Jason Nissé: The Royal dilemma, or the chief executive's fear of the penalty

Business View

Being American, Bob Mendelsohn probably knows little about taking penalties. So for the benefit of the chief executive of the inelegantly named Royal & Sun-Alliance, here is a piece of advice. Before you start your run towards the ball, decide which side of the goalkeeper you are going to kick it, and whether you are going to give the ball an almighty thump or try to place it. Once you have chosen your options, don't change your mind. Because, at this point, any indecision is fatal.

What has this got to do with Mr Mendelsohn's current predicament, in which he may need to go to the market for more money in a move that will surely cost him his job? Well, a great deal.

The insurer finds itself in a particularly nasty bind at the moment. Falling equity markets have eroded its capital base, yet to grow, the business needs capital. The ambitious American may have found ways to release £800m from part of the group where he didn't want there to be loads of capital, and reapply it where it is needed. But if the market does not recover, he will need something more in the kitty before too long – something he admitted to last week in an interim statement which might be described as the second-longest suicide note in history. (Labour's 1983 election manifesto is still the record holder.) Mr Mendelsohn set out five options for raising this capital:

1. Move capital from unprofitable lines of business into profitable ones (but he's already done that).

2. Sell operations not making enough money (in these markets? Do me a favour).

3. Look at another reinsurance deal, like the one struck with Munich Re, to take stuff off the balance sheet (not popular in this post-Enron climate);

4. Continue to remove risk from the investment portfolio by selling equities (see option 2).

5. Ask investors for money, be it through a rights issue, a private placement or a subordinated debt issue (the third option is expensive; the other two could cost something extra – a change of management).

While no one wants to push the ejector seat too quickly, the fact remains that Mr Mendelsohn is facing the sack because of his own prevarication. When running up to take the penalty, he changed his mind.

Early in 2001, the Royal & SunAlliance board took the sensible decision that if they wanted to grow the group's general insurance side, the life business had to go. NM Rothschild started looking for a buyer, but the insurer's other adviser, Goldman Sachs, suggested there might be a more elegant way of raising capital for the business. Mr Mendelsohn gave Goldman a few months to find a better way. The Yank bankers failed, so the life side was put back on the stocks. Aegon agreed to buy it for more than £1bn, but as the sale completion approached, 11 Sep- tember struck and the deal collapsed.

As if this example of "my indecision is final" wasn't enough, Royal & SunAlliance then spent the late autumn mulling a rights issue. Had Mr Mendelsohn pushed the button then, he could have raised money at somewhere in the 250p to 300p-a-share region. The shares closed on Friday at 106p. A rights issue now looks unlikely at anything higher than 70p.

No doubt Mr Mendelsohn will want to wait until next year before he goes to the market, for fear of the consequences. But this could be a foolish strategy. Like many companies, Royal & SunAlliance has a pensions fund shortfall. It has not adopted the controversial FTSE 17 standard, but had it done so, it would have been forced to make a charge of £128m in its last accounts. Most of its pension fund is invested in equities, and the fall in the markets this year indicates that this deficit could be as much as £1bn by now.

If the company waits until the spring to raise money, it will be going to the market while wading in a sea of red ink. This will make a tricky task even harder.

Everyone needs a piece of good luck, and Bob Mendelsohn has one advantage. The chairman of Royal & SunAlliance is Sir Patrick Gillam, who only a few months ago presided over the ousting of another foreigner running a great British financial institution, Rana Talwar at Standard Chartered. He probably does not want to be seen as acting like the chairman of a troubled football club, sacking manager after manager.

But if Sir Patrick were to study the art of penalty taking, he would realise that any lack of nerve can only end in failure.

j.nisse@independent.co.uk