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RBS May Need to Offer Direct Line at 25% Discount, Investors Say

Royal Bank of Scotland Group Plc (RBS) may have to sell Direct Line Insurance Group Plc for about 25 percent less than the insurer’s estimated market value in its initial public offering, investors say.

Direct Line should be priced at about 2.5 billion-pounds ($4.7 billion), according to JO Hambro Capital Management Ltd. and Rathbone Brothers Plc. That compares with a 3.4 billion- pound valuation published in a report by Commerzbank AG, co- manager of the IPO, sent to potential investors and obtained by Bloomberg News.

“There’s a lack of enthusiasm, unless it’s very cheap,” said Julian Chillingworth, chief investment officer at Rathbone, which has 16.7 billion pounds of assets under management. “The only growth is coming from cost-cutting.”

Direct Line is the biggest motor insurer in a U.K. market that hasn’t made an underwriting profit in the last decade because of surging personal-injury claims. RBS plans to offer at least 25 percent of Direct Line in the share sale as soon as October, in the first step of a European Union ruling that determined it must sell the insurer by the end of 2014 in return for taking state aid during the 2008 financial crisis.

The valuation would be equal to Direct Line’s tangible book value of 2.5 billion pounds, as of June 30, according to company filings. Tangible book value is a measure of its assets minus liabilities and goodwill. Goodwill is the amount exceeding the estimated market price of the net assets paid at the time of an acquisition.

Debt Crisis

Market volatility caused by Europe’s sovereign debt crisis has created a difficult environment for new stock sales in the region. Companies raised $1.5 billion this year in London IPOs, compared with $15.6 billion in the same period last year, according to data compiled by Bloomberg. Direct Line’s IPO would be the biggest in the U.K. since the commodities trader Glencore International Plc (GLEN) raised $10 billion in May last year.

Direct Line Chief Executive Officer Paul Geddes is focusing on controlling expenses and improving underwriting after the firm lost money in 2010 because of rising personal injury costs on motor insurance policies. The firm “messed up” by failing to manage claims and raise premiums quickly enough during the period, RBS CEO Stephen Hester said in 2009.

The insurer, which has about 8.5 million mainly U.K. home and motor insurance customers, returned to profit in 2011 and earnings rose 7 percent to 224.2 million pounds in the first half of this year. It paid out 1.01 pounds in claims for every pound it took in premiums in the six months ended June 30.

‘Improving Trend’

“The record of Direct Line over the last three or four years hasn’t been great, although it is on an improving trend,” said Clive Beagles, whose 1.3 billion-pound U.K. equity fund at JO Hambro beat 97 percent of rivals since 2007. “It would appeal to us if the valuation is broadly around book value.”

Investors in the IPO deserve to buy the shares at a lower valuation than competitors such as RSA Insurance Group Plc (RSA), which has “overseas and emerging-market exposure,” according to Chris White, who manages 550 million pounds at Premier Asset Management Plc.

“Even though premiums have risen sharply over the last few years, the U.K. industry as a whole isn’t making a lot of profit because claims have risen as well,” White said.

RSA gets 65 percent of revenue from outside the U.K., 15 percent from emerging markets and trades at 1.1 times its book value, a measure of its net assets, according to data compiled by Bloomberg. Direct Line gets 85 percent of its revenue from the U.K., according to the Commerzbank sales document.

Dividend Key

Direct Line’s dividend yield will be a key metric for investors, Rathbone’s Chillingworth said. That figure should be between 6 percent and 8 percent to bring it in line with other insurance stocks, he said.

RSA’s yields 8.6 percent, Aviva Plc (AV/) 8.8 percent and Admiral Group Plc (ADM) 4.6 percent, according to data compiled by Bloomberg.

Linda Harper, a spokeswoman for RBS, Britain’s biggest government-owned lender, declined to comment on how the bank values Direct Line.

Morgan Stanley, Goldman Sachs Group Inc. and UBS AG are managing the IPO as bookrunners, while Bank of America Corp., Citigroup Inc. and HSBC Holdings Plc are joint lead managers.

To contact the reporter on this story: Kevin Crowley in London at kcrowley1@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net;

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