Analysts expect OFT investigation into car insurance market to hit Direct Line’s premium income and depress flotation price
The top management of Royal Bank of Scotland’s insurance arm Direct Line stand to rake in millions of pounds after its planned stock market flotation, even as a consumer watchdog found evidence that drivers are being overcharged for car insurance and ordered a detailed investigation into the industry.
RBS could be forced to slash Direct Line’s flotation price after the Office of Fair Trading referred motor insurance to the Competition Commission for an inquiry that could take up to two years.
Only hours after the decision, Direct Line, Britain’s biggest motor insurer, released details of its planned stock market debut. The prospectus revealed that its chief executive, Paul Geddes, and finance chief, John Reizenstein, are in line for big potential payouts following the flotation. The maximum annual package for Geddes, including cash and shares, will be £3.8m while Reizenstein could get up to £2.1m.
Geddes will get an annual salary of £760,000, a bonus worth up to £1.3m in deferred shares, share awards under the long-term incentive plan (LTIP) worth up to £1.5m and a £190,000 pension. Reizenstein’s salary is £460,000, plus a bonus of up to £690,000 in shares and £920,000 under the LTIP. A spokeswoman said three-quarters of the compensation was variable and subject to performance criteria.
Direct Line offers home, travel, pet and car insurance. It also owns the Churchill and Privilege brands and the breakdown business Green Flag. It said it would float at between 160p and 195p a share, with the mid point valuing the company at £2.7bn. Some of the 375m to 500m shares on offer – representing between 25% and 33% of Direct Line – will be earmarked for sale to private investors. The spokeswoman said the sale would be done through brokers, rather than a “man-on-the-street type campaign like British Gas”.
Analysts think that the Competition Commission inquiry will force the flotation price down. The OFT asked the commission to investigate after concluding that insurers were inflating the cost of repairs and hire vehicles by £225m a year. The OFT said it had “reasonable grounds for suspecting that there are features of the market that prevent, restrict or distort competition”.
Sandy Chen at Cenkos Securities said further investigation of the motor insurance industry “will almost certainly mean that forecasts for premium income will need to be revised downwards”. He said that any downward revision of expected profitability would put pressure on the float price. He said it was possible that RBS may have to accept a valuation of less than £2.5bn.
Shore Capital analyst Eamonn Flanagan said the commission inquiry could “put a spanner in the works” of the flotation, London’s biggest for more than a year. “We may see Direct Line struggling to achieve a valuation of over £2.7bn.” But he thought the hoped-for value was achievable. “There is a reasonable level of confidence underpinning the dividend.” He also believed that the targeting of retail investors was a “smart move”.
RBS, which is 82% owned by the government, has to sell Direct Line by the end of 2014 under EU rules after the £45bn taxpayer bailout in 2008. The sell-off is likely to happen in three tranches. At least a quarter will be sold in the first round to institutional investors and stockbrokers, led by Barclays Stockbrokers, which will help private investors buy shares.
Direct Line will assess demand before deciding how many shares it will make available to retail investors. The shares formally start trading around 16 October.
RBS has not said what it will do with the float proceeds but given the pressure on the bank to strengthen its capital position, they are likely to go into retained earnings.”Direct Line Insurance Group has a leading market share and its scale has the potential to deliver a significant advantage,” said Richard Hunter, head of equities at Hargreaves Lansdown, one of the brokers involved in the share offer to retail investors. “The first half of 2012 saw the value raised by London Stock Exchange IPOs at similar low levels to those around the depth of the financial crisis in 2009. Given this, and the current economic uncertainty, we believe that the stock will need to be priced to appeal to investors in order to be successful. We also believe RBS will be determined to achieve an acceptable price for their shareholders.”
The flotation is expected to lead to more job losses at Direct Line, which recently announced 891 job cuts from its 15,000-strong workforce. It hopes to save £100m by slashing costs in marketing and IT to improve profitability as a standalone company.
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