The Anglo File: Prudential's Egg Soon to Float

The U.K. insurer's hot online bank faces rising costs, steep competition and uncertain future profit.
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LONDON -- It came as no great surprise when U.K. insurer

Prudential PLC

confirmed Thursday that it has decided to float a minority stake in its online banking division called

Egg

. It also wasn't much of a shock that the break-even date for Egg is looking further off.

Aside from the fact that Egg's expected flotation has been widely reported in the press (

TSC

discussed the possibility in

August), the sheer success of the online bank to date has meant the floating of all or part of it was unlikely ever to be far from the minds of its creators.

Since its launch little over a year ago, Egg has gained 800,000 customers and deposits of 7.6 billion pounds ($12.2 billion). Egg's mortgage book stands at 452 million pounds and personal loans have reached 227 million pounds. Last September, Egg launched an Internet credit card that now has over 250,000 account holders.

Not surprisingly, the costs associated with developing Egg have also risen. In 1998, Prudential spent 77 million pounds on Egg, and in 1999, this more than doubled to 150 million. Costs this year are expected to be around 150 million pounds again.

The Egg flotation overshadowed all the excitement about the 1999 earnings results for Prudential, which is currently seeking a U.S. stock listing. Prudential's operating profit, before amortization of goodwill, investment in Egg and the restructuring costs of its U.K. business, grew 6% to 996 million pounds. Prudential shares closed down 1.1% at 929 pence.

At the same time that Prudential gave the impressive figures for the online unit, it said "current Egg plans are to break even in the latter part of 2001." Although Prudential has not strictly deviated from its aim iterated in July to "break even in 2001," the insertion of the words "latter" and "current plans," together with the cost of the investment coming at the high end of expectations, certainly signals that the fertilization of Egg is proving an expensive business.

And these targets should be considered moving ones.

"The whole online

banking market is constantly changing, and in this kind of environment, these intentions are subject to some fluidity," says Angela Coad, an analyst at

Commerzbank

, which has no investment banking relationship with Prudential. Coad has a hold rating on the insurer's stock.

Indeed, although Egg has first-mover advantage and a good brand name in the U.K., competition is growing everyday with the recent launches of

Halifax's IF.com

and

Abbey National's cahoots.com

. Inevitably this will force Egg to offer more and better products if it wants to retain and grow its customer base, all of which costs money.

Furthermore, Prudential said the expected break-even date is dependent on the cross-selling of its financial products, something that has yet to materialize in any significant way in traditional banking.

While the exact timing of when Egg will be in the black is open to question, what is not in doubt is that the valuation of Egg will be huge. Estimates range from 1 billion to 6 billion pounds, depending on whom you talk to.

Morgan Stanley Dean Witter

calculates that the market is valuing Egg as high as 5 billion pounds. Prudential's market capitalization has grown 43%, while the life sector index has grown just 8%. Assuming it is Egg that is causing this gap between the Prudential and the life sector, "the market is now valuing Egg in the region of 4-5 billion pounds," the bank notes in a research report this week. Morgan Stanley has an outperform rating on Prudential and has no investment banking relationship with the insurer.

To take advantage of the estimated 450 million pounds that a sale of 15% of Egg could generate and avoid any potential nasty surprises of investing in a loss-making bank, one always has the option of sticking with the boring, traditional side of things.