Direct Line has officially accepted Aviva’s £3.7bn buyout offer, after the two parties reached a soft agreement earlier in December.
The deal terms remain unchanged and include 129.7p per share in cash, 0.2867 new Aviva shares per Direct Line share, and a dividend of up to 5p per share, subject to completion.
The deal is now subject to shareholder and regulatory approvals.
The shares rose 2.9% early trading.
Our view
The Direct Line board has finally found a price it’s willing to accept, with Aviva’s upgraded deal offering enough juice to get a green light. The next steps are shareholder and regulatory approval, so this isn’t a done deal just yet.
It’s no secret that Direct Line has struggled over the past few years to deal with a challenging motor insurance market, and operational missteps have been a drag on performance. But there’s a fresh management team focussing on core areas like Motor and Home insurance, and recent results have painted a better picture.
Since Motor makes up nearly half of all active policies, unprofitable contracts written over the past 18 months have weighed on recent performance. But aggressive price hikes have finally caught up with inflated costs. Last we heard, new policies are being written at levels in line with a net insurance margin of above 10% - back in the land of profit.
The Motor division isn’t back to delivering positive margins just yet, but that should fix itself over the second half. Direct Line was slower to raise prices than the wider market which means it’ll take longer to feel the benefits than peers.
But, policyholders tend to be fickle and are happy to switch around in search of a better deal. Motor customer numbers are still falling, though the pace is slowing. That’s okay in the short term, while margins are the priority. Further out, we’ll be hoping to see the introduction of Direct Line to price comparison sites as a catalyst for customer growth.
Aside from Motor, performance across other business lines has been pretty good. Home insurance is a big part of the operation and remains profitable despite an uptick in claims inflation. Price hikes are again being called on, but customer numbers are proving a little more resilient than in Motor.
Capital levels are back at comfortable levels, and the board’s decided to keep an added buffer in place while the transformation efforts run their course. It’s also taking a more prudent approach to dividends with a new policy based on paying out 60% of post-tax earnings. We think this is a good move given the market's cyclical nature.
This version of Direct Line looks more attractive than it has been for some time. However, with so much change in senior positions and a turnaround effort that’s far from complete, there are ongoing challenges.
The Aviva deal offers a quick win, and the valuation has risen in anticipation of a successful completion. That limits the upside from here, and investors should bear in mind that there are still hurdles to clear before this deal closes.
Environmental, Social and governance (ESG) risk
The financials sector is medium-risk in terms of ESG. Product governance is the largest risk for most companies, especially those in the US and Europe with enhanced regulatory scrutiny. Data privacy and security are also an increasingly important risk for banks and diversified financial firms. Business ethics, ESG integration and labour relations are also worth monitoring.
According to Sustainalytics, Direct Line’s management of material ESG issues is strong.
Direct Line’s offering of responsible products is adequate, but it falls short in areas such as monitoring, regular training, and thorough processes for investigating complaints. Improvements could be made in data privacy due to a lack of regular risk assessments and insufficient training and auditing on cybersecurity. On a positive note, the company scores well in governance, featuring a strong board structure and remuneration policies linked to appropriate targets, including environmental, social, and governance (ESG) criteria.
Direct Line key facts
All ratios are sourced from Refinitiv, based on previous day’s closing values. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn’t be looked at on their own – it’s important to understand the big picture.
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