Friends Provident 23 Jul 09


  • GBP £0.79
  • Core
  • 2.Medium

Resolution's first major signing?

2009 was meant to be the year in which life insurer Friends Provident (LSE, FP) was free of any distraction to knuckle down and implement a change of strategy, reduce its cost base and galvanize earnings… not so. The company’s determined stalker Clive Cowdery has returned and the spectre of M&A activity looms once more.

Friends, of course, has been here before. Life without speculation is probably a little strange for management and we are convinced that the current round of jousting will not distract them from primary objectives.

The group rebuffed the advances of US private equity group JC Flowers last year (at 150p) without engaging in conversation. Although the offer made by Colin Cowdery’s Resolution this year is significantly lower, CEO Trevor Matthews has given enough encouragement to suggest a deal can be done. Perhaps the Australian is looking for a welcome distraction from this year’s Ashes series.

Resolution has the aura of a Real Madrid. It is in effect a cash rich shell on a mission to combine several high profile insurers with a view to producing a star studded performer. The group are looking to make Friends their first big name signing and should the move succeed other targets will be easier to snare.

The move has plenty of plus points. Revenues across the industry have taken a buffeting and if earnings are to be sustained economies of scale would prove useful. A tie up with Resolution would also quicken the roll out of new products. Amidst tough trading conditions Friends have acknowledged that industry consolidation is no bad thing… but would rather its own terms and as such launched a ‘pac-man’ counter bid – aiming to hunt the hunter.

Resolution’s initial offer was dismissed as “wholly inadequate” and involved offering 0.8 new Resolution shares for each Friends share. Based on current share prices, such an offer would be worth around £1.7 billion compared with Friends’ pre offer market capitalisation of £1.5 billion.

Listeners of Angus Geddes’ weekly audio (and readers of our Market Comment) would have noted that we are earmarking the coming months as a time to prioritize stock accumulation in select areas as the case for a rally in equities during this year’s fourth quarter gains traction. Judging by the timing of this deal, Clive Cowdery may be a subscriber.

As we stand, Friends have dismissed a revised offer which included a cash element, citing concerns over the Resolution’s corporate structure, its dividend plans as well as the make up of the new board. However, the very fact that the two groups are engaging on such matters suggests that a deal is closer than many think. And with Resolutions’ six largest backers controlling 30 percent of Friends’ shares, the walls could be closing in.

Should a deal materialise, it may well revive the fortunes of Friends’ shareholders who have endured a torrid time over the last 12 months despite the attraction of a decent yield. Holding investment portfolios always carries a degree of risk but life insurers have fallen victim to a wave of negative sentiment. The charts tell the story.

Technically, there has been little improvement to the outlook for Friends Provident since our last review in January. As shown on the daily chart, prices initially fell to a low of 50.8p in March before remaining range bound, between resistance at 78.4p and support in the region of 60 to 55p, over the past three months. We anticipate a continuation of this sideways trend over the coming weeks. Below initial support in the 60p region, the next notable area is marked by the October lows at 47.7p.

Trading conditions remain tough. And whilst Cowdery and the market eagerly anticipate 2009’s first half results, events during this year’s opening quarter indicate that for many, short term survival is taken precedence over planning for long term financial security.

A drop of 40 percent in top line sales reflects not only a tough economic environment but also the implementation of a new strategy. The group’s international arm also showed the scars of the economic slowdown with sales down 11 percent on last years fourth quarter. And what’s more Lombard, its tax and estate planning business aimed at high net worth individuals saw its contribution dropped by 16 percent.

But it is not all doom and gloom and as with the broader economy ‘green shoots’ are beginning to emerge. UK individual protection sales strengthened in March with improvements in application counts through the quarter whilst UK corporate sales from new group pensions schemes also provided some reason to cheer.

The UK market is critical to Friends’ long term earnings. Mortgage approvals during the month of June were 17 percent higher than in May and belief that the economy has passed through the eye of the storm is strengthening.

Cowdery’s quest to make Friends’ his first ‘galactico’ signing would no doubt have received additional impetus from recent developments at ground level.

Friends have an agreement in principle to provide protection products in conjunction with Tesco Personal Finance, the burgeoning finance arm of one of the world's leading retailers.

The company has also made several inroads into its reduction of its cost base. As at the end of the first quarter annualised savings were on target to reach £31 million up from £25 million at the year end. Although not detracting from the importance of bolstering top line, today’s cost base reductions will impact earnings for years to come and underscore that Resolution or not, Friends’ is heading the right direction.

And when it comes to the group’s top line Trevor Matthews is understandably buoyed by the upturn in its pensions business. As a result of the financial market instability and seeing real life stories of worthless pensions being played out in the media, confidence in pensions generally has taken a hit. As at the close of 2008, Friends’ portfolio though did not contain equities and was largely bond dominated. And it is no surprise to see the company securing 20 group pension schemes during this years opening quarter.

All factors considered we remain more than comfortable with Friends Provident as a standalone entity or as part of a consolidated group.

Although near term earnings will continue to face headwinds, the benefits of the group’s new strategy will safeguard earnings over the long term. The group’s own investment portfolio will receive an immediate fillip from global economic recovery and when inflation surfaces its head we expect bonds to take a back seat.

Furthermore, the company has now spun off F&C investment group freeing up more time for efforts to be concentrated its core business and global expansion. Whilst Friends’ broad product offering, expanding geographical remit and cost cutting initiatives bode well long term earnings, a tie up with Resolution at the right price may be no bad thing.

From a valuation perspective, at current levels, we believe Friends trades on an undemanding prospective price earnings multiple of around 12 times and the share is ably supported by a yielding of around 5 percent.

From a longer-term perspective, the unyielding downward trend that has spanned over the last two years still remains the main focal point. Although prices recently broke the downward sloping trend line, we believe that before a sustained upward trend can emerge, a prolonged period of base building near its lows is required first.

As such, Friends Provident will remain held in the Fat Prophets Portfolio.

NOTE: Following this report on the 11 August 2009 it was announced that Friends Provident has accepted an offer of £1.9 billion from Resolution having initially resisted an approach.  Given our healthy exposure to the sector we decided to accept the 79.4 pence per Friend Provident share which was offered.  As such, Friends Provident was removed from the Fat Prophets portfolio on the 5th November 2009.  


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Snapshot FP

Friends Provident
Market Capitalisation £1.68bn