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Is It Time To Dump Standard Life Plc And Buy Aviva plc?

Investing is hard enough without having to deal with government decisions that throw everything off. That’s what investors in Aviva (LSE: AV) (NYSE: AV.US) and Standard Life (LSE: SL) have been dealing with for the past 12 months… to some degree.

When a particular sector is hit by a government decision, or a merger or acquisition, this Fool believes it’s time to re-assess your portfolio.

It’s a big deal

It’s a big deal in anyone’s language: Aviva and Friends Life Group Ltd look set to come together in a transaction worth £5.6 billion. The takeover will create the UK’s largest insurance, savings and funds management firm.

It’s also a very necessary deal. Many companies in the financial services sector were hit by the pensions annuity announcement in last year’s Budget. Annuity sales at Standard Life, for example have halved in the period. Fortunately for Standard Life the company has recorded growth in its much larger funds management business.

It’s now or never

It’s become clear, however, that now is the time for Aviva to stretch its wings. The company has been looking for an acquisition to bolster its balance sheet and the pensions reform has weakened the market sufficiently to enable that to happen.

Now that a few key stakeholders have thrown their support behind the tie-up, momentum is starting to build. Richard Buxton, from Old Mutual (Friends Life’s eighth-largest shareholder), says it will strengthen both Aviva and Friends Life. In addition, Alastair Gunn, of Jupiter Asset Management, says he is also planning to give his formal approval. He has incidentally been increasing his investment exposure since the takeover was announced. Mr Gunn is particularly excited by the potential of the combined management team.

Not everyone’s convinced about this deal though. Some City analysts have already voiced their concern that the entire transaction is no more than a cash grab for Aviva.

Immediate impact of the merger

So, what does it look like on paper? Well following the purchase of Friends Life, Aviva has promised to cut around 1,500 jobs by the end of 2017. Why so many? Again, Aviva is looking for cost savings. The insurer has said it plans to generate as much as £225m in annual cost savings within that timeframe.

The UK’s insurance companies aren’t alone in feeling the squeeze. Companies in the supermarkets space have had to downsize and streamline in order to find new growth roots. Aviva, though, has really been busy, spending the past two to three years getting rid of various businesses. Most notable of these, of course, was its annuity provider, Aviva US. It’s a problem faced by quite a few companies in the FTSE 100.

Side-by-side

Standard Life and Aviva both struggle with their profit margins. That’s actually been a familiar story in the financial services sector more generally. In fact, if you’re after profits, Barclays and Lloyds Banking Group have looked promising in recent times. If you’re staying with the money managers and insurers it’s worth looking carefully at why you might keep Aviva, as opposed to Standard Life.

For this Fool, the choice between the two boils down to the reason why Aviva is so keen on a transaction with Friends Life — that is that it will pretty much solve the company’s balance sheet problems and should boost the company’s ability to pay a steady dividend.

As it stands Standard Life has a dividend yield of 4%, compared to Aviva’s 3%. Standard Life is sitting on a price-to-earnings ratio of 15, while Aviva has a P/E (by one measurement, anyway) of 14. Both companies look quite similar when placed side-by-side, but when you take the merger into account, Aviva looks as if it could have quite a bit more potential, both from a growth point of view, and with regard to its dividend.

This little story of a big company looking to swallow up a smaller company (for the benefit of investors) is another reason to believe that there is always the potential for capital gains in the market. In addition, finding companies who are actively engaged in pursuing bigger dividends is always an added bonus.

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David Taylor has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.