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One STEP at a Time

Life USA Holding arranges cash on schedule.
Ian Springsteel, Others
April 1, 1998

When Life USA Holding Inc. needed $100 million to expand its fast-growing business during the next five years, it skipped over the usual capital providers and went right to a vendor. Far from admitting weakness, submitting to exorbitant terms, or relinquishing some control of its own business, however, the Minneapolis-based insurance holding company found a lower-priced source of capital that will foster growth at a pace that makes sense. Terms were so attractive, according to chief executive officer Robert MacDonald, that investment bankers from Merrill Lynch and Donaldson, Lufkin & Jenrette conceded that it was a better deal than they could devise.

UNCONVENTIONAL AGREEMENT
"Companies traditionally go to banks or the equity markets. It's seen as a last resort to have partners bail you out," says Mark Zesbaugh, chief financial officer and executive vice president of Life USA, which in January announced its unconventional agreement with Allianz Life Insurance Co. of North America, in Minneapolis. "Our view is that the terms from people we do business with are often better because they benefit from our growth," he says.

The agreement, dubbed a sequentially timed equity placement, or STEP, calls for Allianz to purchase $10 million of Life USA's newly issued common stock every six months for the next five years at a fixed price, 250 percent of Life USA's average book value.

By spreading out the infusions, Life USA avoids a single large offering that might leave it awash in cash that would drag down a lofty return on equity. The terms also satisfy the rating agencies, which had expressed concern about Life USA's access to enough capital to keep growing at 25 percent a year. Reacting favorably, Moody's Investors Service put Life USA on review for possible upgrade the day the deal was announced.

Because annuities require very high front-end costs, every $1 of new premiums requires an additional 8 to 10 cents of capital in the first year. The insurer can offset much of these costs, but not without sacrificing returns later on. Fresh capital from Allianz will enable Life USA to write more policies and also increase the portion it retains to 30 percent, from 25 percent, by the end of March 1998.

Before embracing STEPs, Life USA considered convertible preferred debt as a source of capital. But additional debt would have weakened its standing with the rating agencies, which were already concerned about its overall capitalization.

Life USA would probably have re-ceived less than 50 percent equity credit for convertible preferred, says Kevin Ahern, an associate director of Standard & Poor's. Life USA expects that aftertax cost of capital for the STEP transaction will fall below 5 percent, moreover, versus upwards of 5 percent for a convertible preferred. In addition to doubling Life USA's capital, the deal struck with Allianz will substantially eliminate debt once Allianz converts $30 million worth of debt it bought in 1995. Allianz will receive 2.43 million shares of newly issued stock at $12.34 per share in the conversion. All told, Allianz could wind up owning 35 percent of Life USA.

STROKE OF GENIUS
Book value determines the price Allianz will pay for shares of Life USA. At first glance, paying 250 percent of book value might seem like a high price. With book value at $9.41 per share at year-end 1997, Allianz is likely to pay more than $23.50 per share. The premium seems consistent, however, with the one the Dutch holding company ING Group paid in 1997 for Equitable of Iowa Cos.--270 percent of book.

If Life USA continues to grow at the same pace, Allianz may ultimately enjoy the best part of the bargain by collecting a gain on the shares in addition to profits from the new policies. "It may be a stroke of genius for Allianz," says Tony Carideo, an analyst with John G. Kinnard & Co., a brokerage in Minneapolis. Along with an ownership interest, Allianz gets a three-year extension of its marketing agreement with Life USA.

Allianz is further protected against overpaying for the shares. If the 250 percent premium to book value represents more than 200 percent of the current market price for shares of Life USA at the time of purchase, Allianz may opt instead to buy convertible 10-year debt, paying interest for only 5 years at the 10-year Treasury bill rate. But Life USA still gets the cash on schedule.

Linda Corman is a freelance writer based in New York.




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