Chris Blackhurst: Aviva may crow over this merger, but now it must show its mettle

Midweek View: Where is the growth going to come from? Aviva is buying a business in a no-growth industry

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The Independent Online

Aviva is terrifically gung-ho about acquiring Friends Life. At Friends Life, they seem terribly pleased about being bought by Aviva.

Unfortunately, the two sets of senior management are on their own. Staff have worries about the job losses a merger inevitably means. And, despite resolute spinning, the City seems disenchanted by the £5.6bn deal. Shore Capital called it a “rights issue in disguise”. Credit Suisse said it was “neutral on the proposed transaction”. Panmure said it didn’t share Aviva’s assertion that the deal is “compelling”.

These verdicts came after the two companies released the terms for the merger. Friends Life shareholders will own 26 per cent of the enlarged business. They will receive 0.74 new Aviva shares for every share they own. The deal is worth 394 pence a share – a 15 per cent premium to the Aviva share price before news of the marriage broke.

The new, joint entity will have £309bn of assets under management – 29 per cent more than Aviva has at present. Aviva will become No 1 in the UK life market, with 12 million UK life customers.

Andy Briggs, the chief executive of Friends Life, will become chief executive of Aviva UK and join the Aviva board as an executive director. The Friends chairman, Sir Malcolm Williamson, becomes a senior independent director at Aviva and another Friends Life non-executive will join the Aviva board.

But the City is not bowled over. That’s because there’s a distinct feeling of having been here before where Aviva is concerned.

In 2000, Aviva was itself created out of the coming together of two large insurers to create one with a value of £20bn, holding market-leading positions in life and general insurance. Since then, not much – the expected springboard has failed to deliver.

If this deal goes through, the market capitalisation of the new Aviva will be £20bn, so that’s 14 years and another £5.9bn of equity (to buy Friends Life), plus various write-offs amounting to another several billion, in order just to stand still.

This time, though, Aviva is under new management. Certainly there are signs that under Mark Wilson, Aviva is going places. Previous deals were financially-driven. This one is said by Aviva to be both financial and strategic or to quote the mantra, “cash and growth”. On the cash side, the predicted synergies of £225m – much of them from shedding jobs – are twice what analysts were forecasting. They were looking at savings of around £100 – 150m.

It’s the next bit that is tricky, however. Where is the growth going to come from? Aviva is buying a business in a no-growth industry. The UK life insurance sector is seeing massive outflows because of the ageing population and the decline in attractiveness of life and pensions products in an era of low interest rates. The individual annuities market has collapsed, hit by the double whammy of low interest rates and the Chancellor’s decision to scrap compulsory annuities. In addition, UK life faces increasing pressure, both on capital from the new Solvency 2 regulations, and from an avowedly aggressive consumerist watchdog, the FCA.

On the plus side, Aviva is adding 5 million Friends Life customers who can be sold Aviva products. This should work well in online where Aviva is strong.

There’s no doubt the union brings scale, but scale to do what? According to Wilson, the deal will be “a catalyst for our next stage of transformation”. If it is, all well and good. Right now, it’s hard to see where that transformation is going to come from. Wilson probably deserves the benefit of the doubt – his reign so far has been impressive – but he should be under no illusion: the jury is out; merger on its own is not enough.

Ofcom was not supposed to reach this decision

When he privatised the Royal Mail, the Business Secretary, Vince Cable, said the “overarching objective” of the sale was to preserve the universal service obligation, requiring the delivery of mail anywhere in the UK six days a week for a fixed price.

In being so bold, Vince was being the pragmatist and heading off a potentially explosive political row. In truth, by releasing the Royal Mail from Government ownership into the commercial world it was probable the requirement would prove to be a sore – a company charged with making ever-bigger profits for new, hard-headed investors would like the rules rewritten.

But Middle Britain, which sees the universal service as harking back to the innocent, bygone age of the “postie” and a Royal Mail that did not face fierce competition from elsewhere would be outraged. So, we’ve ended up in a situation where the universal service has become a deeply sensitive issue.

A behind-the-scenes lobbying effort has been going on, to try and make MPs and the regulator, Ofcom, see sense – and end the requirement or force other delivery companies to participate. It’s couched in sensitivity – Royal Mail chiefs will maintain until their blue in the face that they want it to stay.

Of course they do. Moya Greene, the Royal Mail’s chief executive, told MPs last week that the universal service cost £7.2bn a year to finance. She went on to say it therefore needed cross-subsidy from profitable urban deliveries.

But you’re the boss, you’re Greene. Ideally, if you could get the service abolished or the opposition compelled to join in, you would, wouldn’t you? Better still from the Royal Mail’s point of view would be the possibility of getting someone else to handle the hot potato and to change the regulations – and deal with the attendant flak.

Which is why the Ofcom decision is not what was meant to happen. The watchdog is unmoved by pointed public references to the threats posed by new entrants, and private complaining about the lack of a level playing field for all the operators. Ofcom does not have to answer to the City or fight other companies – the Royal Mail has a business plan which includes the universal service as it must, and it’s not in any present danger.

As a sop to the Royal Mail, and perhaps mindful of the need to soften any future relaxation and deflect a row, Ofcom has said it will review the factors affecting the company’s ability to meet the universal service. The great battle between public sector provision and hard-headed capitalism continues.