion, the agreement was instantly hailed on Wall Street as a brilliant back-to-basics move for both companies. MetLife would expand its presence as a global insurance giant in new markets and become the largest seller of U.S. life insurance overnight. Citi would finally ditch the idea of being a one-stop shop for all products and focus on its higher-margin banking business.

There's little doubt that Citi made out on the deal. At first glance, the transaction, set to close on July 1, looks like a smart move for MetLife as well. The Travelers unit will broaden the company's life insurance distribution network through new partnerships with Citi's Smith Barney (C) brokerage and Citibank branches in the U.S., Europe, Asia, and Latin America. And Travelers will help MetLife sell more retirement products and services to aging baby boomers in the U.S. So certain is MetLife of success that on May 3 it upped its earnings forecast for this year and 2006, citing its purchase of Travelers Life & Annuity as a main source of strength.

REVENUES UNDER SIEGE

That news, along with a 65% surge in first-quarter earnings, has since fueled a 10% rise in the stock, to $44 a share, more than making up for the loss it had suffered since the transaction was announced. Yet as details of the merger come into focus, it's looking increasingly like MetLife has stiff challenges ahead. The insurer's initial estimate of goodwill -- the premium it paid for Travelers' assets -- has risen to $5 billion from $3 billion since Jan. 31. Rating agencies have put it on negative credit watch over concerns about MetLife's ability to finance the deal and smoothly merge the two companies. And Travelers' revenues are under siege: Many institutional clients who bought insurance from both MetLife and Travelers are diversifying by doing business with rivals in the wake of the merger.

Further raising concerns was the Apr. 26 news that MetLife Chairman and Chief Executive Robert H. Benmosche, 60, will be stepping aside next spring. MetLife President Robert C. Henrikson will assume the top job. Although Benmosche has said publicly that he has had ongoing discussions with the board on succession planning, some question the timing. "This is a huge deal for MetLife," says Rob Haines, an insurance analyst with New York researcher CreditSights. "So for the CEO to leave that quickly, it's curious." Benmosche and other top execs declined to comment for this story.

Local politics is also complicating the merger. Connecticut Attorney General Richard Blumenthal fiercely opposed the pending sale because it would "destroy jobs, damage our economy, and disadvantage families." MetLife buckled in mid-April and agreed to lay off only 490 instead of 600 employees in Hartford. Eric N. Berg, an analyst for Lehman Brothers Inc. (LEH), now estimates that the deal will create less than $60 million in savings, rather than the $150 million MetLife is promising.

If all that weren't enough, regulatory heat from New York Attorney General Eliot Spitzer's office and other state AGs on broker compensation has only just begun. MetLife and other life insurance companies are being investigated for commission payment practices. Similar probes into the commercial insurance brokerage industry resulted in multimillion dollar fines by regulators against the largest players -- Aon (AOC), Marsh & McLennan (MMC), and Willis Group (WSH). Investigations into American International Group's (AIG) business practices are ongoing.

All of this is leading some to question how quickly the merger will pay off. At the $10 million Forester Value Fund (FVALX), portfolio manager Thomas H. Forester unloaded the fund's entire MetLife stake, valued at about $400,000, in the first quarter. "I believe the story in the long term," says Forester. "But frankly there are some real serious issues."

GROWING DEBT

MetLife insists the deal still makes sense. "The integration to date is going well," MetLife Chief Financial Officer William J. Wheeler said at a May 25 investor conference. "It's not simple, but we are focusing all our resources on making sure it's successful." But the $2 billion increase in goodwill suggests the insurer discovered something after it inked the agreement, says Lehman's Berg. MetLife won't comment, but analysts believe the problem may stem in part from the lost institutional sales to pension funds and 401(k) retirement plans. These customers are the primary buyers of complex insurance products called guaranteed investment contracts (GICS), which are used mainly to insure large retirement accounts. The business accounted for 30% of the operating earnings of the Travelers unit in 2004. But first-quarter institutional sales dove 30%, to $1 billion.

More worrisome is how MetLife plans to finance the purchase. The heated New York real estate market helped the company raise about $2.6 billion by selling two well-known Manhattan skyscrapers, including its headquarters. But the transaction is also using more debt than initially forecast because MetLife had planned to sell even more assets. Instead, it will raise roughly $8 billion in debt and preferred stock that carry fixed interest payments.

That could be problematic, since Standard & Poor's (MHP) put the insurer on a credit watch for a possible downgrade when the deal was announced. S&P insurance analyst Kevin T. Ahern will be looking to see if the company has enough cash to cover the increase in interest payments. MetLife's debt load will climb to 30% of total capital, vs. 25% in the past. Ahern, who reaffirmed his negative rating watch on May 20, says that the purchase has "strategic value" but the outcome of the proposed financing is murky. "We're taking a hard look," he says.

Analysts also will be keeping tabs on MetLife's plans to maintain close ties with Citi's brokers. The two companies entered into 10-year pacts under which MetLife will sell products through Smith Barney brokers and bank branches. Keeping those relationships intact will be critical to making the merger work, says Ahern. "At the end of the day, that's a fair amount of what they are buying."

Given Travelers' price tag, MetLife has little room for mistakes. Even fans of its stock don't think the acquisition will improve the insurer's profitability any time soon. Says analyst John Nadel of New York investment bank Fox-Pitt, Kelton: "If we had to be on one side or the other, we like Citigroup's side of that equation a little bit better." Unlike Citi, a perennial buyer until recently, MetLife is new to the acquisitions game. It will have to work hard to prove that it, too, has cut a smart deal.

By Mara Der Hovanesian in New York


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