OFT threat to Direct Line’s £3bn listing

By MARTIN FLANAGAN
Published on 09/09/2012 00:00

ROYAL Bank of Scotland’s plan to float its Direct Line business next month could be hit by a referral of the car insurance industry to the competition authorities.

The Office of Fair Trading has already expressed concerns over certain practices in the sector and is expected to decide within weeks whether the Competition Commission should engage in a full inquiry.

The OFT recommended a “provisional” referral of the sector to the Commission in May, but has been consulting the industry over the summer.

Direct Line includes a strong motor insurance operation, with brands including Direct Line, Churchill and Green Flag, and a referral would impact on sentiment ahead of the estimated £3 billion flotation. There have also been warnings that RBS and its advisers could be tempted by the rebound in Direct Line’s performance to price any issue at the top of the range and thereby deter institutional investors.

Eamonn Flanagan, insurance analyst at broker Shore Capital, said: “There is a good appetite for the Direct Line float, but there are definite dangers. It all depends on the price. Direct Line is a well-run business, with a terrific brand, scale and good market position. But there is a risk RBS could shoot themselves in the foot on pricing. My other ­worry is it also seems the company and its advisers are keen for the City to view Direct Line more as an Admiral-type growth stock rather than an RSA-type dull but safe stock.”

Flanagan said that was “very much a warning bell”, as institutions that might be interested in the float as a good income-yield stock could be put off “by a suggestion of any change of business model to a high-growth riskier operation”.

When the OFT made its initial referral to the Competition Commission, Admiral’s shares were hit because it makes 60 per cent of its money from referral fees to lawyers, credit hire companies and so on. This is an area the regulator is particularly worried about.

One institutional investor in RBS said: “I’m not so worried about RBS overpricing the float as they have been mandated by the European Commission to divest Direct Line. They cannot be too choosy. I don’t think they will achieve a very rich valuation because they don’t have that many cards to play. I’m more concerned about the regulatory uncertainty around the listing. It is likely that the whole car insurance sector will be referred to the Competition Commission, and then there is a real danger that it would delay the divestment.

“It could push it well into 2013 rather than one tranche going now. The lack of clarity on the regulatory issue, including any terms of reference, is not helpful to investor sentiment around the flotation.”

It is believed RBS is relaxed about a possible full regulatory referral of the car insurance market. Direct Line Group has already gone public with its support of the need for an examination of the replacement vehicle and repair aspects of the industry. It is understood the bank believes concerns about possible overpricings of the float are overcooked.

RBS chief executive Stephen Hester’s hopes for the flotation of a first tranche of the shares in October “subject to market conditions” are believed to

have been fuelled by a strong rebound in trading at Direct Line last year. The business made a profit of £454 million, compared with a loss of £295m in the previous year. Hester said this year the turnaround was due to Direct Line writing less risky business and closing some sites.