Direct Line Fair Value Maintained as Aviva Deal Edges Nearer

Aviva AV. and Direct Line DLG have jointly announced they have a preliminary agreement on the financial terms of an Aviva acquisition of Direct Line.

These terms include a cash offer of £1.29 per Direct Line share plus a stock offer of 0.2867 new Aviva shares which at the £4.89 closing price of Aviva on 5th December represents a stock offer of £2.70 per share of Direct Line.

The consideration has been sweetened by a 5p per share dividend to be paid to shareholders of Direct Line.

That cash consideration is £1.69 billion, stock consideration £1.82 billion, dividend consideration £65 million, for total consideration of £3.6 billion for Direct Line.

Based on interim results for both Aviva and Direct Line, post the acquisition Aviva would have around 3,078.8 million shares. And post Direct Line integration, we believe Aviva could be worth something in the region of 5.85p per share.

While we don’t typically like M&A and view it as value destructive in the main, we think the combination of Aviva and Direct Line could be good for several reasons.

The first is that we believe the current financial plans are highly ambitious for Direct Line. The second is that even if these financial ambitions are achieved, can they be sustained? And where would that leave Direct Line long-term? This is a highly competitive industry where Direct Line is up against a highly effective incumbent to whom it has been ceding market share as a standalone.

There are good similarities between Aviva and Direct Line that improve the chances of cost removal and business benefits from being combined.

They both operate their own garage repair networks, have both relied on a business model that has included partnerships to sell policies in the UK, and combined data and technology could improve underwriting in personal lines. We maintain our £5.70 and £2.20 fair values respective and our ratings of no moat.