Two of the biggest names in British insurance are locked in a takeover tussle that has the potential to redraw the UK market.
Aviva, the £13bn UK insurance behemoth whose roots can be traced back to the late 17th century, is pursuing the younger, smaller Direct Line Group: a household name best known for motor cover and its marketing mascot — a red phone on wheels.
However, a £3.3bn approach by Aviva for Direct Line was firmly rebuffed by the latter’s board earlier this week, prompting Aviva to appeal directly to its smaller rival’s shareholders.
Where might Aviva go next in its pursuit of Direct Line and what are the implications for the UK insurance market?
Why does Aviva want to buy Direct Line?
Aviva believes a tie-up with Direct Line would boost its exposure in the personal insurance market and deliver “material” cost and capital synergies. Aviva also reckons the deal would help the group, which has a substantial life insurance book, pivot towards capital-light business.
Dame Amanda Blanc, Aviva’s chief executive since 2020, is keen to accelerate the group’s performance, in part through acquisitions. She has overhauled the group, selling a series of overseas operations early in her tenure and returning billions of pounds to shareholders.
The approach by the FTSE 100 group comes as Direct Line, formed in 1985 and whose brands include Churchill, Green Flag and Darwin, is in the early stages of a recovery plan.
“It’s no secret that Direct Line has struggled over the past few years to deal with a challenging motor insurance market, and operational mis-steps have been a drag on performance,” said Matt Britzman, senior equity analyst with Hargreaves Lansdown.
Fresh management, including chief executive Adam Winslow — Aviva’s head of general insurance in the UK and Ireland until the beginning of this year, when he moved to its smaller rival — were put in place this year, to help turn around the lossmaking business, and recent results are more promising.
Winslow, the son of the founder of price comparison website Compare the Market, also hired Direct Line’s chief financial officer and chief risk officer from Aviva as part of the planned turnaround.
But weakness in Direct Line’s share price has left the group vulnerable to a takeover.
What were the terms of the deal?
Aviva made a tentative offer on November 19 that valued the Direct Line business at 250p per share, or about £3.3bn.
The proposal comprised 112.5p in cash plus 0.282 new Aviva shares for every Direct Line share.
Aviva described its proposal, which represented a 57.5 per cent premium to Direct Line’s closing share price on November 27, as “highly compelling”.
But Direct Line’s board, which is led by chair Danuta Gray, did not agree. It described the proposal as “highly opportunistic” and “substantially” undervaluing the company.
Aviva said the FTSE 250 group had declined to engage further after rejecting its proposal.
Subsequently, Aviva has begun to contact Direct Line shareholders in an effort to encourage the Direct Line board to come to the table, the Financial Times previously reported. That could pave the way for a possible hostile takeover.
A source close to Direct Line said: “The ball is in Aviva’s court.”
Aviva has until 5pm on December 25 to either make a firm offer or walk away. That will make for a busy Christmas for the insurer and its bankers at Goldman Sachs, who originally advised Direct Line on its rejection of Belgian insurer Ageas earlier in the year. Clifford Chance is also advising Aviva.
For its part, Direct Line has turned to Morgan Stanley, Robey Warshaw, Slaughter and May, and Brunswick among other advisers.
What do shareholders think?
The initial shareholder reaction was positive with shares in Direct Line surging 41 per cent.
The two insurers both have some large shareholders in common — including Schroders, Fidelity, Redwheel and M&G.
One top-20 shareholder of Direct Line said that Aviva’s bid was not a surprise, given the amount of excess cash the insurer is sitting on and the opportunity to merge the motor businesses to boost scale and extract costs.
“The reason Direct Line has described this as opportunistic, though, is that they’ve been going through a turnaround. They have highly qualified executives who have all come from Aviva,” the investor said.
Although he believes the offer of 250p a share undervalues Direct Line, he forecast that most investors would back an offer of 300p.
Another significant Direct Line shareholder confirmed that Aviva had contacted his institution directly. “The bid came out of the blue. We will make a decision by early next week. Could a private equity buyer come along? This might be a reason to hold out.”
Where could Aviva go from here?
Analysts reckon Aviva will need to dig deeper in its pockets to win over its target.
“Direct Line’s undemanding (but perhaps fair on a standalone basis) valuation, combined with . . . synergies, would make the deal financially accretive,” said analysts at Jefferies. “With this in mind, we would not be surprised if Aviva makes an additional offer and thus we reiterate our view that an offer of at least 270p might be acceptable.”
Analysts at KBW reckon the deal would become “borderline” for Aviva at around 300p per share.
Deal buzz around Direct Line could also bring old suitors out of the woodwork such as Ageas, which made two unsuccessful bids for Direct Line this year.
“The old Ageas offer is currently worth about 260p for comparison,” said MKP Advisors. “Ageas stock has been strong since the Direct Line overtures ended.”
William Hawkins, an analyst with KBW, said an Aviva-Direct Line combination was “the most logical one to add value for investors”.
However, he added: “Looking at the wider picture, we think the emergence of a counter-bidder that can offer a higher cash component in a bid and a commitment to support growth in DLG should not be ruled out.”
Ageas declined to comment.
Could the deal be blocked?
A combination of Aviva and Direct Line could lead to competition concerns in certain sectors due to the dominance of both groups in the motor and home insurance markets.
Figures from comparison site Confused.com show that Direct Line has 10.8 per cent of the motor insurance sector, making it the second-largest player, while Aviva is close behind with 10.5 per cent. A deal would lead to an enlarged group dominating more than a fifth of the market.
The UK’s Competition and Markets Authority is likely to review any deal that pushes market share in a product area above 25 per cent.
Aviva also dominates the home insurance market, with a share of 8.7 per cent while Direct Line has 6.2 per cent, according to Confused.com.
Barrie Cornes, an analyst at Panmure Liberum, said the CMA “will have a view on the combined group but we assume that Aviva have considered this and have discounted it as being an issue”.
Any merger would need the consent of not just the CMA but also the Bank of England’s Prudential Regulation Authority, in what would be the first big test of its competition mandate as the supervisor of insurers.
Additional reporting by Ian Smith in London