After UK insurance firm Aviva rejected a £5bn ($7.8bn) offer from rival RSA to acquire its general insurance (GI) operations, the Financial Times has reported that leading Aviva shareholders are pressing the UK insurer to reconsider its dismissal. However, Aviva seems adamant in its rejection and equity analysts are equally convinced Aviva will not change its mind.
On July 28 Aviva received a conditional proposal from RSA to acquire Aviva's general insurance businesses in the UK, Ireland and Canada, excluding RAC and Health for a cash consideration of £5bn funded entirely from a rights issue by RSA. The proposal would have left the pension liabilities of the GI business with Aviva as well as the general insurance businesses in the Netherlands, France, Italy, Poland, Turkey and Singapore.
The board of Aviva rejected the proposal on the basis that “the highest value to shareholders will be delivered by retaining these businesses within the group.”
Aviva and analysts alike do not believe the value of the offer adequately recognises the fact that Aviva is a leading general insurance business in the UK and Ireland, and the number two player in Canada.
Oriel Financial’s analysts have said that the offer is a serious undervaluation. But they said in a research note: “The £5bn is nearly half of Aviva’s market cap of £11bn while GI in our opinion represents around one-third of the value in the group. In our opinion this highlights that the equity is worth more than £15bn.”
Joy Ferneyhough, analyst for Execution Noble, told Reactions there is a “massive impasse” between the price that is accretive for RSA shareholders and the price that Aviva will accept, given that it is not just purely about the absolutely fair value of the asset that is being discussed.
“The fact that Aviva gets a huge amount of capital efficiency on their own economic model means that for RSA to be able to compensate Aviva for the loss of that capital efficiency over and above the actual asset that they would be buying means it would be totally dilutive for their shareholders and, therefore, no one would agree to finance it,” she says.
Aviva does have the opportunity for it to sell its operations for considerably more than the enterprise value of the business. But this would call for Aviva to break itself up which would only put upwards pressure on the share price, said Oriel.
Analysts at Oriel pointed out that Aviva has been restructuring its non-life businesses in a difficult market, by shedding unprofitable lines. As a result, earnings have and should continue to rebound and even more so with a recovery in pricing. Therefore Oriel’s analysts claim “selling now would be like selling at the bottom.”
In addition, the combination of the life and non-life businesses operating as one brand with cross-selling opportunities means Aviva can run them with substantially less capital than the two businesses would do on a stand-alone basis, which is likely to be further reinforced under the Solvency II proposals.
Under Solvency II the composite model should require less capital through greater diversification, said Oriel.
Marcus Barnard, analyst at Oriel, told Reactions that Aviva does not need to sell. The only reason to do so would be to buy back shares. But he adds: “Until Solvency II rules are finalised, why take the risk – there is already lots of excess capital on the balance sheet.”
Therefore, he does not think this deal will happen.
Ferneyhough at Execution Noble agrees that Aviva is in pretty good shape and the company is just starting to experience the benefits of its decision to redomicile its European business to Dublin and various cost cutting and restructuring programmes.
“I think there are a lot of good things going on at Aviva which needed to go on because it has been under performing for some time,” she says. “They have proven that they have done a big strategic review, they have decided on a direction, and there is no reason to derail by getting involved in another change in strategy.”
The analysts that Reactions spoke to were in agreement with the fact that Aviva will be a stronger entity for keeping both its life and non-life earnings, especially as insurance markets start to improve. The GI business is highly cash generative for Aviva, although Aviva recognised in a statement that its present business performance does not reflect its full earnings potential. For example, Aviva's general insurance businesses in aggregate made operating profits of £1.0bn in 2009 compared to £1.7bn in 2006.
Although RSA sees strategic benefits from the deal, analysts are dubious that it would reap the benefits. Oriel’s analysts note that RSA would need to raise more than its market capitalisation (£4.4bn) to complete this transaction. It is also at slightly at odds with RSA's stated strategy of making small bolt-on acquisitions to generate growth.
“This offer was a bold move by RSA and we are not surprised by Aviva's rejection given current cyclically low GI earnings, valuations, and the benefits (expenses & capital) from its composite model,” said Oriel. “RSA's management has significantly improved its operational performance and market perception in recent years and the timing of the offer could be seen as shrewd given current low valuations. However, we fear there is now a degree of uncertainty as to whether RSA intends to pursue a strategy of small bolt on acquisitions or whether it will look for transformational deals and the risk of this could weigh on the shares.”
Ferneyhough does not see this as the start of a similar trend of deals in the UK market. She says it was a fairly “left field” deal.
“There are not a lot of companies out there who are willing to allocate cash to deals so therefore it becomes very difficult to make things accretive,” she says. “All the larger European companies have stated that they are unlikely to do any deals unless it was for equity which makes it slightly more difficult.”
She adds: “We haven’t seen a flurry of deals or expect there to be one in the near term. Certainly in the UK it is a relatively mature market in both p/c and life so it would have to be a very specific situation such as the AXA UK [sale of its life business to Resolution, the life insurance investment vehicle] to really see anything more happening.”