Bagging a win-win deal for Wesfarmers, IAG Wesfarmers had no intention of embarking on an aggressive campaign to increase its insurance business. THERE are three elements to the $1.85 billion deal between Wesfarmers and IAG. The first is the further rationalisation and consolidation of the sprawling Wesfarmers conglomerate into an essentially pure retail business. This makes for an even more interesting contrast with Woolworths. The second is the impact on IAG. It will make it the biggest player in general insurance, elevating it over QBE at an interesting and arguably even challenging time for that company. The final element is the way IAG is financing the purchase. It is almost 100 per cent equity and quasi-equity financed, but despite the minimal gearing will be earnings accretive immediately. That said, IAG is not picking up the Wesfarmers insurance business (SANS the broking arm) at a bargain basement price. After a choppy period through 2011 and 2012 when Wesfarmers - and indeed all insurers - got hit by excessive disaster claims, the business recovered very strongly in the 2012-13 year. This history both cemented the decision to sell what had increasingly become a peripheral business, and created the opportunity to maximise the selling price. IAG won the informal but very real auction. At a price which was a win-win to buyer and seller. The timing turned out to be heaven sent for IAG, with QBE the most logical - and in times past, likely the most aggressive, competitor - locked out of the bidding by the 30 per cent fall in its share price. A fall, that was driven by over-exuberant acquisitions, albeit in the US. For Wesfarmers the sale further consolidates it as a retailer, with now just shy of 90 per cent of group profit generated at a cash register ubiquitously near you. Last year Coles contributed 42 per cent of group operating profit, with a further 25 per cent coming from Bunnings - its original and still most successful retail business, grown out of its organic place in the original farmers co-operative - and another 16 per cent from Kmart, Target and Officeworks. Apart from of course the big, company-defining Coles group acquisition, this has developed to some extent indirectly and as a consequence of Wesfarmers 'playing the conglomerate game'. Since the turn of the century, Wesfarmers has sold its Landmark rural services business - the first clear statement of it inevitably breaking out from its farming roots - Premier coal and now the insurance underwriting. It didn't sell the broking side of the business because IAG didn't want it. But it's effectively put it 'on the market' and will realise a further hefty sum from its sale. These sales have been less a deliberate intention to rationalise down to retailing, and more the consequence of relentless, even ruthless, portfolio management demanded of a conglomerate that aims at unemotionally maximising its returns. Each decision comes down to a simple if brutal question: can we justify injecting more capital into a business to grow it; if not it goes on the market. Last year only 5 per cent of the group capital budget went to insurance; 81 per cent went to retail. The question will continue to be asked about Wesfarmers' remaining sub-scale businesses in chemicals, fertiliser and coal. We are now getting closer to two pure head-to-head retail giants. With Woolies still the dominant although challenged player in supermarkets and Wesfarmers the undisputed king of home improvement, with Woolies making heavy of its Masters thrust. The general retailing in the middle is very interesting, and very bricks-and-mortar challenging for both. Kmart and Target versus Big W. At its core the deal is similar to the decision made in Detroit over Holden. Prepare to get bigger, arguably much bigger, or get out. Wesfarmers had no intention of embarking on an aggressive campaign to grow its insurance business. Given the structure of the market, it would have been - expensively - fruitless even to try. But that market structure - with still three major local players, IAG, QBE and Suncorp, and three global majors in Allianz, Lloyds and Zurich - made it the perfect time to sell. That meant two things. There was more than one buyer and the market has sufficient number of strong players for the deal not to run into any competition problems. At least, not this side of the Tasman. The deal will further cement IAG and QBE as the two biggest players, but they will still have less than 45 per cent of the general underwriting market between them. Allianz and Suncorp each have around 10 per cent, Lloyds has a little less, while Zurich, which is the smallest of the big six with around 6 per cent, certainly ain't going anywhere. Further, there are a host of smaller players which between them still have around 20 per cent of the market. For IAG - and indeed any of the other big six players - the Wesfarmers business represented one of the last opportunities to buy scale, in two ways. The acquisition itself, and an easy clearance from the ACCC. Trying to put any of the 'Big Six' together could be a problem, made slightly bigger by this deal. NZ, though, could be a real and immediate problem. Over there IAG is already the biggest player in a market dominated by just two - the other is Vero. Further, Wesfarmers was itself the third biggest player. The buy would elevate IAG to 40 per cent of the market, giving it a significant increase over Vero which has 25 per cent, while also cementing the duo's dominance with 65 per cent between them. The NZ Competition Authority has tended to be freer than the ACCC. But this could be too big an ask. The main game for IAG is, of course Australia, and the buy represents a big coup. Assuming there are no big disasters in our future, as the enlarged IAG will have a larger slice of them. The merger delivers significant synergies, and without the broking arm, should be relatively seamless. It is a measure of the inherent upside that the deal could be almost entirely equity-financed and still be immediately earnings accretive. Of the $1.845 billion, $1.4 billion will be financed by basic equity. Some $1.2 billion comes from the institutional placement, and a further $200 million from the smaller shareholder SPP. A further $300 million is provided by subordinated debt, which strictly speaking is debt, and so some extra gearing, but is also quasi-equity. The same goes for the final $145 million of cash. It has the effect of marginally increasing net debt. The heavy weighting of equity speaks both to today's more prudent times and the market's appetite for attractive equity. UBS has got the placement away at a modest 4 per cent discount, which moderates the - in my view undesirable, even inappropriate - dilution for non-participating IAG shareholders. This is further moderated with the follow-on SPP. But with its mandated limit of $15,000 remains inequitable. Altogether IAG and UBS are almost where I believe we should be, qualified by what is allowed. But the best mix would be a money-guaranteeing placement and as close as possible to a pro-rata follow-on issue to other shareholders.