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Björn Wahlroos’s Capital Allocation Hat Trick with Sampo

Sampo is a Finnish financial services group. This is notable for two reasons: first, financial services is an inherently cyclical sector; second, financials are a type of business where capital expertise is critical. Marathon Asset Management writes: “Financial companies are probably the most challenging of all for CEOs to manage, as they require many more capital allocation decisions compared with, say, running a large food retailer or consumer products company.” An ominous note, perhaps.

Björn Wahlroos arrived at Sampo in 2001, after selling Mandatum — his boutique investment bank — to the group for €400m. This was a 100% equity deal, with Wahlroos’s 30% holding in Mandatum turning into a 2% stake in Sampo. As part of the sale, Wahlroos stepped up to become CEO of the larger financial group.

At the time, Sampo operated three major domestic businesses: a bank, a property & casualty (P&C) insurance business, and a life insurance business. The group also owned around 1% of Nokia’s outstanding shares, making up €1.5bn or 22 per cent of Sampo’s net asset value. Almost immediately, Wahlroos began selling down this stake — bringing the group’s ownership from 35m shares to 6.7m shares, at about an average price of €35 a share. Nokia’s share price collapsed but a few months later.

Wahlroos then turned his attention to Sampo’s P&C insurance business. At the time, the business was ‘essentially mature’ — it held 34% market share in Finland’s domestic market and had little headroom for growth. Wahlroos injected this business into a pan-Nordic P&C business named ‘If’, in exchange for a 38% ownership stake (and half the voting rights), along with €170m in cash. ‘If’ controlled 37% market share in Norway, 23% in Sweden, and 5% in Denmark. I’m not entirely sure if Sampos had a direct say in management, but ‘If’ quickly introduced pricing discipline (cough: oligopolistic pricing), and began reducing their combined ratio from 105% to 90% over the course of four years. (The combined ratio is the sum of incurred losses and expenses divided by earned premium. A combined ratio of > 100% indicates an underwriting loss; below 100% indicates an underwriting profit).

In 2003, before ‘If’’s combined ratio hit 90%, Sampo took full advantage of the financial distress of its partners and bought out 100% of the equity at an implied valuation of €2.4bn. ‘If’ hit 90% combined ratio in 2005; in 2010, a mere five years later, the lowest valuation of insurance group was €4bn. Sampo paid a fraction of that for an asset that had essentially doubled in value; in 2010 Wahlroos began trumpeting an open invitation for a sale of ‘If’ … for €8–9bn.

Wahlroos’s next big move came in 2007, right before the global financial crisis. Sampo announced the sale of its Finnish retail banking business to Danske Bank, at top-of-market prices (€4.1bn). Financial sector valuations collapsed a few months later. Wahlroos took this cash and slowly built up a 20% stake in Nordea — the largest Nordic banking group, and a higher quality retail bank — right out of the depths of the financial crisis. Marathon notes, approvingly: “Sampo have now invested €5.3bn in Nordea at an average price of €6.39 per share, which compares with the current price of €7.70. Almost half of the position was acquired at a price of around 0.6 times book value, implying an impressive arbitrage compared with the 3.6 times book value achieved on the sale of the Finnish business.”

As impressive as that was, Sampo’s greatest capital allocation move came right before the Lehman bust. Wahlroos decided to sell down the weighting in equities down to 8% of Sampo’s investment portfolio, keeping its position in liquid, fixed income assets. As a result, Sampo had so much cash lying around that it was able to buy €8bn–€9bn in commercial credit in the autumn of 2008, purchased at fire sale prices from distressed sellers. Two years later, the bonds have yielded a €1.5bn gain.

Marathon Asset Management closes out a case study of Sampo with the following paragraph:

As a result of these astute capital allocation decisions, the Sampo share price has comfortably outperformed its financial services peer group and has outperformed the overall European stock market by a factor of nearly 2.5 times since January 2001. The Sampo case study combines many of the key elements that we look for in management; namely, it has a chief executive who both understands and is able to drive the industry’s capital cycle (the Nordic P&C consolidation story), allocates capital in a counter-cyclical manner (selling equities prior to the GFC), is incentivized properly (large equity stake) and takes a dispassionate approach to selling assets when someone is prepared to overpay (Finnish bank divestment). The pity is that there are so few examples of Sampo-esque management elsewhere in Europe.

If all of this activity sounds like investing, that’s because that is what it is. Granted, Sampo is a financial services company, which means Wahlroos’s actions are necessarily more capital allocation than anything else. But it’s worth noting that even regular companies have to make investment-type decisions with the cash generated from their businesses. This is the point of Buffett’s quote: “after ten years on the job, a CEO whose company retains earnings equal to 10 per cent of the net worth will have been responsible for the deployment of more than 60 per cent of all capital at work in the business”.

Over the long term, a significant amount of company value creation is determined not by operating decisions, but by capital allocation decisions.

This is more difficult than it first seems.

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