Intesa, Generali Are Better Off Apart

(Bloomberg Gadfly) -- Bravo, Carlo Messina. The CEO of Intesa Sanpaolo SpA made the right choice in backing away from a takeover of Italy's Assicurazioni Generali SpA.

A merger of the country's biggest bank  ^before

Investors welcomed the decision, sending Intesa's shares up by as much as 6.4 percent on Monday. Generali, with no other obvious suitor, slumped by almost the same amount.

But the story isn't over for either company. Shares of both are lower now than they were before the talks emerged: Intesa is down by 9 percent, while Generali slumped at one point on Monday to the lowest since December.

The two companies need to fix deeper cracks in their respective investment cases that were thrown into focus by the bid speculation of the past month.

Intesa says its standalone strengths are myriad: The ability to deliver a promised 10 billion euros ($10.6 billion) in cumulative dividends between 2014 and 2017, significant growth in wealth management, cross-selling power as well as revenue growth as interest rates rise.

But these were all under pressure in 2016. Low interest rates helped to reduce revenue by more than 5 percent, with fee income also falling. The main support for dividends came from asset sales, which generated almost 1 billion euros. Prioritizing pay-outs to shareholders may force the company to sell assets that hamper future profitability, according to analysts at Berenberg.

Shareholders now need reassurance on how Messina will use deal-making in future. There's nothing wrong with using M&A to counter a slowdown in your core business -- an acquisition in the wealth-management business might give Messina extra scale to counter slowing revenue growth.

But Generali wasn't the right target, and the communication around the effort was poor. There appeared to be a worrying combination of political pressure and weak stakeholder support.

At Generali, there's a pressing need to fix the problems that made it so vulnerable. Some of the responsibility lies with No. 1 shareholder Mediobanca SpA. Its decision to start cutting its stake to about 10 percent may have triggered Intesa's approach.

But Generali's CEO, Philippe Donnet, has to do more to entrench his team, given the recent departures of his chief financial offer and chief investment officer, and deliver more value to shareholders through cost-cutting or deal-making.

His underlying business has a lot going for it: an above-average return on equity, a combined ratio close to Allianz SE, and new business margins that are catching up to AXA, according to Bloomberg Intelligence.

The shares, however, trade at about 11 times earnings, about half the average of the insurer's peer group, according to Bloomberg data. Narrowing that gap will involve either deeper reductions in expenses, or more aggressive asset sales than the current 1 billion euros of cash the company hopes to raise by shrinking its global footprint.

A deal with another insurer, similar to NN Group NV's purchase of Dutch competitor Delta Lloyd NV, might offer a path to scale and deeper cost cuts.

The good news is a bad deal has been avoided. Now it's time for Intesa to defend its high price tag and for Generali to convince shareholders it's too cheap -- alone, or with others. Just not together.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

1. By market value.

To contact the author of this story: Lionel Laurent in London at llaurent2@bloomberg.net.

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