Royal Bank of Scotland (RBS) is selling part of home and motor insurer Direct Line at a price range of 160p and 195p a share. Between 375m and 500m shares are up for sale, representing 25-33 per cent of the existing shares, and implying a market value for the insurer of £2.66bn.
But the announcement, which comes after four years’ attempting to sell the company, couldn’t have come at a much worse time as it coincided with news that the Office of Fair Trading has launched an enquiry into motor insurance premiums amid allegations that policy holders are being over charged.
The worry here is that not only could the investigation take years to reach a conclusion, but there is also no clear idea what conclusions it might reach. None of this is helpful in attracting investors into buying shares in Direct Line, especially since the insurer has not been performing too well itself. True, the combined operating ratio (of claims paid as a percentage of premium income) improved from 121 per cent in 2010 to 100 per cent last year, but this deteriorated slightly to 101 per cent in the first six months of this year against a background of excessive costs relating to personal injury claims. In short, drivers involved in accidents that are not their fault, have been claiming compensation – most infamously for whiplash injuries – where there is uncertainty over whether many of the claims are false or contrived. Moreover, competitors such as Admiral and RSA have more favourable combined operating ratios.
So, how attractive are shares in Direct Line? For private investors the answer is largely academic because the first of three projected tranches will be directed at institutional investors, although Barclays Stockbrokers will lead stockbrokers with a view to attracting retail interest. In fact, depending on demand, the number of shares that RBS makes available to retail buyers could be very few. But this is where it gets tricky because if allocations for retail investors suddenly rise, it could be as a result of institutional investors turning up their noses.
Much uncertainty remains, but some facts are already clear. An implied valuation of £2.66bn represents a premium to Direct Line’s reported net tangible asset value of £2.5bn, albeit down from market expectations of a valuation nearer £2.8bn. But a midpoint valuation of 175p a share values Direct Line at just 1.13 times tangible book value, a significant discount to nearest quoted peer RSA at 1.7 times. But is the discount sufficiently attractive? On this the jury remains out. There isn’t even any certainty what the final offer price will be, and if the take-up is weak then the next two tranches may have to be priced at a bigger discount, and this will drive the share price lower.
