Analysts at Moody’s Ratings have suggested that the potential acquisition of Direct Line by Aviva could bring credit positive benefits to both firms.
Late last month, Direct Line rejected Aviva’s £3.28 billion 100% acquisition proposal, stating that it does not adequately reflect the company’s standalone value, describing the offer as “highly opportunistic” and not in line with its long-term potential.
As per British takeover rules, Aviva is required, by not later than 5 p.m. on 25 December 2024, to either announce a firm intention to make an offer or announce that it does not intend to make an offer.
Despite the rejection, Moody’s has released a report noting that an acquisition of Direct Line would accelerate Aviva’s strategy of shifting its business mix towards capital-light products, thereby strengthening its return on equity.
“Direct Line’s high profile brands and good market position would also reinforce Aviva’s already strong UK franchise, although its dependence on the UK would increase,” Moody’s analysts explained.
They continued, “Post-acquisition, we estimate that Aviva’s UK & Ireland general insurance business would account for around 45% of the combined group’s insurance revenue, compared with 34% as at YE2023.
“While such a large acquisition would be inherently risky and would reduce Aviva’s available capital surplus, we believe the combined group would in the medium term have stronger capital generation prospects.”
Moody’s has also anticipated that the integration of Direct Line into Aviva’s P&C business would yield additional savings.
“The transaction would entail immediate acquisition and integration costs for Aviva, and there would be some business overlap. However, we believe the operating earnings of the merged group would, over the medium term, exceed the combined earnings of Aviva and Direct Line as standalone businesses,” the rating agency’s analysts said.
This would reportedly support Aviva’s goal of generating £2 billion of operating profit by 2026, with capital-light business such as UK P&C insurance contributing 70% of the total.
Moody’s concluded, “From Direct Line’s perspective, the main benefit of an acquisition by Aviva would be support from a larger, more diversified parent group with better credit quality.
“Further benefits such as cost synergies would be recognized over time, subject to Direct Line’s successful integration into the group. While Direct Line benefits from a strong position in the UK personal lines market and has powerful brands, its relative concentration in the UK personal motor business has amplified its exposure to recent market-wide challenges.
“While motor premium rates have started to fall, market conditions remain markedly better than 12-18 months ago due to reduced claims inflation. However, the market remains highly competitive and subject to intense regulatory scrutiny.”
Analysts from the UK investment bank Peel Hunt also recently responded to the news, suggesting that the proposition was “reasonable”, and captures Direct Line’s excess capital and discounts a turnaround in the firm’s profitability in the next two years.
Peel Hunt’s analysts said, “We believe Direct Line’s current share price does not discount the potential recovery of the insurer’s profitability by the end of 2026.
“However, despite Direct Line’s healthy capital position, there are some recent cycle and regulatory headwinds which suggest the recovery could be bumpier than anticipated earlier this summer.
“The downside risk to Direct Line standalone strategy of delivering cost savings and switching the Direct Line brand to PCWs has increased in our view. As such, engaging with Aviva to fully explore their offer in more detail would make sense.”
“In our view, the combination of Aviva and Direct Line would further strengthen Aviva’s position in the UK personal lines market and take its market share in UK Motor to 22% at a time when Motor rates are starting to peak and regulators are again reviewing underwriting practices in the UK Motor market.”
