How much are Direct Line shares really worth?

In the uber-competitive British insurance market, organic growth is hard won. After a turbulent two years, Direct Line has made itself an easy target for an insurer looking to expand its customer base.
Aviva’s 250p cash and shares approach for its troubled rival represents a 50 per cent premium to the book value forecast by analysts at the end of this year, which falls to 40 per cent next year, when the impact of poor previous underwriting decisions is expected to wash through.
The shares last traded at as high a premium at the start of 2022, when the industry was just coming off a period of ultra-low claims inflation after the pandemic took cars off the road. That was when the insurer reported a combined operating ratio of 90.1 per cent for 2021. During the first six months of this year, it had only just slipped back into profitability with a ratio of just over 98 per cent.
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If Aviva can offer a sweetener, the certainty of cash plus shares in an enlarged insurer should be appealing to Direct Line shareholders beaten around by a series of operational missteps.
For Aviva, the strategic rationale is sound. Overlap in the motor and home insurance markets should give rise to significant cost and capital synergies, which could give Aviva room to increase its offer and still make the deal accretive. Analysts at Berenberg have estimated that the reduction in administrative costs alone could be as high as £130 million, equivalent to about 9.8p a Direct Line share. Analysts at Jefferies are even more bullish, putting potential savings at at least 27 per cent, or £150 million, which it thinks justifies an offer of about 270p a share.
There is also the capital benefit that Aviva has thanks to being more highly diversified geographically and by product line, which carry different risk profiles.
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Under Adam Winslow, the new Direct Line boss and former Aviva exec, Direct Line is attempting to strengthen its underwriting discipline and has unleashed a cost-cutting programme to get the insurer back on a firmer footing and restore investor confidence. It is now back in profitable territory.
In March, Direct Line managed to fend off a second 237p cash and shares bid from Ageas, the Belgian insurer. Aviva’s offer is not only higher, but also potentially more palatable to UK investors more willing to hold shares in the London-listed Aviva than Ageas, whose shares trade in Brussels.
It is an opening shot from Aviva, but one that seems more likely to eventually land.