A deal made in heaven, or at least in the operating theatre? That was the claim of Aviva chief executive Mark Wilson, who argues that his group’s planned purchase of Friends Life “is one of those rare transactions where the two organisations fit with surgical precision, building on each other’s strengths and addressing the challenges”.
Here’s the less bullish version: Aviva’s investors will have to wait until 2017 for the deal to achieve earnings neutrality; and Friends Life’s shareholders will suffer an effective cut in their dividend in 2016, maybe of about a quarter.
That’s the sort of financial surgery investors would normally wish to avoid, which is why the market’s reaction to this deal has been so lukewarm. Aviva’s share price has fallen 7% since the initial announcement. That has reduced the value of the all-share terms to the point where Friends is agreeing to be bought at a premium of only 8% to the pre-leak share price – not much to shout about.
Yet the financial logic is better than it appeared at first glance, a fortnight ago. Cash generation, not earnings, has been Aviva’s problem. Friends’ closed book of life policies should deliver a decent cash injection. Throw in £225m of planned cost savings and the numbers would seem to add up. What’s more, some of the savings seem easy to achieve: it’s not hard to appoint Aviva Investors to manage the bulk of Friends’ funds.
On the Friends side, some of the dividend pain is deferred via an up front 10p a share sweetener. And, by throwing in their lot with Aviva, Friends investors gain exposure to general insurance and international operations. That provides some comfort against the worry that George Osborne’s next annuity market reform could be even more damaging.
For all that, this transaction hardly screams confidence on either side. “Logical but not compelling” – broker Panmure Gordon’s verdict – seems about right. In surgical terms, let’s call it a hip replacement: the recipients will move more easily, just don’t expect them to sprint.
Mail shot
It was a comprehensive lobbying defeat for Royal Mail and Moya Greene. The chief executive had thundered to MPs last week that rivals’ cherry-picking activities in dense and low-cost urban areas brought “an existential threat” to the universal service obligation.
Not so, replied regulator Ofcom. Or, at least, not currently. Such end-to-end competition accounts for only 0.6% of all letter deliveries. Dense areas, such as London, aren’t always low cost. And Royal Mail can still charge rivals “zonal” prices for using its services in rural areas – but, warned Ofcom, such charges must be based on real costs, rather than whatever Royal Mail thinks it can get away with.
For good measure, the regulator advised the privatised postal operator to concentrate on maintaining “a reasonable rate of improvement” in productivity. In short: less grumbling, more action, please.
A disaster for Royal Mail? Not quite. The silver lining in the mass of documents was the fact that Ofcom still regards a profit margin of 5%-10% (before interest and tax) for Royal Mail’s regulated business as the guarantee of a sustainable USO. The regulator is also planning to have a look at the other factors affecting the universal service, including pressures on the parcels side of the business. In other words, a different form of regulatory relief may arrive in time.
Ofcom’s stance, as far as it goes, is consistent and coherent. The regulatory framework was always designed to keep Royal Mail’s feet to the fire. Allowing more competition to develop at this stage is reasonable.
The danger, however, is that the system relies entirely on Ofcom’s ability to judge perfectly how much competition is enough. Damian Brewer, RBC’s analyst, asks a good question: “How does encouraging an industry in decline to add more fixed cost solve the long-term threat to the USO?”
It’s a basic point, and still unanswered. Bring on the next inquiry.
Who profits?
No doubt about it, it’s a remarkable figure: sales rose by 22% at John Lewis last week. This imported Black Friday razzmatazz has definitely caught shoppers’ attention. Whether the promotional activity actually helps retailers’ profits is another matter.
One suspects any semi-organised consumer does most of his or her Christmas shopping when the discounts are on offer and then sits back and waits for the Boxing Day sales. Not all of us are so competent, luckily for the stores. But this spectacular half-time sales scoreline could still prove grossly misleading in terms of profit.
