Tell Sid…about the Direct Line IPO

RBS is flogging off some of their holding in Direct Line with an Initial Public Offering (IPO) to close on the 9th. On the face of it, there’s a lot to be said for Direct Line, one of the larger UK motor insurers.

Motor insurance is something you have to have. Well, I don’t but I don’t have a car, if you do then you need it and there are all sorts of threatening aggravation if you don’t, which has been recently computerised. So the elasticity of demand is lower than for more elective forms of insurance, like life, house or contents insurance. DL does write a fair amount of that, too, FWIW.

Normally, when you buy shares, there’s some history. You shouldn’t use that because previous performance is not guarantee of future gains etc, but it seems to work often enough in combination with some valuing of the company, leastways with dividend targeting. The trouble with an IPO is you don’t have any history other than what’s in the Prospectus, and the information on valuation is provided by the IPO sponsors 😉 In the end deciding whether to go for an IPO is all about valuation, which is a bastard, because of this (brazenly pinched from the pricing press release):

  • Price range set at 160 pence to 195 pence per share.
  • Offer of up to 500 million shares (the “Offer Shares”) (prior to any exercise of the over-allotment option), comprised solely of existing shares being sold by RBS Group.
  • Expected offer size in the region of 375 million to 500 million shares, representing between 25% and 33% of the existing shares.
  • Over-allotment option of up to 15% of the aggregate number of Offer Shares (prior to exercise of the over-allotment option) granted by RBS Group.
  • The mid-point of the price range implies a market capitalisation for Direct Line Group of approximately £2,663 million.

So you get to make an offer on a moving share price target that can vary by 20% from the low-water mark to the high-water mark. At the top end, if every one goes for it, DL is valued at 2925 million pounds. DL also seems to make a loss on its underwriting, and there’s an OFT investigation into collusion with third party service providers in the motor insurance market. There are a lot of known unknowns.

It’s being offered at less than RSA which is a share I own. I’m thinking of hitting this in my ISA, which happens to have a lot of space in it due to the fracas invoved in moving it from iii to TD direct.

Insurance companies fit my desire for yield, however, I already have a shocking weighting towards insurance in my ISA, despite RSA’s best attempts to reduce it 😉  The sector represents about a sixth of the asset allocation, and this could potentially more than double. OTOH perhaps I should look at my equity holdings as an integrated whole, in which case it’s a lot less bad because my ISA is < 50% of my holdings at the moment and there’s no insurance in the unwrapped part.

Tactically, in the event I do come to the conclusion this works for me, I will leave it to close to the deadline. October has bad memories for Sid because the 1987 stock market crash hammered the BP IPO across Black Monday, the anniversary of which just happens to be when DL shares become freely tradeable (Oct 16th, Black Monday was 20 Oct 1987). And the stock market is frothy at the moment with no good reason I can see. However, that yield is attractive. So far I haven’t fallen into any value traps, but there’s always a first time 😦