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Zurich, RSA investors face struggle to bridge valuation gap

Zurich, RSA investors face struggle to bridge valuation gap

(Reuters) — Shareholders in British insurer RSA Insurance Group P.L.C. are bracing for a lowball bid from prospective suitor Zurich Insurance Group Ltd., putting one of Europe's largest-ever insurance deals in doubt.

After flagging its interest to the market on July 28, Zurich has until Tuesday evening to make an offer or retreat for at least six months, unless RSA asks for an extension.

Investors in both companies anticipate an offer just ahead of that deadline, enabling further talks between the advisers and top investors, who hold the key to the success or failure of the union.

A deal would make Zurich the leader in British commercial insurance, help it expand further into Canada and Latin America, and enter the lucrative Scandinavian market.

But hopes of a bumper payday among some RSA shareholders are fading in the absence of any serious counterbidders and against an uncertain interest rate outlook that has dented its appeal to buyers, even as a turnaround plan under former RBS boss Stephen Hester has made a good start.

Media reports following the July statement suggested Zurich was weighing a bid of 525-550 pence ($8.24-$8.63) for RSA, for a deal worth more than $8 billion.

RSA's share price, however, has trended down since hitting 528 pence ($8.29) on Aug. 4, its highest since November 2013, and currently trades at 492 pence ($7.72) a share, indicating sliding expectations for a generous takeover offer.

Sources close to the British insurer have put forward various possible prices, as high as 600 pence ($9.42) a share.

But leading investors in the $47 billion Swiss firm are against a bid at 600 pence and have expressed only vague interest in a deal at the lower end of the touted range.

"We expect an offer before the deadline, and have spoken to the company several times and told them not to overpay," said a top-10 investor in Zurich, adding a deal at 525 pence was "bearable" with 510 pence ($8.00) "preferable."

Analysts see little sign of a counterbid, with big European insurers Allianz S.E. and Axa S.A. flagging caution on merger and acquisition activity.

Neither RSA nor Zurich has commented since July, but they have released results suggesting a strengthening in RSA's hand and a weakening in Zurich's.

Six of nine Zurich shareholders surveyed by analysts at Bernstein said they would prefer management to return surplus capital to investors than make a play for RSA.

"I am somewhat disappointed by Zurich's approach to RSA," said Andrea Williams, senior fund manager for European equities at Royal London Asset Management, a Zurich shareholder.

"I got the impression that the desire was to use the excess capital via buybacks or higher dividend and thus return it to shareholders and was not aware that a large deal was contemplated."

The mood among RSA investors is less easy to read.

Some believe RSA is only part-way through a multiyear turnaround plan that could take its shares close to the 600 pence price tag.

RSA's top shareholder — activist Cevian Capital with a 13% stake — is seen to be taking a hard line on price, but the company declined to comment on its return expectations or the likelihood of a deal.

According to the Bernstein survey, RSA owners who do not have an interest in Zurich see 572 pence ($8.98) as an acceptable valuation on average — an 8% premium over Zurich shareholders' valuation — a gap worth £400 million ($627.7 million).

RSA's goals include an underlying return on tangible equity of 12%-15% by 2017 and a tangible equity-to-premiums ratio of 35%-45%.

But some shareholders are less bullish on the outlook and have indicated they might be willing to do business at a more modest price.

"Maybe a bird in the hand would be worth two in the bush," one of RSA's investors said, when asked to evaluate the size of offer premium needed to reflect RSA's future value.

Private equity houses who have flagged interest in insurance acquisitions, including CVC, Permira and Apollo, have yet to show interest in RSA, nor have Chinese or Japanese insurers, despite buying other Western peers.

Still, event-driven hedge funds are not striking bets on an imminent fall in RSA's share price, indicating they expect a bid from Zurich.

About 7% of RSA shares that could be borrowed were out on loan on Aug. 19, according to data from Markit, down slightly from 9.6% at the end of last month, and below a current FTSE 100 average of 8.2%.

William Fitzpatrick, senior equity analyst at Manulife, which holds RSA and Zurich, said an offer of 550 pence appeared to be "fair value" given RSA's attractive Scandinavian and Canadian businesses.

"The industry has been consolidating, it will continue to do so, there is only a handful of these mid-cap players that are available," he said. "550 pence is a sweet spot for both companies."

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