Banking M&A – The saga continues…

Last year, we came out with a series of articles on banking consolidation, saying that opportunities abound for possible M&A deals that could trigger a new round of banking speculation similar to what happened in 1999. In our initial article, we discussed how the table has turned for Equitable PCI Bank (EPCI). "From being a hunter — which started the M&A frenzy in 1999 — it is now the one being hunted by a new predator on the prowl (The hunter becomes the hunted — Philequity Corner, May 30, 2005) ."

The new predator refers to Banco de Oro (BDO) — the most aggressive bank during the last five years — which has expanded its branch network and asset base by acquiring branches and deposit liabilities from other banks. BDO merged with Dao Heng Phils. in 2001, acquired 57 branches and deposits in First E-Bank in 2002, purchased Banco Santander Phils. and Santander Investment Securities Phils. in 2003, and acquired 66 branches and deposits in United Overseas Bank last year. BDO now has a nationwide network of 184 branches. Its majority shareholder is the SM group which has a 41-percent stake.

Equitable PCI Bank, with its low-cost funding base (over 40 percent of total deposits coming from CASA or current account/savings account), will certainly be a prized catch for any acquiring bank with ambitions to being the no. one in terms of asset size. EPCI has total resources of P327 billion and is currently third in the asset ranking behind Metrobank and BPI.

In pursuit of a prized catch

As early as December 2003, the SM group has shown its interest in EPCI by securing a memorandum of agreement with the SSS to buy the latter’s 26-percent stake in EPCI at P43.50 per share. However, the Go family who owned 25 percent of EPCI back then, blocked the move by claiming that any sale of government assets should be through a public bidding and not through a negotiated sale. Up to now the deal has not pushed through and a case regarding the sale agreement is pending in the Supreme Court.

Not to be discouraged by the pending case, the SM group pressed on, leading to a highly contentious annual shareholder’s meeting in July 2005. SM allied with major EPCI shareholders (SSS, GSIS and the Romualdez family), disputing the Go family’s use of the voting rights of EBC Investments. When the smoke cleared several weeks later, the SM group surprised everyone by announcing that it has acquired the Go family’s 25-percent stake in EPCI. In an article following that announcement, we said that "The move is seen as a first of a series of moves which will eventually end in the merger of the two banks, BDO & EPCI… (The race goes on — Philequity Corner, Aug. 8, 2005)."

After the sale of the Go block, the SM group became the biggest shareholder of EPCI. As of 3Q05, the SM group held 30 percent of EPCI, followed by SSS with 29 percent. GSIS and the Romualdez family held, 14 percent and eight percent, respectively.

The stalking ends… the chase begins

The stalk is now over for the SM group after acquiring a substantial stake from the Go family and the chase for EPCI control is now out in the open. Recently, Banco de Oro announced that it has offered EPCI shareholders a share swap deal that would lead to a merger between the two banks, with BDO as the surviving entity.

Under the terms of the offer which expires on Jan. 31, 2006, EPCI shareholders have two options. The first option is a swap of 1.6 BDO shares for every one EPCI share. Since BDO’s share price at the time of the announcement was P35.50, it translates to a valuation of P56.80 per EPCI share, which is roughly the same price paid by the SM group for the Go family’s holdings. The second option calls for a swap ratio based on book value comparisons adjusted to conform to International Accounting Standards (IAS).

But the chase appears far from over. With EPCI now trading at P65 per share, it would be unlikely that shareholders would agree to swap their shares with BDO trading at only P36 per share. At EPCI’s current share price, BDO should at least trade at around P41 per share (or P65/1.6). Even so, the GSIS and the Romualdez family are apparently not keen on the BDO deal.

At least two groups of foreign investors have reportedly approached GSIS and given their intentions of buying its 13.7-percent stake in EPCI at P92 per share. SSS, meanwhile, has refrained from commenting on the issue since it still has a pending case.

BDO, however, is hoping that EPCI shareholders would agree on the merger in order to prevent a future capital call when the EPCI eventually conforms to IAS.

Others in the hunt

Other banks remain in the consolidation hunt. BPI acquired and merged with Prudential Bank last year. But as we previously mentioned, "given Prudential’s small size compared to BPI’s previous acquisitions, it should take a shorter time to digest which leaves room for further acquisitions down the road (BPI makes the first move — Philequity Corner, Aug. 1, 2005)".

Also last year, the Lucio Tan group bought the government’s share in Philippine National Bank which is seen as possible move leading to an integration with Allied Bank, another bank which is majority-owned by the group.

Meanwhile, we cannot discount the Ty family which has long held the No. one position with its flagship Metrobank. Recall that in 1999, Metrobank refused to let go of its top position by merging with several smaller banks after BPI merged with Far East Bank and Equitable merged with PCI Bank. A similar action from Metrobank may be triggered if another bank encroaches on its leadership position.

There’s also the strong possibility that well-run, profitable mid-sized banks (such as Union Bank, Security Bank, China and IBank) will acquire or be merged with other banks of similar size. Possible targets are UCPB, Export and Industry Bank, and other smaller banks.

Ripe for consolidation

The industry is indeed ripe for consolidation as most banks have started to aggressively dispose of their bad assets. The weaker banks that should find it hard to recapitalize will potentially be acquisition targets.

Meanwhile, most of the listed mid-tier banks have already recovered in terms of profitability (ROE) but are still trading at relatively cheap levels (in terms of P/BV and P/E), as you can see from the table below. This also makes them attractive for possible M&As deals.

Comparative Valuation

In other countries, the same trend towards banking consolidation is happening as industries brace for an increasingly-competitive global landscape. The BSP, likewise, has been espousing it especially after the domestic banks were hit during the 1997 Asian financial crisis.

And as we have noted in the past, this banking sector consolidation will also be a key catalyst for the stock market. If indeed a foreign bank gets hold of EPCI, then BDO will all the more be prowling again for other banks to gain the coveted top spot. This should further boost the consolidation moves done so far. Remember that GE Consumer Finance, already bought into Keppel Bank (formerly Monte de Piedad, the oldest savings bank in the Philippines) in October last year. This is part of a regional consolidation going on in Asia, with bigger global banks buying into China, Korea and the ASEAN. Foreign banks buying into Philippine banks will actually enhance the consolidation in the Philippine banking industry as there are only a handful of well-run Philippine banks.

In the long run, not only will the market benefit from healthy speculation, but the banking industry itself will benefit as a whole, as these mergers tend to create bigger but more efficient banks. Overall, we in Philequity believe that this consolidation among domestic banks will be beneficial for the country. We therefore urge the government to continue to encourage it.

For comments and inquiries, you can email us at [email protected] or [email protected]