Aviva buys RAC for £1.1bn

INSURANCE group Aviva today unveiled a deal to buy motoring services group RAC for £1.1bn. The insurer, which also owns Norwich Union, said the addition of RAC's brand and customer base would boost its general insurance business, which covers one in seven of all UK motor vehicles.

The proposed deal has the backing of the RAC board but is very likely to trigger a bid battle for the motoring group. It came after a day of frenzied speculation in the City that a bid was in the pipeline for the 108-year-old business. Shares in the RAC rocketed from 742p to 880p during the day.

Other potential bidders for the RAC could include Cinven, the private equity group which made an unsuccessful offer for the RAC in 1999. Kohlberg Kravis Roberts, the aggressive US buyout firm, failed to win the battle for the RAC's rival, the AA, last year and is also thought to be interested this time. The AA went for £1.75bn to CVC Capital Partners and Permira.

The takeover would likely result in the loss of 1,700 British jobs - 900 would likely be lost through a consolidation of Norwich Union and Aviva support functions, and a further 800 sent offshore. The combined number of staff involved in the proposed acquisition is about 24,000, including Norwich Union Insurance sites at Norwich, Worthing, Sheffield, Perth, Glasgow and Liverpool.

Separately, Aviva revealed a 25% rise in operating profits to £2.34bn today, slightly ahead of the £2.25bn forecast by analysts - the increase was fuelled by a 47% jump in general insurance profits.

Aviva is the first European insurer to report operating profits under European embedded value, a new standard designed to to give investors a more consistent and clear picture of life insurers' profits and financial strength.

Aviva shares fell yesterday amid mounting speculation of a bid as analysts expressed fears that a takeover of the RAC would dilute earnings per share. For Aviva, a bid would represent quite a departure from its insurance operations - but there is some commercial logic to a tie-up.

The AA has built up a substantial car insurance business that makes £50m a year in profits by selling car cover to its 15m customers. And the RAC wants to replicate that success, however boss Andy Harrison has only just wrested back the rights to sell insurance from French-owned Axa Direct.

The RAC owns the British School of Motoring and runs one of Britain's largest vehicle hire businesses. Last year it made profits of £88.6m, up £1.9m on the previous year.

City concern about a takeover, however, could focus on the RAC's £211m pension fund deficit. The shortfall increased last year from some £175m and surprised observers who had expected the fund to have made up ground amid a stock market recovery.

But the RAC revealed last month that it had not managed to ride the market's recovery. Now observers believe the fund's trustees could demand that any new owner of the RAC takes action to plug the funding gap - and this could affect whatever price they pay.