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LONDON -- Some say it is because they fear there will be poor institutional demand. Others see a government inspired PR move, echoing the "Tell Sid" marketing campaigns of Margaret Thatcher's shareholder revolution. Either way, the flotation by RBS (LSE: RBS.L ) of shares in its Direct Line insurance subsidiary promises to be a rare opportunity for private investors to buy into an IPO.
Already, some retail stockbrokers such as Hargreaves Lansdown have started garnering investor interest.
Whether it's a good opportunity or not will depend on the float price. But to my mind, there is good reason to think the company will be sold at a low valuation, and it's worthwhile registering your interest and having funds in place.
The company intends to float at least 25% of its shares. RBS is a forced seller, as a condition of receiving state aid in 2009 was to cede control of Direct Line by the end of 2013 and sell it fully by 2014. Private equity groups are circling, but the bank is ploughing ahead with a flotation.
Direct Line is the U.K.'s leading personal motor and home insurer with market shares of close on 20%. It is also No. 1 in Italy and No. 3 in Germany in direct car insurance. It sells through multiple distribution channels including direct to consumers, via price comparison websites, and through branches of partners such as RBS itself, Nationwide, Prudential, and Sainsbury.
Having run up against a time constraint, RBS will have to price the float cheaply.
It's a bad time generally for flotations. Markets are soft and unpredictable, and IPOs have been few and far between with a number of high-profile failures. Furthermore, it's a particularly bad time to float a motor insurer. Rival Admiral warned only last week that margins were going into reverse as insurers were squeezed between aggressive competition and rising claims.
RBS must make a success of this initial flotation. Not only is its reputation on the line, but it has to sell the balance of the company in barely more than two years' time. That will be a daunting task if the shares don't perform well post flotation, and it would be a headache for the company if it can't dispose of the remaining stock at a higher price than the initial float.
Just being cheap does not make it a good investment. But Direct Line has some valuable features:
- Its leading position and brand in its core U.K. market is an important competitive strength, even though the market is mature and saturated.
- It can increase earnings through cost savings. It is targeting 100 million pounds of annual savings, to ratchet up return on tangible equity to 15% from its current 10%.
- The industry is cyclical, and Direct Line should benefit from an eventual upturn, most importantly in the returns from its conservatively managed investment portfolio.
- It's possible that, free of the constraints of RBS ownership, a well managed general insurer with a leading U.K. market position might explore other avenues of growth.
Most city pundits anticipate the flotation to value Direct Line at between 2.5 billion pounds and 3.5 billion pounds. That corresponds to a multiple to tangible book value of 1.1 to 1.5, and a prospective price-to-earnings (P/E) ratio of 8 to 10. By comparison, RSA trades on a multiple of around 1.7 times book value and a prospective P/E of 10.
The expected valuation is a far cry from the 7 billion pounds that RBS tried to sell direct line for in 2008. What's good news for Direct Line investors is bad news for the bank and another reason to sell RBS.
The company has indicated a dividend payout ratio of 50% to 60%. That suggests the shares would yield in the range of 5% to 7.5%. Yield is one of the most attractive features of the sector: RSA's projected yield is 7.7% and Admiral's 7.3%. At the lower end of the valuation range, Direct Line could look very attractive.
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