The untold story of RSA's bid for Aviva

It took more than a fortnight for insurance’s biggest story to be leaked, but by 8.05am on 13 August 2010 Sky News’ City editor Mark Kleinman had nailed the details and posted them on his blog. RSA had made a £5bn offer for a large chunk of Aviva’s general insurance businesses, which had been almost immediately rebuffed.

The story electrified the insurance sector last summer, excited investors immediately doing the sums on just how much – or how little – they could make on this deal, should RSA take another stab.

Despite the column inches that were generated by the story in the media and in analysts’ reports, the story slowly died a very quiet death. At the end of September, RSA finance director George Culmer admitted “that chapter has closed” and that the 300-year-old general insurer had turned its attentions to other acquisitions in the UK, international and emerging markets.

A week later, RSA had shelled out £259m for Canada’s GCAN Insurance.

Quashing rumours

Yet rumours of RSA’s continuing interest in Aviva have persisted to the extent that RSA chief executive Andy Haste had to reiterate the company’s position in its annual results, published in February: “We’ve moved on from that. We respect their decision and that is history.”

Not that a bid would be easily affordable now, as Aviva stock has soared. The day before the bid news broke Aviva shares were 367.3p. By mid-March their value had grown more than 20% to 441.7p.

During that same period RSA stock only went up a couple of pence, a performance that has led to speculation that the group is now a takeover target. Zurich Financial Services, Finnish giant Sampo and even Aviva have been linked with tilts for RSA in recent months.

So the questions the City and the insurance industry are asking are: what actually happened during those heady days last summer? Can the RSA-Aviva deal ever return? And just what are the chances of RSA itself being taken over?

Suddenly last summer

Aviva’s then chairman, Lord Sharman, was stunned when the letter from his opposite number at RSA arrived. He knew John Napier well. Indeed, two years earlier Napier had succeeded him as chairman at advertising and media group Aegis.

But there had been no hint from Napier that he had designs on core parts of Aviva’s general insurance business. “It came out of the blue,” says a source close to Aviva. “It was a surprise approach and it was clear from the letter that the bid was indicative of what appeared to have been [RSA’s] own calculations.”

RSA had been working on the bid for more than a year, following a presentation from corporate advisers at Rothschild that showed the purchase could provide £300m a year in synergies, or savings in cutting out duplication such as IT and human resources systems. This would benefit Aviva and RSA investors, many of whom appeared on both share registers.

Serious paperwork

Over the next few months sources estimate that about 70%-80% of the work was completed on the bid. But Rothschild does not have the ability to underwrite massive deals. Other banks – in this case HSBC, BNP Paribas and Deutsche – were brought in to underwrite a rights issue to fund the purchase. That means the banks would guarantee the money should investors not stump up the cash from the deal in the form of buying additional, discounted stock.

“Huge amounts of work went into preparing the bid,” says a City source. “For example, there were pages upon pages on the tax and legal structures needed for the bigger group.”

The four banks had also concluded that the deal would be free of any major regulatory hurdles. RSA only wanted the UK, Irish and Canadian parts of Aviva’s general insurance arm, not even the big-name motor insurer RAC. “There aren’t any really insurmountable competition issues, on the margin maybe something [small would need to be sold] in the UK,” says a source involved in the preparations. “The Ireland and Canada territories would basically be clear.”

Competing models

But Aviva was dismissive of RSA’s efforts, the board soon meeting and concluding that what RSA wanted was actually worth closer to £7bn. “There was no discussion before the letter and valuation came in and certain assumptions were just wrong,” objects one opponent of the offer.

Aviva is a composite life and general insurer. Its executives believe that the mix helps the group spread its risk so that it requires less capital on its balance sheet. One internal estimate is that Aviva’s general business can write 30%-40% more business than if it was a standalone company.

In effect, life and general insurance divisions cross-subsidise each other. This balance becomes even more important as the incoming Solvency II directive puts greater stress on the need for capital-heavy balance sheets.

Sources on the RSA side insist that they could not have taken “a softly softly approach” to the deal as this would have risked encouraging Aviva to test the market and start an auction that would push up the price.

“If RSA had gone more openly Aviva could have put an information memorandum out [on the general business] and when there is an auction process typically five or 10 people put their hands up and suddenly you’ve lessened your chances of winning,” explains a key strategist in the talks.

‘Over my dead body’

RSA advisers felt that Aviva chief executive Andrew Moss was under pressure to make a move that would reshape the business. Reuter had reported in February that two top 15 investors in Aviva believed Moss should be replaced, the share price being 38% down on its pre-credit crunch high.

“In Moss’s quest to achieve his ‘One Aviva, twice the value’ strategy [announced in a rebrand in 2008] Moss was nowhere near, more like halving the shares. This £5bn could have helped get them there, boosting their capital ratios and they could have focused on growing their life businesses in continental Europe and abroad,” says one of the offer’s masterminds.

Sources differ on detail but not on the broad thrust of what happened in the fortnight between the letter being sent and story being broken. An RSA insider says that “two or three” meetings were held between the chairmen, with Sharman “effectively saying over my dead body”, while Aviva supporters say that it was just one flat refusal.

Either way, investors were not informed as no consideration was given to the offer and most people at Aviva hoped that the matter was resolved.

The response

When the news came out, the takeover panel could not force a “put up or shut up” deadline on RSA as the offer was not for the whole company. Aviva’s brokers, Morgan Stanley and JP Morgan Cazenove, went straight to the phones to impress on investors the virtues of the group’s composite model and that RSA was striking at the bottom of the market, hoping to get the business on the cheap.

A leading City fund manager who has stakes in both companies says: “Aviva made a very, very good point, that you couldn’t extract that business, that it was not as simple as taking out an operating line. It would have made sense in theory, but when you look at it the extraction was much more complicated as there was capital between the businesses.”

A member of RSA’s team admits to “underestimating” just how effective this argument would prove. Aviva investors were convinced that the bid undervalued the business, while RSA supporters told Haste that he should not be forced into raising the price.

Over that August weekend following the Friday leak, both companies decided how to manage their response to the market. In the intervening weeks Aviva had announced strong interim results, with operating profit at £1.27bn, up 21% on the first half of the previous year.

This gave Aviva the confidence to issue a measured response on Monday 16 August, carefully detailing the composite model’s benefits and taking the opportunity to trumpet the conclusion of a recent strategic review of the business. A source even declares it to be “one of the most brilliantly calm, unemotional, responsible responses” in any deal he has been involved in.

RSA was more hostile, criticising Aviva for a composite model that “no other UK insurer continues to pursue” and that “returns on equity have been behind those of certain other UK insurers in the past three years”. Privately, RSA advisers are believed to have demanded that Aviva open the books in order to prove its [Aviva’s] financial judgments were sound.

A quiet resolution

Both sides believe that the battle was effectively won and lost that on that Monday in August. “I think the mood music coming from Aviva board plus the reception from investors was reasonably against the deal,” says an RSA supporter. “RSA slightly retired hurt to the cricket pavilion.”

With no takeover panel deadline and the offer having been already refused once, the deal essentially disappeared with time. Since then Aviva has grown strongly and RSA has pursued its aggressive acquisition strategy.

Sources who worked on the offer concede that the approach is unlikely to be revived anytime soon, at least not with the same management teams involved. Investors made their choices then and have not encouraged a return.

The hunted?

As often happens in these situations, a wounded predator is immediately seen as prey. Despite the market chatter, little solid intelligence has emerged about a bid for all or part of RSA. Undoubtedly, major rivals will have made calls and run some figures on RSA’s relative strength and whether a bid would be worthwhile.

But RSA is still a strong, well thought of empire worth more than £4.5bn and few banks are willing to lend what it would cost to take it out as a takeover target.

As one analyst puts it: “RSA is a huge business and you would have to pay a decent premium on top of that. I’m not sure the likes of Zurich would be able to do that without raising money and the equity markets are volatile.”

If John Napier gets the kind of letter he sent to Lord Sharman anytime soon, then that would be a real shock.

Mark Leftly is deputy business editor at The Independent on Sunday