- Ageas walked away from bid last month
- Operational improvements must come through this year
The now-withdrawn bid for motor insurer Direct Line (DLG) by Belgian insurer Ageas laid to rest the myth that insurance is not a very exciting business. The Belgian company’s final offer of 120p in cash plus a 28-for-one share swap failed to convince Direct Line’s management and its major shareholders, who include Schroders, Threadneadle and FIL Investment Advisors.
The combination is likely to be remembered as one of the great 'What ifs…' of the insurance market. The £3.1bn deal would have expanded Ageas’ presence in the UK motor insurance space from its current market share of 3.74 per cent. According to NimbleFins, a merged Ageas and Direct Line would have had a combined market share of 14 per cent, taking it past Aviva (AV.) and Admiral (ADM) to lead the pack. Direct Line has lost market share in the past 12 months, and currently sits third overall in UK motor insurance, losing second place to a resurgent Aviva.
That said, there were definite problems with the pricing of the bid. The offer was a bare 16.5 per cent premium to Direct Line’s £2.66bn, 175p a share IPO price back in 2012 – a scant reward for years of patience from its longstanding investors. The key problem for management is that achieving something for its shareholders is going to take heavy lifting in the short term through cost cuts and pulling in new customers. Investors should not underestimate the scale of the challenge.
The company’s newly installed chief executive, Adam Winslow, must also overcome one key problem that seems to be unique to Direct Line; while it has managed to achieve price increases in its new underwriting of 25 per cent, which is in line with the market average, its stronger rivals have driven premiums up by 30 per cent, a feat that Admiral achieved in its most recent results.
There does not appear to be any qualitative difference in their insurance policies that would make one company more attractive to consumers. It simply boils down to the fact that Admiral has been much more consistent with the pricing and volume of its underwriting over the years, plus granting special payouts in addition to its dividend, and possessing a more diversified business model.
Buying market share
However, to thrive the company must win market share in a highly competitive market in a way that does not lumber the company with unprofitable underwriting contracts, which was a key mistake made by the company’s previous management. Despite investing significantly in new pricing, Thomas Bateman, an analyst at broker Berenberg said that the policy count in its core motor business was 2 per cent lower at the last results. “We still find it difficult to envisage a scenario where Direct Line can gain market share in the next 12 months,” Bateman said.
In short, the pressure is on to deliver the new 13 per cent net insurance margin target. This goal is key for the company. Bateman estimates that were this level of net insurance margin to be achieved, the impact on earnings per share (EPS) would be substantial, but only if the company can also cut £100mn from its £895mn operating costs as management says it will. In this scenario, the Berenberg analyst reckons that earnings for 2025 and 2026 could be raised by as much as 19 per cent, overall.
The other important trigger will be whether dividends and share buybacks return in quantity. This will depend on how much free capital the balance sheet generates this year; analysts expect that management will outline exactly how the dividend policy will be implemented at a capital markets day in July. Currently, this rests on an implied payout ratio of 60-65 per cent of earnings under normal conditions, which Berenberg estimates is low enough to allow the return of payments, along with an assumed £250mn of share buybacks over the next two years. The shares are currently valued at a price to book value of 1.16 for 2024.
The challenge for new boss Winslow is significant, but he can take confidence from avoiding a low-ball takeover before his tenure had even properly started. He has also whistled up more reinforcements from his old company, Aviva, by appointing Jane Poole, formerly finance head for Aviva’s UK & Ireland general insurance business, as Direct Line's new chief financial officer. Ms Poole replaces Neil Manser, who had been in post for three years.
A great deal rides on his expertise, but he did build up Aviva’s motor insurance arm at a time when the company was heavily distracted by the sell-off of many of its non-core businesses. If Direct Line can write profitable new business that also allows it to take market share, then investors will be rewarded for their patience.
