RSA plunges after Zurich volte face

A profits warning at its general insurance business has forced Zurich Insurance to scrap its proposed £5.6 billion takeover of RSA, a day before its "put up or shut up" deadline expired. The deal, which had not yet been officially launched, was worth 550p per RSA share, although the UK firm was said to be holding out for an improbable 600p. Zurich's volte face has wiped £1.2 billion off RSA's market cap, implying that investors think the likelihood of another opportunistic buyer stepping in is slim. But are they right?

The proposed acquisition was first announced back in late-July and RSA has continued to deliver against its turnaround Action Plans since, including the sale of its Latin America business for £403 million cash. And the insurer was desperate to absolve itself of any responsibility for the failure of this deal.

"Zurich has confirmed to RSA that the due diligence findings were in line with their expectations and, while the process had not been finally concluded, they had not found anything that would have prevented them from proceeding with the transaction on the terms announced on 25 August 2015," said the company Monday.

In fact, it's last month's massive explosion in the Chinese port of Tianjin that's ruined a bumper payday for RSA shareholders. Ahead of its third-quarter results in November, Zurich warned that aggregate losses linked to the series of explosions at a container storage station in Tianjin would be about $275 million. In truth, it could be more. US auto liability and other lines of business are behind a further hit of $300 million this quarter, which will tip the general insurance division into a $200 million operating loss for the three months.

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Zurich chief executive Kristof Terryn is reviewing the division and took the decision to drop interest in RSA. He said: "The group's focus instead will be on taking the necessary actions to deliver on the required performance of the general insurance business."

The termination was a surprise to Panmure Gordon analyst Barrie Cornes, who has downgraded to a 'sell’ and reverting to his pre-offer stance of a poor trading and earnings growth outlook. The analyst reckons the shares are worth just 385p, 30% less than the previous price target: "We had thought that the deal would go through which would have been an excellent exit route for long suffering RSA shareholders. RSA will now have to do the tough job of delivering earnings from its reduced size.

"CEO Stephen Hester had almost done a classic turnaround by cleansing the business of poorly performing businesses had selling it shortly thereafter without the need to demonstrate that his strategy was sound. Unfortunately for RSA shareholder it now looks as if he is going to have to deliver earnings growth on the businesses he now has left. Close but no cigar."

On Friday's closing price of 509.5p, RSA's shares were trading on a 2015 price/earnings (PE) multiple of 17.9 times, hardly cheap. Investors rushed to sell on the news and the shares were the third most active blue-chip stock on Interactive Investor. After plummeting to intra-day lows of 390p, bargain hunters chased the shares up to 405p by mid-morning, putting the shares on 14 times forward earnings, in-line with the sector.

However, there's little growth currently pencilled in for 2016 and a prospective dividend yield of 2.4% falls short of the sector average of 3.8%

RSA's turnaround has certainly got a lot harder, with any earnings growth coming from the smaller entity alone. But in a sector rife with consolidation and with RSA back in the shop window, attention will inevitably switch to other potential suitors. Germany’s Allianz and Italian insurer Generali stand out.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.