Prudential's takeover of AIA collapses

It was meant to be a deal that would make Prudential the undisputed leader in Asia's life insurance industry and more than double the UK-based insurer's pre-tax profits by 2013. But yesterday, the confirmation finally came that its high-profile acquisition of AIA Group, the Asian life insurance business wholly-owned by American International Group (AIG), had fallen apart and will not happen.

The collapse had been brewing for some time and began to look like a distinct possibility when it emerged that Prudential had last week asked AIG for a reduction in the acquisition price from the originally agreed $35.5 billion to $30.4 billion. Quite predictably, AIG issued a statement late Tuesday saying it would not consider revising the terms of the deal.

Yesterday, Prudential issued a statement saying that it was in negotiations with AIG to terminate the acquisition agreement. However, it was clear that the "negotiation" element was a pure formality and that the deal was now truly dead.

"While AIA was an excellent opportunity, since we announced the potential transaction we have seen significant falls in the markets. We listened carefully to shareholders over the price and initiated a renegotiation of the terms with AIG. Unfortunately, it has not been possible to reach agreement so we feel it is in the best interest of our shareholders not to pursue this opportunity. We are therefore withdrawing from the transaction," Prudential's chairman Harvey McGrath said in yesterday's statement.

And then early this morning came another statement in which Prudential confirmed that its agreement with AIG to take over AIA "has been terminated".

It will pay AIG a break-up fee of approximately £152.6 million ($222 million), although the costs in terms of Prudential's loss of reputation and brand image are likely to be much more far-reaching than that.

Tidjane Thiam, who took over as CEO of Prudential only in October last year, has staked his career on the AIA transaction and has worked increasingly frantically over the past three months to keep the deal together while the criticism from the firm's existing shareholders mounted and the equity markets turned against him. Observers now widely believe that he will lose his job. And chairman McGrath, who has repeatedly voiced his support both for the transaction and for Thiam, could be following him out the door.

There are also reports in the UK press suggesting that Prudential itself could now become a takeover target. To be sure, the firm does look vulnerable in Asia, where its biggest rival AIA would have gained valuable insights into its competitor as the work to gain acceptance of the deal has been ongoing. 

AIA, on the other hand, may have gone strengthened out of the ordeal as Prudential has spent the past month marketing it to the world and telling everyone what a great asset it is. As a result, investors should now be well aware of its qualities.

There are likely several reasons for the collapse of the acquisition, and market conditions, as citied by Prudential, probably played a role. However, it seems the key reason was a growing lack of confidence among Prudential's existing shareholders in the execution of the deal. The fact that the management embarked on such a large and costly transaction without having first ensured the support of its largest shareholders did raise eyebrows and as more and more shareholders openly voiced their discontent in the media, it became increasingly difficult for Thiam and company to keep the deal together.

The delay in publishing the prospectus for the rights offering after the Financial Services Authority (the UK regulator for the financial services industry) expressed concerns about the minimum regulatory capital levels at the combined group, also gave rise to doubts. The issue was sorted out partly by changing the structure of the planned fundraising and the deal was put back on track, but the slight delay prompted people to question the other approvals necessary for the acquisition to go ahead. Or as one observer put it: "How would Prudential be able to get the acceptance for the deal by 15 different regulators in Asia if it cannot even get its own regulator in the UK on board in time?"

The £14.5 billion ($21 billion) rights issue to pay for the transaction was another worry. Some shareholders would have had to put hundreds of millions, even billions, of dollars, on the table to take up their share of the offering and prevent being diluted - a task made more difficult by the fact that the value of many of their other assets were falling in line with the stock markets.

Prudential's shareholders were to have voted on the acquisition and the rights issue at an extraordinary general meeting on Monday. They will now not get the chance to do that and we will never know how much support there really was for the deal. However, the attempt to renegotiate the price tag with AIG clearly suggests that the Prudential management didn't think it would get the necessary 75% to vote in favour without sweetening the deal. Unfortunately, AIG's CEO Robert Benmoche wasn't prepared to give up the sweet deal that he had secured and which would ensure $25 billion in cash up front to be used to repay part of the $182.3 billion of bailout money that the company received from the US government in 2008. Aside from the overall lower price, Prudential's revised bid would have resulted in only $23 billion of cash and the rest in shares.

Prudential's share price jumped 6.8% last Thursday when the attempt to renegotiate the price leaked to the market and speculation that the deal was falling apart was taking off in earnest. It jumped another 6.3% on Tuesday after AIG rejected the proposal, but fell 2.5% yesterday to 561 pence. The share price dropped 19% in the two days after the transaction was first announced on March 1 to a low of 487.50 pence, but had recovered part of that since. Trading in the stock has been extremely volatile throughout this period.

Aside from the future of Thiam and McGrath, the investors' attention will now turn to the several other issues that remain unresolved. Chief among them is what will happen to AIA. AIG still needs to raise capital to repay the government and an initial public offering of AIA, which was in the works before Prudential made its move, is still a possibility. A banker said yesterday that should AIG decide on that option, the Hong Kong IPO could be resurrected quite fast - perhaps by September or October.

Meanwhile, Prudential will need to decide what to do with its brand new listings in Asia. The UK-listed company obtained a dual listing in Hong Kong and a secondary listing in Singapore last week as part of its attempts to ensure sufficient support for the $21 billion rights issue. However, since the Hong Kong listing was via introduction only, meaning no new shares were issued, trading volumes have been thin so far. And they are likely to get even thinner now that the acquisition of AIA is off. Clearly, the draw of the Prudential stock was the exposure it was meant to give to AIA - without that the Hong Kong shares are likely to become orphaned unless Prudential does a share placement to ensure there is proper liquidity in the stock. And even if it does, it is questionable how much additional interest there is among Asian investors to hold shares in Prudential, especially since most of those who are interested would already own the stock in London. 

The rights issue was to have been fully underwritten by Credit Suisse, HSBC and J.P. Morgan Cazenove, who will now miss out on hundreds of millions of dollars of underwriting fees (admittedly to be shared with just over 30 sub-underwriter, but still a decent sum). Credit Suisse and J.P. Morgan Cazenove also advised Prudential on the acquisition together with Lazard.

On the other side of the table, Citi, Deutsche Bank and Goldman Sachs were advising AIG together with the company's long-term adviser Blackstone. Morgan Stanley has been involved in the negotiations through its role as an adviser to the US Federal Reserve with regard to the government's controlling stake in AIG.