UK insurer Prudential Plc is pulling out of its bold $35.5 billion takeover of AIG's Asian life insurance arm, ending a 3-month battle with shareholders who had argued the deal was over-priced.

The widely expected move on Wednesday came after American International Group (AIG) rebuffed Prudential's attempt to lower its offer, and could pave the way for American International Assurance's (AIA) potentially up to $15 billion IPO.

We listened carefully to shareholders over the price and initiated a renegotiation of the terms with AIG. Unfortunately, it has not been possible to reach agreement, Prudential Chairman Harvey McGrath said in a statement.

We are therefore withdrawing from the transaction.

Prudential's Hong Kong-listed shares jumped as much as 7.1 percent to HK$68, tracking a 6.3 percent rise in its London-listed shares on Tuesday. By 0630 GMT, the stock was trading up 0.6 percent.

The failure of what would have been the biggest insurance M&A deal in history could make the position of Prudential's management untenable and increase the call for the British firm to be broken up, analysts and fund managers have said.

But a graceful retreat would help Prudential avoid an embarrassing defeat at the hands of shareholders, who were due to vote next Monday on the deal and a $21 billion rights issue to help fund it.

Chief Executive Tidjane Thiam, who has been in the job less than a year, had driven the transformational deal, but shareholders have pointed to tactical errors, including a delay in the release of the rights offer prospectus.

Thiam had argued the AIA deal would give the 162-year-old British insurer a rare opportunity to grab a commanding presence in Asia. But shareholders said the deal was expensive and there was risk in integrating staff and agents of two fierce insurance rivals.

Tidjane Thiam's tenure as CEO does not look secure, David Buik, London-based partner at BGC Partners, said in a note.

Thiam's audacious plan of changing the emphasis of its operations away from the UK and the U.S. to the Far East ... was a very big ask in an environment where the financial sector is just recovering.

Prudential <2378.HK> said it would not proceed with the planned rights offering in London and Hong Kong.

Prudential estimated the cost of the failed AIA transaction so far at about 450 million pounds ($659 million), which includes a break-up fee of 152.6 million pounds.

SHAREHOLDER OPPOSITION

AIG Chief Executive Robert Benmosche was in favor of accepting a revised deal as it offered more liquidity, and sooner, one person familiar with the situation told Reuters.

But the AIG board, which met late on Monday, decided against doing so. One important sticking point was that AIG's board wanted assurances from Prudential that it would be able to close a revised deal, other sources familiar with the matter said.

Prudential was not able to provide those assurances, said the sources, who declined to be identified as the talks were confidential.

The UK insurer originally offered $35.5 billion for AIA, then lowered that to $30.4 billion amid resistance from its shareholders over the price.

AIG is likely now to revive a planned initial public offering of AIA. But there are doubts whether an IPO could fetch the same valuation as offered by Prudential.

There is also the issue of timing the market so as not to clash with a flood of Chinese bank capital-raising slated to hit the market later this year.

Capital-hungry Chinese lenders are set to raise up to $60 billion in new capital in the next 6-8 months.

Benmosche told employees in an internal memo that AIG would have several options to consider regarding AIA -- more than it did in March. AIG, nearly 80 percent-owned by the U.S. government, also would have more flexibility on timing, he said.

These options include selling parts of the AIA business by geography, two of the sources said.

AIG took advice from Citigroup , Morgan Stanley , Goldman Sachs , Blackstone and Deutsche Bank , according to Thomson Reuters data.

Credit Suisse, HSBC and JPMorgan Cazenove were leading Prudential's rights issue as joint sponsors, global co-ordinators and bookrunners.

They were joined as financial advisers by Ondra Partners and Lazard , while Nomura <8604.T> gave a fairness opinion to Prudential's board.

A further 30 banks were joint- or co-lead managers or co-managers for the rights issue.

($1=.6829 Pound)

(Additional reporting by Clara Ferreira Marques in LONDON; Editing by Muralikumar Anantharaman and Jean Yoon)

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