Investor/An insider's guide to the market: European equity markets have been very strong so far in 2006 as evidenced by the year-to-date gain in the FTSE Eurofirst300 index of just under 8 per cent. The Irish market is up by slightly more than this on the back of good performances from financial stocks, which still account for a high proportion of total market capitalisation.
Merger and acquisition (M&A) activity is proving to be a key theme for European markets in 2006. The telecommunications sector has been a focus of activity and this has spilled over on to the Irish market with first Swisscom's, and now Babcock and Brown's interest in acquiring Eircom.
Earlier this week it emerged that UK insurance giant Aviva, which owns Hibernian, had approached the board of Prudential with a view to merging the two companies. If successful the combined entity would have a market capitalisation of £36 billion (€52 billion). Prudential shares soared on the news and are currently trading well above Aviva's indicative offer.
A feature of the current wave of M&A activity is that many of the deals are being structured as all-cash deals. This is in contrast to the last merger and takeover boom in the late 1990s, when most transactions were financed through the issue of new shares by the acquiring companies. For example, Vodafone's purchase of Eircell was funded through the issue of new (and highly priced) Vodafone shares. Aviva is proposing an all-share deal and is only prepared to proceed on the basis of agreement with the Prudential board. The Prudential board has rejected the approach but Aviva is engaged in a series of meetings with the Prudential's major shareholders to persuade them to back the deal.
Events could, however, overtake Aviva's lobbying campaign due to speculation regarding a rival bid. While Aviva's chief executive, Richard Harvey, said Aviva was not working on sweetening its proposal, some improvement in the initial terms will clearly be required if the merger is to succeed.
Not surprisingly the entire UK life assurance sector rose by 4 per cent on the news, while the broader European life sector rose by 3 per cent. Irish Life & Permanent's (IL&P) shares initially surged by 5 per cent but settled up 3 per cent on Monday.
With a market capitalisation of just under €5 billion, IL&P is a minnow compared with Aviva, Prudential and other large European insurers such as Axa. It is also almost exclusively focused on the Irish market and therefore it does not offer many obvious synergies to a new entrant. Of course the medium-term growth prospects for the Irish mortgage and long-term savings markets are second to none, which clearly makes IL&P an attractive investment proposition.
The company's results for 2005 were very strong and there is every indication that this momentum has carried into 2006. Bank volumes are also growing but profit growth is being eroded due to intense competition.
Reflecting these positive underlying fundamentals, IL&P's shares have been strong over the past year, with a gain of approximately 30 per cent. At a prospective price/earnings ratio of 12 and a dividend yield of 3.7 per cent the shares still offer good value. It is, however, doubtful as to whether the company would be attractive to a potential suitor. Life businesses are usually assessed on the basis of asset values and returns on capital.
Estimating the so-called embedded value of a life business is complicated. Furthermore, IL&P is an unusual hybrid of a bank and a life assurance company. These asset-based yardsticks of value indicate that at its current price IL&P is quite highly valued. Given that a potential suitor would have to pay a premium to the current share price, substantial cost savings and other synergies would be required to financially justify such a transaction.
Investor, therefore, takes the view that a bid for IL&P is unlikely. However, the medium-term prospects for the business are such that shareholders should continue to enjoy attractive returns from the company in its present form.
