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Merchants Mutual to buy Merchants Group?

Merchants Mutual Insurance Co., one of Merchants Group's biggest shareholders, is interested in buying the Buffalo-based insurance company for $29 per share in cash.

The proposed price is 30 cents less than Merchants Group's closing price of $29.30 on Monday, before the offer was disclosed in a filing with the Securities and Exchange Commission.

Bryant H. Prentice III, Merchants Mutual's chairman, acknowledged that the proposed price is less than the current market price in a letter sent Monday to Merchants Group's directors, but he also indicated that the offer could have some appeal to the insurer's shareholders.

"We believe the indicated price is within the range that Merchants Group's shareholders will find acceptable for an all cash offer . . . given the absence of a significant public market for their shares," he wrote.

The all-cash offer also would allow Merchants Group shareholders "to avoid the risks, timing issues and costs involved in liquidating or maintaining their holdings," Prentice wrote.

Merchants Group hired a Connecticut investment banker in February 2005 to seek ways to boost its returns to shareholders. "Apparently, Merchants Group has not yet identified any such alternatives," Prentice wrote, adding that the agreements between the two firms to share services and pool their insurance operations can be canceled at the end of 2007.

"Merchants Mutual believes that its acquisition of Merchants Group offers a fair and reasonable way for the parties to those agreements to avoid any business interruptions or disruptions if those agreements are terminated," Prentice wrote.

Merchants Mutual, which owns 11.9 percent of Merchants Group's stock and provides all of the facilities and personnel that the insurer uses to operate its business, said its offer to negotiate an acquisition will extend through April 4. The offer could be extended through April 21 if Merchants Group indicates by April 4 that it needs more time to evaluate the offer, Prentice wrote.

"The question is why would anybody sell, unless they want to get out of the business," said Christopher Carosa, who runs the Bullfinch Greater Western New York Series mutual fund, which does not own any Merchants shares.

While trading in Merchants' stock picked up on Tuesday, in the wake of the offer, volume remained low and the insurer's shares rose by 5 cents to $29.35. Trading volume was almost six times higher than average, but just 6,000 shares changed hands -- an indication that investors are not expecting a bidding war to break out.

"When you get a first offer that's below the market price, you're not going to get much better than market price on a second offer," Carosa said.

Buying the Merchants Group shares that it does not already own would cost Merchants Mutual nearly $54 million. The deal values the entire company at slightly more than $62 million.

Prentice, contacted Tuesday by The Buffalo News, referred questions to Robert M. Zak, Merchants Mutual's president and chief executive officer. "The documents pretty much speak for themselves," said Zak, who also is Merchants Group's chief operating officer.

Thomas E. Kahn, Merchants Group's chairman and a vice president at a St. Louis-based investment management company owned by Merchants' biggest shareholder, John D. Weil, could not be reached to comment.

The idea of Merchants Group and Merchants Mutual changing their intertwined ownership structure is something that the two firms have explored in various forms for more than a decade. Both have said changing their relationship could improve their insurance operations and reduce the chances for conflicts of interest.

Merchants Mutual provides all of the facilities, management and personnel that Merchants Group and its subsidiary, Merchants Insurance Co. of New Hampshire, use in their day-to-day operations. Merchants Group and Merchants of New Hampshire do not have any employees of their own. But Merchants Group and Merchants Mutual have separate boards of directors.

Merchants Mutual, which had owned 57.6 percent of Merchants Group until a 1993 secondary stock offering cut that stake to less than 10 percent, filed with state regulators in late 1994 to convert from a mutual to stock ownership in a move that would make it easier to raise capital.

Merchants Group offered to sponsor the conversion, but Merchants Mutual dropped its plan two years later after its financial condition improved.

In the mid-1990s, the companies first studied the possibility of pooling their insurance operations, only to decide not to proceed with the idea. Then, in 1998, Merchants Mutual discussed buying Merchants Group, only to drop the plan four months later.

Merchants Group's profits have been improving since the company began focusing on business insurance and stopped writing new auto policies in New York and Rhode Island and pulled out of the New Jersey market entirely. That shift reduced the company's premiums, but cut its overall claims even more.


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