Killing two birds with a partial IPO

August 6, 2009

SPORTS YACHTINGBanks and insurers are looking for ways to bolster their capital, while having the flexibility to strike if there are acquisitions to be had on the cheap. To achieve these twin goals, Spain’s Santander and now British insurer Aviva intend to float minority stakes in subsidiaries.

Aviva’s chief executive Andrew Moss, who cut the insurer’s dividend with its first-half result on Thursday, argued that it must be ready to take advantage of acquisition opportunities. Moss plans to float 25-30 percent of Delta Lloyd so that Aviva’s 92 percent owned Dutch insurance unit can take part in the restructuring of the Benelux insurance market.

This has echoes of Santander’s plan to float around 15 percent of Banco Santander Brasil. That move will not only allow the parent to bank as much as $4.5 billion from the sale, but will give the subsidiary an acquisition currency, allowing it to go out and buy more assets.

The logic of a minority IPO is fairly clear. It allows parent banks to raise capital by selling shares in more highly rated subsidiary companies, and also gives those subsidiaries a more highly rated acquisition currency. It sidesteps any objections parent company shareholders might have to capital raisings. And it is a way — at least in theory — to reveal the value of a “hidden gem”.

But there are plenty of pitfalls. Creating a listed subsidiary can spawn all sorts of other complexities. 

First, it limits the scope for any synergies between the subsidiary and the parent because of the need for a formal legal separation. Second, the subsidiary’s board needs to be accountable to the minorities as well as the parent. This raises governance issues, not least the question of arms-length transactions and ensuring that the offspring has an independent board. And there is the additional financial penalty of tax leakage if the parent’s stake falls below a certain threshold.

From the parent’s perspective, there is a risk that these drawbacks will lead to the market actually penalising the parent with a “conglomerate discount”. This somewhat defeats the valuation argument for listing a subsidiary.

It is also questionable how effective listed subsidiary stock is as an acquisition currency. Stocks with a small free float are often difficult to value, and can be extremely volatile. Sellers of businesses can be deterred by the idea of taking shares in a majority owned company.

Of course, some of these issues are familiar to Aviva. Delta Lloyd already has minority shareholders and the Dutch insurer has always viewed itself as a separate independent company with a large majority shareholder. This has fuelled disagreements over governance with Aviva, which — like Santander — has gone to great lengths to present a unified global brand.

By giving Delta Lloyd — which tellingly has not yet adopted the Aviva name — more independence and diluting its shareholding, Aviva may put paid to these niggles. But equally it could raise expectations of full sovereignty for the Dutch.

Depending on the reaction to Santander’s Brazilian IPO and Aviva’s Dutch flotation, others may be tempted to follow. Those who do, should weigh up the dangers very carefully first. Buying out minority shareholders down the road isn’t half as simple as selling them stock in the first place.

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