Aviva and Direct Line Group have agreed a sweetened cash, shares and dividends deal that will see Aviva acquire its rival and capture more than a fifth of the combined UK motor insurance market.
FTSE 100 constituent Aviva (LON:AV) had previously attempted to acquire Direct Line Group (LON:DLG) for 250p in November, but Direct Line’s board dismissed this offer out of hand, describing it as “highly opportunistic”, according to the FT.
The latest offer, consisting of 129.7p in cash, 0.2867 Aviva shares and a 5p dividend for every Direct Line share, was accepted quickly though. The two companies issued a joint statement confirming the agreement in principle this morning (6 December).
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“Aviva had no choice but to dig deeper if it wanted to secure Direct Line,” said Dan Coatsworth, investment analyst at AJ Bell. “Lo and behold, the offer has been raised to a much more realistic level to get the deal done.”
The deal is worth approximately 275p to Direct Line shareholders, based on Aviva’s share price before the start of the offer period, and therefore equates to a 73% premium compared to Direct Line’s share price at that time.
Direct Line shares opened 6 December at 252.2p, 6.86% above their close price the previous session, and jumped a further 2.22% to 257.8p later in the morning before falling back to around their opening price.
Why is Aviva buying Direct Line?
In effect, Aviva is taking advantage of a rival enduring a tough patch, and moving decisively to capitalise on it.
“Let’s not sugarcoat it: Direct Line has hit some serious potholes lately”, said Matt Britzman, senior equity analyst at Hargreaves Lansdown. “Market share has been sliding, underwriting hasn’t exactly been flawless, and regulators have been knocking on the door.”
Direct Line’s share price had fallen 9.9% in the year up until Aviva’s first bid on 27 November.
“For Aviva, the price is pushing the limit of good value but snapping up Direct Line could be a strategic jackpot,” says Britzman.
The deal will see the combined entity control more than 20% of the motor insurance market, as well as offering Aviva the opportunity to guide Direct Line’s ongoing business transformation and realise efficiency gains from the new entity’s scale.
“Aviva has performed every step of the takeover dance flawlessly,” says Coatsworth. “It’s spotted a rival going through a weak phase and thrown its hat into the ring as an interested buyer.”
Should you buy Direct Line shares?
Direct Line shares are currently trading at approximately 252p, notably below the implied value of Aviva’s offer. So, is there an easy payday in store for anyone who buys Direct Line shares now?
Not necessarily. The first point to remember is that both parties have only reached an agreement in principle. Nothing is confirmed whatsoever as yet; Aviva has until Christmas Day to confirm that it wants to make a firm offer in line with the agreement.
“There was speculation overnight that Aviva had quietly proposed 261p versus the 250p previous offer,” says Coatsworth. “If true, perhaps the indicative response to 261p was negative so Aviva might have raised the price to 275p and felt rushed into going public on the proposal without having all the paperwork finalised to make a formal bid.”
Direct Line Group shareholders will then vote on the deal. While this is also likely to go through, given that the board has indicated that it will recommend to shareholders that they accept the offer and the premium it implies on Direct Line’s prior valuation, it is another point of potential uncertainty.
Will the CMA block Aviva’s Direct Line takeover?
Besides the two companies following through on the deal, there are other factors that could scupper it. For example, given the substantial share of the motor insurance market the combined entity would control, it is possible that the Competition and Markets Authority (CMA) could block the takeover.
“The competition watchdog will almost certainly look at the deal as the enlarged group would account for a large chunk of the motor insurance sector,” Coatsworth told MoneyWeek.
Direct Line’s share price has already gained substantially since Aviva’s interest in a takeover became known, and as such, its shares are implicitly overvalued compared to its business performance at present, despite still trading below the 275p level the offer implies.
Should the deal fall through for any reason, Direct Line’s share price would likely fall back significantly, and investors who bought at current prices expecting a quick payout will be left carrying the bag.
“There is an arbitrage opportunity with Direct Line’s shares given they are trading below the new proposed offer from Aviva,” says Coatsworth. “But any investors considering jumping in now must understand the risks to the deal.”
