Terms of a takeover of Friends Life (LSE: FLG) by Aviva (LSE: AV) (NYSE: AV.US) have been finalised and announced today. The deal sees Friends Life shareholders receive 0.74 shares in the new Aviva in return for each share of Friends Life, which values the company at £5.6bn – unchanged from the initial announcement of the proposed deal on 24 November.
Shareholders in Friends Life will also receive a second interim dividend of 24.1p per share, with investors in Aviva due to receive around 12.3p per share as a final dividend in 2014.
The takeover will create the major player in the life insurance market, with the new entity expected to have around 16 million life insurance customers. However, is it good news for existing investors and, crucially, is the new entity worth buying a slice of?
Valuation
The £5.6 billion valuation of Friends Life seems to be a fair price to pay. It equates to a price to earnings (P/E) ratio of around 16 which, for a major insurance company with improving future prospects, appears to be rather reasonable. Indeed, the acquisition perhaps highlights the confidence that Aviva’s management team has in the financial standing of its own business, as well as the progress that has been made since it was forced to slash its dividend in March 2013, which is encouraging for investors in the stock.
Synergies
As with any takeover or merger, the overarching reason for it being undertaken is synergies. In the case of Aviva and Friends Life, this is in the form of cost savings, with the new Aviva set to shed significant amounts of costs when it combines the two companies.
For example, Aviva expects to generate around £225 million in annual cost savings from 2017 onwards, which is perhaps higher than the market was initially expecting, but seems likely to take longer than had been anticipated. A key reason for this is that Aviva is in the midst of its own turnaround and still has to rationalise its own business, so the combination of the two companies must be done while this is ongoing.
Although this could be a potential concern for investors in the new Aviva, the current management teams are being kept mostly intact, with Aviva’s CEO heading up the Group activities, while the CEO of Friends Life is set to become the CEO of Aviva UK Life. This means that there is consistency in the short to medium term, which should help to make the transition to a combined energy much smoother than if one management team had been disposed of.
Looking Ahead
Clearly, combining two vast businesses is a challenging and complicated task. There will inevitably be upfront costs, with a reduction in staff numbers an obvious example. However, Aviva has stated that it believes the combined entity can deliver up to £600 million in excess cash flow per year in the long run. If achieved, this would be great news for income investors and could mean that, in the long term, the dividend prospects for the new Aviva remain highly appealing.
In addition, the two companies were forecast to deliver earnings growth in the mid-single digits over the next year, which is in line with the expected growth rate of the wider market and, with synergies included, it would be of little surprise for the combined bottom line to improve on this over the medium to long term.
So, with a fair price being paid, significant synergies on offer, and the potential for improved cash flow over the long run, the new Aviva could prove to be a strong performer. Certainly, there may be lumps and bumps in the short run, as there inevitably is when two large businesses are combined. However, for longer-term investors, the new Aviva could deliver an excellent total return.
