Wednesday, May 5, 2010

Banks’ appetite for acquisitions Dr Kamal A. Munir

The banking industry witnessed an unprecedented number of acquisitions between 2005 and 2010. One bank, involved in two acquisitions, was the ABN AMRO Bank, Pakistan.

The ABN AMRO Bank, Pakistan (AABPL) first acquired the Prime Commercial Bank in 2007, and was then itself acquired by the Royal Bank of Scotland (RBS) the same year.

Now in 2010, the RBS is up for sale. Out of the various parties that initially signalled interest in buying the RBS, the State Bank of Pakistan has allowed only the Faysal Bank and the EFG-Hermes, an Egyptian Private Equity outfit, to proceed with due diligence. But does it actually make sense for either to buy the RBS operations in Pakistan?

Before we go to the Faysal Bank or the EFG, let us for a minute consider the RBS status. The RBS Pakistan is essentially the AABPL, whose parent was globally bought out by the RBS. The ABN had managed to steadily establish itself as one of the leading foreign banks in Pakistan. Buoyed by the banking sector reforms introduced by the Shaukat Aziz government, the AABPL, in an attempt to expand its loan and deposit base, decided to buy out the Prime Commercial Bank, a growing local bank with an extensive network of 69 branches, spanning 24 cities.

The acquisition of Prime Bank for $227 million, however, did not pay the dividends that the AABPL had expected. The cultural differences turned out to be too big to bridge and attempts to apply much more stringent credit and risk controls on the newly acquired portfolio were fraught with difficulties.

Despite significant integration costs (sources place it at more than $30 million), efforts to effectively harmonise the two teams also proved to be beyond the capabilities of the new management. Combined with the bursting of the consumer lending bubble, the non-performing loans suddenly increased.

The situation was accentuated by a general demoralisation of the PCBL employees, who thought they were being treated as pariahs within the AABPL. Perhaps frustrated by these problems, the then CEO of the AABPL, Naved Khan, decided to leave for Faysal Bank after less than one year of the acquisition. Meanwhile, in 2007, the AABPL/RBS posted a loss of Rs1.6 billion, which was followed by further losses of Rs518 million and Rs1.3 billion in 2008 and 2009 respectively.

The ABN AMRO’s global sale to the RBS meant that the AABPL was now the RBS Pakistan. Given the situation, however, there was little that the RBS could do to turn things around. Unsurprisingly, within a year, the RBS Pakistan was looking to sell. Ironically, or perhaps encouragingly, one of the strongest suitors on the scene is Naved Khan, who was the CEO of AABPL when it acquired the Prime Bank.

The problem, however, is that just as acquiring the Prime Bank proved to be an organisational challenge for the AABPL, in bringing the RBS into the folds of Faysal Bank, Khan could find himself contending with very similar problems.

Faysal Bank already has around 130 branches and is active in almost all segments including corporate, SME, consumer and Islamic banking without having a clear leadership position in any of these. Buying the RBS (remember, the operations will come without the RBS brand) is unlikely to bolster their position in any particular line of business. Nor is it likely to create any synergies.

On the cost side, the RBS salary head is far bigger than Faysal Bank’s and assimilation of the RBS employees is likely to be a hugely expensive proposition. After all, there is very little that could convince the RBS employees to stay and work for a lesser brand at a smaller salary. The 130 branches of Faysal Bank and 79 of the RBS will also need to integrate. If the $30 million or more that the AABPL spent on integrating the Prime Bank is anything to go by, this will also significantly add to the total bill.

On the revenue side, many of RBS’s prized preferred banking customers, who were attracted by the brand, are likely to leave. Similarly, many of the multinationals who valued the RBS’s global network (as well as brand) are also likely to take their business elsewhere. Consider all this, and one begins to wonder where the synergies will materialise from?

For the EFG-Hermes, the buy makes more sense. The RBS is probably a simple valuation play for them. Not only will they not have the headache of assimilating one bank in another with all the usual organisational and cultural problems and expenses, but buying the RBS will also save them from setting up a new bank and incurring a cost of Rs7 billion in paid up capital as prescribed by the State Bank of Pakistan

Add to this, an existing infrastructure which would probably take another $25 million or more to build. Since the Muslim Commercial Bank has already set a benchmark with its offer of $87 million, the EFG’s bid may be lower. At this bargain price, the EFG can simply wait for better times and sell its assets in Pakistan at a much higher price.

The asset quality that the RBS is carrying on its books, off-balance sheet derivative contracts worth a whopping Rs78 billion, and the successive losses are quickly eroding its equity.

The only hope is that Naveed Khan, having been at the helm of RBS probably knows more about any value that may be hidden in this deal. If he is able to pull it off, it would be a case worth teaching in business schools around the world.

The author is Professor of Strategy at LUMS and Cambridge University.

Source: http://news.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/banks-appetite-for-acquisitions-350

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