Banking M&A fever continues– Buy bank stocks

Banking consolidation has been the major theme why Philequity has been overweight in the banking sector since 2004. Even if had you bought banking stocks 10 months ago – at the time when we wrote our article titled "The Hunter becomes the hunted – Philequity Corner, May 30, 2005" – chances are, you would be up more than 20 percent. We mentioned, back then, that opportunities abound for a new round of banking speculation similar to what happened in 1999 when Equitable Bank started an M&A frenzy after acquiring and merging with PCI Bank. But this time around, it is Equitable PCI Bank (EPCI) that is the target for acquisition by Banco de Oro (BDO), the new predator on the hunt.

Being the major target for acquisition, EPCI’s share price increased the most – up 50 percent since the time our article came out. This was followed by IBank and BPI, whose share prices have increased by 44 percent and 29 percent, respectively. Except for PNB, other banks returned at least 20 percent from the period of May 27, 2005 to date, clearly outperforming the benchmark Philippine Composite Index (Phisix).

M&A fever part 2

When the M&A fever of 1999 died down, the only aggressive bank to come out afterwards is Banco de Oro, which has since tripled both its total assets and deposit base largely through M&As. It merged with Dao Heng Phils. in 2001, acquired 57 branches and deposits in First E-Bank in 2002, and acquired Banco Santander Phils. and Santander Investment Securities Phils. in 2003. BDO then sparked a new wave of banking consolidation when it announced its intention to purchase a significant stake in EPCI as early 2004.

Last year, several M&A deals pushed through:

In May, BDO purchased 66 branches (with P11 billion in deposits) of United Overseas Bank for P600 million.

In July, BPI stealthily managed to acquire Prudential Bank (with 187 branches) for P6.1 billion.

In following month of August, the SM-BDO group delivers a coup by acquiring the Go family’s 25-percent stake in EPCI.

Also in August, the Lucio Tan group regained control of Philippine National Bank (PNB) after it matched Union Bank’s bid of P43.77 per share during a joint-auction with the government to sell a combined 67-percent stake in PNB.

This year, the latest in the banking consolidation saga is the offer presented by GSIS president Winston Garcia – in a letter to the SM-BDO group – of an undisclosed buyer willing to purchase the 34 percent EPCI stake of the SM-BDO group at P95 per share.

We can only surmise a few local groups who are capable of doing such an acquisition: the Ayala-BPI group, the Lucio Tan Group, the Ty-Metrobank group, and the Gokongwei group as discussed in a previous article titled "Priming up for a possible M&A – Philequity Corner, June 21, 2005."

But we also do not discount the possibility of foreign banks buying into EPCI which would all the more enhance the consolidation in the Philippine banking industry. There were already precedents last year but on a smaller scale. Citibank acquired Insular Savings Bank, while GE Consumer Finance bought into Keppel Savings Bank (formerly Monte de Piedad, the Philippines’ oldest savings bank). There is also an ongoing trend of regional consolidation in Asia, with bigger global banks buying into China, India, Korea and the ASEAN countries.

Is P95 per share too much to ask?

At P95 per share, EPCI is being priced at 3x adj. book value per share. Note that adjustments were made to exclude goodwill from EPCI’s reported book, and assume a 30-percent recovery rate on NPLs and 60-percent recovery rate on foreclosed assets.

Compared to BPI’s acquisition of Prudential Bank at 2.0x adj book, EPCI priced at P95 per share seems a bit steep. But of course, EPCI deserves a premium for its size (since it is ranked 3rd overall and has five times more of Prudential Bank assets). Moreover, there are only a handful of well-run, profitable banks left out there.

The valuation of EPCI at P95 per share is more at par with the bank acquisitions back in 1999-2000. Back then, PCI Bank was acquired at 1.8x book value. Far East Bank fetched 2.4x book value, and Solid Bank was priced at 2.2x book. If we adjust their book values for NPLs and ROPOA, however, it is likely that their valuations (at the time of acquisition) would fall near the 3x adj. book level.

Also notice trend of declining asset quality and lower profitability during the M&A frenzy in 1999, compared to the current industry trend of improving balance sheets, higher profitability and increasing efficiency. With better outlook for the banking industry this time around and the absence of other takeover targets the size of EPCI, the bank may turn out to be a steal at P95 per share, after all.

Catalyst for further price upside

We believe that the SM-BDO group will seriously consider the sale of its EPCI stake at P95 per share. At that price, they would easily earn a 68-percent premium over their purchase price of P56.50 per share from the Go family last year. Note that the SM group also recently raised $115 million through the issuance of global depository receipts, part of which will be used fund bank acquisitions.

A sale by SM-BDO group of its EPCI stake will intensify the sector’s consolidation all the more as the major banks jostle for position and the medium sized banks merge among themselves to remain competitive. SM-BDO, awash with cash, will once again be prowling for its next acquisition target.

Call it a bluff for now. But if this is correct – that there indeed is a buyer at P95 per EPCI share – we expect an upward revaluation on all banking stocks. We also foresee this to be the catalyst that will push the banking index back to its 1999 highs, and consequently catapult the Phisix towards our 12-month target of 2,300 to 2,400.

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