LONDON State-backed Royal Bank of Scotland (RBS) (RBS.L) is to press ahead with the forced sale of its Direct Line insurance division in what could be the biggest listing on the London Stock Exchange (LSE.L) for more than a year.
RBS, which is majority-owned by the government after a bailout during the 2008 financial crisis, was told to sell Britain's biggest motor insurer by European Union regulators as a condition for taking state aid.
Analysts say that the initial public offering (IPO), announced by RBS on Friday, could value Direct Line at between 2.5 billion pounds ($4 billion) and 3.5 billion pounds, but achieving that could prove difficult in tough market conditions that have already scuppered a stock market flotation by Talanx HDIVGT.UL, Germany's third-biggest insurer.
"The recent pulling of the Talanx IPO in Germany does not read across positively for RBS, suggesting it remains a buyer's market, which may frustrate RBS's valuation expectations," Oriel Securities analyst Vivek Raja said.
Talanx abandoned its Frankfurt IPO on Wednesday, saying that investors were demanding too big a discount on the company's valuation relative to what its investment banking advisers had foreseen.
On a conference call with reporters, Direct Line Chief Executive Paul Geddes said that Talanx's abandoned IPO would have little effect on his company's prospects. "Eighty percent of that business is reinsurance and life (insurance), so it's a very different market," he said.
If RBS were to encounter a similar experience to Talanx, it would have the option of re-examining a straight sale or asking Brussels for an extension to its deadline. Under the EU directive, RBS must sell more than 50 percent of Direct Line by the end of 2013 and the rest of its holding a year later.
RBS will market the offer to potential investors over the next few weeks and will be under political pressure to secure a good deal. UK taxpayers are sitting on a loss of more than 20 billion pounds after Britain pumped 45 billion pounds into the bank to secure its future.
The bank's finance director, John Reizenstein, told reporters there had been positive dialogue with investors. "We've had a lot of discussions with them over the past year and there's a lot of interest," he said, adding that the IPO would be expected to complete in the next few weeks.
RBS is planning a three-tranche sale - one this year, one next year and a final sale in 2014. The bank said it planned to sell at least 25 percent of Direct Line's shares in the first tranche, in line with the minimum requirement under stock exchange rules.
One source close to the deal said that the valuation could come in anywhere between 1.5 billion pounds and 4 billion pounds and that RBS could drop the IPO in favour of an outright disposal if it is at the bottom end of the range.
"That is a very low number and you would get a lot of private equity interest at that price," the source said.
The business's tangible net asset value stood at 2.3 billion pounds after September's dividend payout.
Oriel Securities analyst Raja said the shares could be offered at 170 pence each. Based upon the 1.5 billion shares that currently comprise Direct Line's equity capital, that would value the business at 2.58 billion pounds.
With investors wary of unpredictable markets and companies reluctant to sell large chunks of their stock cheaply, Europe has seen little IPO activity over the past year.
Regulatory uncertainty provides a further challenge for Direct Line's flotation. Britain's Office of Fair Trading (OFT) will decide next month whether to call for a full anti-trust probe of the motor insurance market because of concerns that a lack of competition is pushing up premiums for customers.
RBS has stuck to its plan to sell the business on the stock market after interest from private equity firms failed to elicit a compelling offer. Bain Capital and Blackstone (BX.N) had considered an offer for Direct Line, while Apax Partners, BC Partners and KKR (KKR.N) also mulled bidding.
"We believe it has a strong future as a standalone insurance group, continuing to serve its customers well while delivering attractive returns to investors," RBS Finance Director Bruce Van Saun said in a statement on Friday.
Direct Line, which opened for business in 1985 with a single call centre in Croydon, south London, now has more than 10,000 employees selling insurance products to more than 10 million customers across Britain and Europe. Apart from Direct Line, its brands include Churchill, Privilege and the Green Flag roadside recovery service.
The company stepped up a charm offensive with investors this month, saying that it expected to become more profitable after its stock market flotation. It said that it would cut almost 900 jobs as part of plans to deliver 100 million pounds in cost savings by the end of 2014.
Goldman Sachs (GS.N) and Morgan Stanley (MS.N) are joint global co-ordinators, sponsors and bookrunners for the IPO, with UBS also a joint bookrunner. The shares will be offered to institutions and to retail clients through intermediaries. ($1 = 0.6205 British pounds)
(Additional reporting by Kylie Maclellan and Steve Slater; Editing by David Goodman and David Holmes)