Prudential snaps up AIA shortly before a planned IPO

The agreed merger takes bankers and investors by surprise and may leave Hong Kong without a flagship IPO this year.

After a weekend of speculation that eventually turned into more substantial reports, UK-based Prudential plc yesterday confirmed that it has reached an agreement to merge with AIA Group, the Asian life insurance business wholly owned by American International Group (AIG), in a transaction valued at $35.5 billion.

The merger, which ranks as the largest insurance M&A ever, will create a life insurance powerhouse in Asia with more than 20 million customers and businesses in 15 countries. It will also provide AIG with much needed cash as it strives to repay the $182.3 billion of bailout money that it received from the US government in 2008. However, the development deals a blow to the Hong Kong stock exchange, since the initial public offering that AIA was working on will now not happen. At a talked-about size of more than $10 billion, the deal had the potential of being the largest IPO in Asia this year and it was widely anticipated by investors.

AIG's decision to go with a trade sale of AIA instead also means a significant loss of fees for the nine investment banks mandated to arrange the IPO. Several of the banks do have roles on the merger, according to sources, but the reimbursement on an M&A is typically significantly smaller than the 2.5%-3% fee that is the norm on a Hong Kong IPO.

Prudential said in a statement filed with the London Stock Exchange, however, that "in recognition of the importance of Asia to the combined group (it) intends, in due course after the completion of the transaction, to seek a dual primary-listing on the Hong Kong stock exchange". The merger, which requires approval from Prudential's shareholders (the deal and the financing) as well as Asian regulators, is expected to be completed in the third quarter this year.

The $35.5 billion price tag comprises $25.5 billion in cash and $10.5 billion in new Prudential shares, mandatory convertible securities and preferred shares. And rather than a straight-forward takeover, the transaction will be effected through the acquisition of both Prudential and AIA by a new holding company, currently named New Prudential. The new company will eventually assume the name Prudential plc and, like its current namesake, it will be listed in London and on the New York Stock Exchange (through American depositary receipts).

Observers referred to AIG's change of tack as a smart and sophisticated move that will allow it to realise more immediate benefits. While expectations were that the IPO would value AIA at up to $35 billion on a fully-distributed basis, a trade sale will allow AIG to sell the entire company in one go, avoiding the execution risk that may come with having to rely on later follow-ons to complete the sell-down, and won't require an IPO discount. It will also result in a lot more cash up front.

And, at the same time, AIG will benefit from the potential upside offered by the Prudential shares that it will receive as part-payment.

Indeed, AIG initially attempted to offload AIA through an auction process, but that plan was called off in March 2009 as it didn't think the bids were high enough, which is perhaps not too surprising given that the sales process was launched at the very bottom of the global stockmarket rout and AIG itself was at the epicentre of the financial crisis.

It then decided to go for an IPO instead and, in June last year, mandated Deutsche Bank and Morgan Stanley as joint global coordinators to help arrange a listing. Last month it added another seven bookrunners to the deal line-up, giving no hints that it was also keeping the door open for an M&A transaction. And it is probably an understatement to say that yesterday's merger announcement would have come as a surprise to several of the banks involved in the IPO.

However, Credit Suisse has been advising Prudential since it made the first bid in early 2009 and is now acting as a joint global coordinator and underwriter for the $20 billion rights issue and the $5 billion senior debt that will be sold to help finance the merger. The other joint global coordinators and underwriters working with Prudential are HSBC and J.P. Morgan Cazenove.

And, according to sources, Citi, Deutsche Bank and Goldman Sachs are advising AIG together with the company's long-term adviser Blackstone, while Morgan Stanley as an adviser to the US Federal Reserve is also assured of a role.

For the other banks that were mandated last month -- Bank of America Merrill Lynch, CCB International, ICBC and UBS -- the celebration of having been picked for what would quite likely have been the largest IPO in Asia this year, turned out to be short-lived.

Prudential was one of the bidders in early 2009 and, aside from doing a lot of due diligence then, it is now also benefitting from the work that AIA has done to prepare for an IPO.

"Time has helped the (Prudential) board get more and more comfortable with the asset. They are paying more, but the market has recovered, their own share price has recovered and they have the benefit of a cleaned up asset and extended due diligence," said one banker.

"This transaction is hugely exciting and a one-off opportunity to transform the group," noted Tidjane Thaim, CEO of Prudential. "The combined group would have 60% of 2009 new business profit coming from Asia and puts us in a strong leadership position in all the critical growth markets in the region."

According to the statement, New Prudential will have a market leading position in seven Asian countries (Hong Kong, Singapore, Malaysia, Indonesia, Vietnam, Thailand and the Philippines) and will also be the leading foreign life insurer in China and India.

Meanwhile, the poor start to the Hong Kong IPO market this year may have helped convince AIG that a listing of AIA was a less certain route. Of the 11 listing candidates that have been in the market so far this year, several have been priced at the low end, a couple have been pulled and most of them are trading below issue price. The largest newcomer, Russian aluminium producer UC Rusal which raised $2.2 billion, was down 27% as of last Friday.

"It doesn't feel like the market is very supportive, especially if you want to do a large offering of up to 50% (of a company)," the same banker added.

According to a statement filed by Prudential to the London Stock Exchange, the purchase price translates into 1.69 times AIA's embedded value as of November 30, 2009, and 25.4 times its new business profit as of the same date. This compares with the 2.5-2.7 times embedded value that the fast-growing Chinese insurance companies are trading at and the 2.7 price-to-embedded value multiple that French insurance company AXA paid when it bought out its partner from its Asia-Pacific business in December.

The transaction is expected to result in annual cost savings of about $340 million before tax within three years of completion, and will also allow for revenue synergies through enhanced agency productivity, shared bancassurance relationships, enhanced customer cross-selling and synergies across asset management activities.

Not everyone was immediately convinced about the merits, however. Prudential's share price fell as much as 14.5% after the announcement and closed 12% lower at 530 pence. AIG did significantly better, gaining 4.1% to $25.78.

The decline in Prudential's share price was likely partly due to the potential dilution from the large rights issue that it will need to complete to finance the merger and the fact that AIA is being acquired at higher multiples than what Prudential is currently trading at. But one observer also noted that there was a lot to take in straight away and suggested that the share price will recover once investors begin to understand the long-term value creation.

¬ Haymarket Media Limited. All rights reserved.
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