Will the hunter become the hunted at Colonial?

This has increased the appeal of some banks (see our article on page 11) and other financial services providers, including Colonial Ltd.

Acquisition under scrutiny

While Colonial may be on the watch list of potential suitors, this partly explains why it's also on the acquisition trail. The purchase of Legal & General Australia is the most recent insurance investment corporate play on our shores and one that analysts have questioned due to the price paid and the method of funding.

What it does do is demonstrate the willingness of Colonial management to expand operations as it moves to ensure the group's future - either you get bigger or you get smaller and then get eaten. In past cases, such acquisitions have delivered - the acquirer has usually been successful in cutting costs and gaining substantial rationalisation benefits from a broader market access.

Legal & General is Australia's 11th largest life insurer by premium income, offering risk, superannuation and investment products. Importantly, it has a strong independent agent distribution system that should assist in developing sales for the strong 'First State' investment management brand name. It also has a business that's complimentary to Colonial, focusing on risk, single premium and annuity business, traditionally a weak area for Colonial. Despite the price, Colonial should be able to extract shareholder value from the acquisition.

The $892 million purchase will be financed through the placement of 64.7 million shares to institutions at $4.90, raising $317 million. These shares will then participate in a rights issue of 1 for 5 of 142.5 million shares at a price of A$4.50 for Australian holders and NZ$5.25 to NZ shareholders. The total funds of $959 million will fund the acquisition and contribute capital costs towards Colonial's joint venture in China.

Colonial a bigger pill

This acquisition is defensive as well as aggressive in the sense that Colonial is now a far bigger pill to swallow for a potential acquirer. AMP holds 6% of issued capital! By issuing equity Colonial is able to maintain debt at current levels, allowing for further gearing from a higher equity base in the future, particularly if further acquisition opportunities come into view.

The recent announcement of the rights issue and placement has resulted in a price retracement to current levels from its recent high of $5.98, as the markets realises that this will effectively put a cap on the stock in the short term. But it doesn't detract from the quality of the core business including;

• Ownership of the Colonial State Bank which has experienced falling cost-to-income ratios and has a highly attractive mortgage market share in NSW.

• Attractive overseas divisions in Colonial UK and CMG Asia which offers insurance products to the Asian region. This includes the recent approval given by Beijing to allow Colonial to sell insurance in China.

•An international funds management group with over $27 billion in funds under management. This includes the State Bank's highly successful investment management team of First State Fund Managers.

The group should benefit from favourable economic fundamentals of low interest rates (although there's now some doubt as to how long this will go on for) and strong performances from world equity and bond markets which have assisted their banking and insurance/investment operations.

Every takeover means there's one less target

The group is also well-managed and unlike many of its competitors, has effectively started to sell its product range to banking customers.

Nobody wants to rely on just mortgage income anymore so there's a strong drive to develop other income streams. It's this that makes Colonial attractive, having successfully developed an 'allfinanz' (all in one financial packages) approach to banking, providing a diversity of income that others must envy.

It will be a while before the merits of the L&G acquisition are proved. But Colonial has a strong business base, sound management and another significant factor in its favour - for every takeover, there's one less target and when supply is short we all know what happens - prices rise. BUY the ordinary shares - cum rights below $4.80.