Investment Column: Prudential investors face a tricky choice
Tuesday 01 June 2010
Our view: Sell
Share price: 541.5p (-6p)
prudential has produced a swathe of pretty graphs to show why the $35.5bn (£24.5bn) takeover of Asian insurer AIA is a thoroughly good idea. Unfortunately they have failed to convince the City and the company is desperately trying to negotiate a reduction in the price. What are shareholders to think?
It is all but certain that the original $35.5bn deal is dead. So, in considering tactics, we will base our thinking on a price of around $32bn – in line with the 10 per cent cut the Pru is trying to negotiate.
At that sort of level, AIA looks much more attractive, although it is still not cheap. Even if profits at AIA grow by 20 per cent this year (a big ask) the acquisition is on a multiple of 18.6 times earnings. But insurers with earnings dependent on volatile markets are usually valued on a multiple of their in force book of policies. If you pay one times "book", you're allowing for no growth in the business. Were AIA priced at $32 bn, it puts the operation just ahead of 1.4 times book and the deal starts to make a bit more sense.
But falls in world markets suggest AIA would struggle to reach such a price if its US government-owned parent – AIG – floated the business. So the price at $32bn looks like a full one. And while the Asian region does offer more growth prospects than the US or Europe, Prudential-AIA still has only limited exposure to the two really exciting markets: India and China. Hong Kong and Singapore, for example, might look good, but they are mature. In China, the merged company might be the biggest foreign group but compared with domestic players such as China Life, it will be a tiddler.
All things considered, we consider a price of about $30bn – or about 1.35 times book value – to be more sensible. But unless Prudential is an awful lot better at negotiations than it has so far shown, that is unlikely to be achieved.
Even if you accept that AIA offers exciting growth potential in the world's most dynamic economic region, the elephant in the room is this: do we trust Prudential, under its current management, to successfully integrate the two businesses?
It is worth looking back at Prudential's history, which has been characterised by a series of strategic missteps and blunders: from being by a distance the most active mis-seller of personal pensions, to its decision to fight and then drag its heels over the mis-selling review, and from the mishandling of the proposed takeover of American General to the miscommunication of its 2004 rights issue.
Management teams may have changed, but this is a company that appears to have hubris embedded within its DNA. And the current disastrous miscommunication of the AIA deal is the most egregious manifestation of that tendency for several years.
At the very least, Prudential investors need the company to conduct a thorough review of all its advisory relationships. Heads should roll. And they will have to roll if Prudential is to make a success of this deal, even at a lower price.
What is worrying about Pru's handling of the deal is that it seems to be unaware it is a "people" business. And its high-handed tactics are dangerous. Mergers are often sold as "one plus one makes three" because of synergies and other benefits. But, in insurance, one plus one may not even make two if you lose your most productive salesmen.
This is a region where loyalty counts. AIA has already lost two executives. They may be followed by Mark Wilson, its chief executive. Rivals are circling around others. Pru does have an integration expert in charge of putting the companies together, but some attrition is inevitable. Put simply: the integration risk is huge. We fear that, while Pru does have some good people, the company may not be up to it.
So, where do investors go? First, the votes. Markets have fallen by more than 15 per cent since the deal was announced, which effectively increases the cost to investors of AIA. At a reduced price, the deal is still no steal and given the risks we have highlighted, our advice would be to vote against.
If the deal does fail, we would look to sell when the shares have settled. We would switch into Aviva, which has a stable and consistent strategy. If the deal succeeds, shareholders are over a barrel with the rights issue. Eleven for two at a deep discount leaves them on the horns of a nasty dilemma: selling your rights is not likely to generate much profit and your investment will be badly diluted. But we would still sell the rights. There is an argument for supporting British companies with the gumption to take risks and become major players on the world stage. But look where that thinking got Royal Bank of Scotland. If the deal is not a good one, shareholders should pass and Prudential has made too many slip-ups. Sell.
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