Why The City Hates Aviva plc’s Deal With Friends Life Group Ltd

Aviva’s (LSE: AV) decision to buy peer Friends Life (LSE: FLG) was supposed to mark the beginning of a new chapter for the former. However, few believe that the deal will improve Aviva’s fortunes, and some are now openly criticising Aviva’s decision.

In fact, nearly every City analyst has raised doubts about the deal, which is expected to be approved by shareholders later this month. Many are concerned about Friends’ exposure to the UK annuity market, which has been shaken up by the new pension rules expected to come into force in April. 

Since the Chancellor announced that these rules would come into forced, new annuity sales have fallen by 16% and 15% at Friends and Aviva respectively. 

Still, Aviva believes that it can drive £225m a year in cost saving synergies once it acquires Friends, while there will also be increased benefits to customers as synergies flow through.

Merger and integration costs are set to total £350m, of which £200m will be incurred next year. Aviva itself is planning to cut a further £1.8 of costs out of its own business.

Not convinced 

On paper the numbers appear to make sense, but the City is not convinced. Neither Friends nor Aviva has a good record of being able to seamlessly integrate acquired businesses. There’s no guarantee that it’ll be any different this time.

But the most importation question analysts are asking is: why exactly does Aviva want to do the deal in the first place?

Aviva is halfway through a huge turnaround plan, and many analysts believe that there are bigger issues that the company needs to deal with first, before making such a large acquisition.

Two key issues as improving regulatory compliance across the group and improving Aviva’s organic rate of growth. Indeed, after trawling through Aviva’s 2014 results release and stripping out one-offs, the company’s IFRS operating profit for 2014 missed expectations by 10%. Far from rising 6%, after stripping out one-offs, the company’s operating profit actually contracted by 6%. 

Moreover, some analysts have gone so far as to call this deal a “rights issue in disguise” as Aviva will issue stock to finance the deal. Further, Aviva requires the extra cash the merged entity will generate in order to reduce gearing. 

Concern has also been raised about lack of international diversification Aviva will have once the deal completes. Sure, the combined Aviva-Friends will be a forced to be reckoned with in the UK insurance market. However, the group’s international presence will be limited meaning that the enlarged group will be reliant on UK growth to maintain revenue expansion. 

Only time will tell

Of course, Aviva could prove all of its doubters wrong, but only time will tell if the company is making a big mistake by acquiring Friends.

Still, as always, I strongly recommend that you do your own research before making any trading decision -- you may come to a different conclusion.

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Rupert Hargreaves 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.