Friends/Aviva tie-up still faces number of outstanding issues
Management line-up of combined entity yet to be decided
Friends Life "decaying" cashflow flagged as potential issue
There are still a number of issues outstanding in the talks between Aviva [LON:AV] and Friends Life [LON:FLG], two sources close to the situation said.
Both have progressed to advanced stages in their mutual due diligence, but issues, including the role of Friends Life management in the combined entity, have yet to be decided, one of the sources said. It was “unfortunate” that the deal talks were leaked before certain matters were resolved, this source said.
One sector banker speculated certain issues were likely to come up in due diligence, particularly in relation to Friends Life’s future cashflows. These slow considerably in the next two to three years, the sector banker claimed.
But an insurance analyst argued that Friends Life’s cash flow is likely to be stagnant over the next few years but should not drop markedly. The life insurer’s cash flow will slow as its closed books mature, but this will be a gradual process over many years, he said.
Friends Life’s value in force – roughly the present value of future profits from its existing insurance policies – will show a strong surplus even by 2023, the first source agreed. The value in force decays over decades rather than years, he said.
Aviva is carrying out the deal to substantially increase cash flows and accelerate the growth of its dividend.
Friends Life estimates that its expected return from in-force business will decline from GBP 600m in 2014 to GBP 370m in 2023, according to its 1H14 report.
Aviva is offering a high price for Friends Life, the sector banker and the analyst agreed. The offer price is roughly equal to Friends Life’s embedded value – the adjusted net asset value plus the present value of its future profits – the analyst noted. In order to motivate that, the bidder will need to identify strong synergy potential during the due diligence process, he argued.
Aviva’s share price has declined almost 6% since the potential all-share offer was announced. Because the offered ratio of 0.74 Aviva shares for each Friends Life share already implies a hefty price tag, the suitor may need to reconsider those terms if its share price continues to decline, the analyst said.
Aviva reserves the right, with the recommendation of the board of Friends Life, to amend the exchange ratio of Aviva ordinary shares for Friends Life ordinary shares, according to a joint stock exchange announcement.
From a strategic standpoint, the proposed deal is “surprising” as Aviva has large operations outside of the UK and showed little interest in an expansion at home, the first and a second sector banker agreed. But the deal could make financial sense thanks to the potential for cost synergies, they said.
A tie-up could allow the parties to take out “loads of overheads”, said Liontrust fund manager Stephen Bailey, who holds around 0.5% of Friends Life. The deal would allow Aviva and Friends Life to trim some costs, including the ones for head office functions and pension plans, a second Friends Life shareholder agreed.
Apart from cost reductions, the deal would also generate capital synergies, the second shareholder said. Aviva’s and Friends Life’s insurance books will have different risk characteristics. And when they spread the risks over a larger book, they might be able to hold less capital, this shareholder added.
Aviva announced it had agreed the terms of a potential all-share takeover of Friends Life on 21 November. The deal terms value the target at 398.9 pence a share based on Aviva’s closing price on the day of the announcement. It represented a premium of 15% on 21 November and 28% to Friends Life’s three months average share price.