LONDON — U.K. insurer Prudential PLC Monday said it would pay $35.5 billion to buy American International Group Inc.'s Asian life-insurance business, in a deal that would make Prudential an Asian insurance giant and will allow AIG to pay back a chunk of its massive debt to the U.S. government.

The deal, which requires Prudential to launch one of the biggest rights issues in the U.K., caused Prudential's stock to fall as investors worried over a possible dilution of their shares in the company and questioned whether Prudential is overpaying for AIA.

Near the close, Prudential shares were down 73 pence, or 12%, at 529 pence, even though the company also reported good full-year earnings and a recovery from losses in 2008. At 1615 GMT, AIG shares were up $1.41, or 5.7%, at $26.19.

Prudential said AIG will receive a total of $35.5 billion, comprising of $25 billion in cash and $10.5 billion in new Prudential shares and other securities.

After completing the deal in the third quarter, Prudential intends to have a dual primary listing in the U.K. and in Hong Kong.

The cash component of the purchase will be financed through an underwritten rights issue, raising $20 billion (GBP13.4 billion), and through the issuance of $5 billion of senior debt.

The U.S. government is backing the deal. "The administration supports the board of directors at AIG in its decision to sell and recognizes this is a major step in the AIG restructuring plan to de-leverage, de-risk and pay back taxpayers," a U.S. Treasury spokesman said.

The rights issue is close to the size of Prudential's market capitalization, and is just a shade below the record GBP13.5 billion rights issued in November by Lloyds Banking Group PLC (LYG), which is now 41%-owned by the government after receiving state aid during the financial crisis.

Credit Suisse, HSBC and J.P. Morgan Cazenove, as global coordinators and joint bookrunners, will underwrite the Prudential rights issue in full and have committed to provide the senior debt underwriting.

The new shares to be issued to AIG means that AIG will own around 11% of Prudential once the transaction is completed.

Prudential posted a 2009 net profit of GBP1.245 billion on a European Embedded Value basis, reversing the previous year's GBP1.34 billion net loss, helped by a strong contribution from the U.S. business and gains on investments.

On an IFRS basis, the insurer had net profit of GBP676 million, up from a GBP396 million net loss, also helped by increased premiums and investment gains.

Its capital position was strengthened, with capital surplus at GBP3.4 billion, more than double the GBP1.5 billion it had in 2008. It also raised its full-year dividend by 5% to 19.85 pence a share.

Prudential Chief Executive Officer Tidjane Thiam said the purchase "is hugely exciting and a one-off opportunity to transform the group."

"We believe that the combination of Prudential and AIA will create a unique life insurance business with a common set of customer-focused values and heritage," Thiam said.

In 2009, Prudential's Asian business accounted for 44% of new business profit. This will rise to 60% with AIA onboard.

Prudential said the combination will make it the top life insurer in Hong Kong, Singapore, Malaysia, Indonesia, Vietnam, Thailand and the Philippines in terms of new business sales.

It will also have a stronger business China and India.

Apart from those countries, AIA is also present in South Korea, Australia, Taiwan, New Zealand, Macau and Brunei.

Its Web site shows that Prudential Corp. Asia is also in those markets except Australia, New Zealand, Macau and Brunei. Prudential's Asian operations also cover Japan and United Arab Emirates but AIA doesn't.

In its financial year ended November, AIA had operating profit after tax of $1.44 billion.

Panmure Gordon analyst Barrie Cornes downgraded Prudential to a buy from hold rating and cut the target price to 656 pence a share from 732 pence.

Apart from the issue of shares being diluted, Cornes noted some discrepancy in valuations. He estimates the price being paid for AIA indicates a multiple of 1.5 to 1.7 times AIA's embedded value, more expensive than the 1.15 multiple at which Prudential itself was trading.

Still, Cornes also noted that Asian assets trade at even higher multiples.

"The new combined group would become the undoubted leader in the region. But in the short term, we believe that the valuation and execution risks are very real," Cornes said.

Analysts from Keefe, Bruyette & Woods said the deal is "potentially a lovely combination."

"Given that a combination of AIA and Prudential's Asian operations would dominate the agency distribution channels–-we believe door-to-door selling is the best way to tap the Asian "cash under the bed" savings stock--in the faster growing Asian regions, we believe that they would have a competitive advantage," KBW said.

KBW has an outperform rating and target price of 880 pence on the stock.

In a briefing, Thiam said that some Asian insurers are trading at multiples higher than the one derived from the AIA bid, with Ping An Insurance (Group) Co. of China Ltd. trading at 2.63 times its embedded value and Chine Life Insurance Co Ltd trading at 3.22 times.

Thiam said Prudential can have cost savings of around $340 million per year from buying AIA.

Thiam said the purchase of AIA could produce "significant revenue synergies which can increase the new business profit on a net basis by something like $700 million per annum."

"This is primarily about combining two great brands and two great franchises in the most attractive region of the world," Thiam said.

He indicated that job cuts from combing the two companies may be limited.

"AIA tends to be strong where we're not strong, and we tend to be strong where they're not strong," he said.

"If you take for instance, Thailand or the Philippines, they're dominant and we're much smaller. If you take Indonesia and Vietnam, we're really dominant and they're much smaller. So you don't get that much of an overlap between the two footprints. We only have three markets--Malaysia, Hong Kong and Singapore - where the two companies have comparable sizes," he said.

Thiam said it would be hard to put up another acquisition of the scale of AIA, which was worth $35.5 billion. "I cannot foresee another transaction of this scale for a while," he said.

Prudential's offer is a coup for AIG, which had been planning to raise roughly $15 billion through an initial public offering for part of AIA. AIG is under pressure to start repaying the U.S. government, its 80% owner after the extension of up to $182 billion in financial support at the height of the financial crisis in 2008. AIG has drawn about $130 billion of the total.

Prudential PLC doesn't have any links to U.S. insurer Prudential Financial Inc.

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