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Are Aviva plc & Prudential plc Targets For Warren Buffett & Private Equity?

Aviva (LSE: AV) (NYSE: AV.US) and Prudential (LSE: PRU) could do with an investment from the Oracle of Omaha, but will Mr Buffett target the two UK-listed insurers following its latest deal? 

Background

 “Warren Buffett’s Berkshire Hathaway has bought a 3.7% stake in Insurance Australia Group for A$500 million (£249 million) as part of a partnership that IAG said would reduce its capital requirements and support its return on equity targets,” Reuters reported on Tuesday. 

Assuming no discount to their market price, Berkshire Hathaway could take a 3.7%% stake in each of Aviva and Prudential for a total of up to £2.2bn — after all, neither stock is particularly expensive at present. If Mr Buffett is not up for it, there remains a chance that private equity may eye stakes in either British insurer, in my view.

The market doesn’t seem to price in such an outcome, though — and here lies the opportunity. 

Aviva

High synergies is the name of game at Aviva following its £5.6bn takeover of Friends Life. It’s not to say that such a strategy earned it a round of good publicity, but that’s the inevitable way forward, which appeared clear since first deal rumours emerged at the end of November. 

A “capital raising in disguise”, as the deal was labelled by some analysts, the tie-up is more than that — it’s an attempt aimed at rendering Aviva an even more efficient entity on its cost base. The market has yet to be convinced that its strategy would work: Aviva’s stock price has gone nowhere in the first half of the year. 

Its lowly relative valuation, however, could make it an appealing target for Mr Buffett and private equity. When Mr Buffett makes a move, others tend to follow (as usually happens when the laggards try to catch up with the leaders).

An example? 

Apollo Global Management is mimicking Warren Buffett’s investment strategy by using its recent $1.8bn takeover of Aviva’s US fixed annuity business to build an insurance operation with more than $60bn in assets,” the Financial Times reported in November 2013. 

Now it may not be too different: a 4% stake in Aviva would cost up to £800m.  

Prudential 

There’s a lot of interest in the private sector for insurance assets, and Prudential would benefit from an investor like Buffett after the departure of its chief executive,” a senior rainmaker in New York told me in the wake of the IAG deal. “Private equity interest also makes a lot of sense.

Prudential has not done much better than Aviva in recent months on the stock exchange. A 4% stake in Prudential would cost up to £1.6bn, although eager buyers would have saved a fortune had they invested 12/24 months ago. 

The story could repeat in a couple of years’ time,” my source concluded. 

Investors are not entirely convinced that Aviva and Prudential will draw the attention of strategic buyers, but Buffett’s latest move signals that the valuation of the sector’s leaders may appreciate at a faster pace than in the past on the back of investment targeting some of the biggest players in the industry. 

The same applies to several other companies outside the insurance sector that could be targeted by Mr Buffett and private equity: consider these value names, whose trading multiples point to bargain territory in this market.

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Alessandro Pasetti 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.