Incentive for AFG to merge with HLB
Exercise will result in quantum leap in AFG’s scale
PETALING JAYA: With scale being an increasingly important factor in the local banking industry, talk has now emerged that Alliance Financial Group Bhd (AFG) could be looking to merge with Hong Leong Bank Bhd (HLB).
The twist, though, is that AFG, which is the smallest financial institution in Malaysia in terms of asset size, could be the acquirer in the potential merger and acquisition ( M&A) exercise, instead of being the target company to be acquired, according to UOBKayHian Research.
“Scale has always been a stumbling block for AFG. Without scale, the group has to stay competitive by targeting niche segments, while investments would require longer payback periods without the benefits of economies of scale ... as such, it is not surprising that the latest market rumours involve a potential merger with HLB and AFG being the potential acquirer,” the brokerage wrote in its report.
HLB is the fifth-largest lender by assets in Malaysia. The 64%-owned unit of Hong Leong Financial Group Bhd is listed as the main earnings driver for its parent company.
Meanwhile, AFG last Thursday dismissed speculation that it was the subject of a merger. The bank, which saw some changes in shareholding, said it was financially sound and looking to lift its returns to shareholders.
In rationalising the potential M&A between AFG and HLB, UOBKayHian said completion of the exercise would result in a quantum leap in AFG’s scale, with its branch network increasing from 94 to 394 branches. This would outpace Malayan Banking Bhd’s 363 domestic branches.
In addition, the merged entity would be valued at RM266bil in terms of total assets. This would make it the fifth-largest institution after the merged RHB Bank Bhd-AMMB Holdings Bhd.
“Such a merger will likely be near-term dilutive, but the potential synergies that can be derived from the quantum leap in scale and cross-selling opportunities arising from a low level of customer duplication and expertise would be highly beneficial for AFG over the longer term,” UOBKayHian explained.
“Given AFG’s small scale, duplication can be well-contained and the cultural similarities of both banks will ensure lower execution risk post-merger,” it said.
AFG’s strength lies in the small and medi- um enterprise (SME) segment, which provides for a strong SME CASA (current and savings account) base, whereas HLB’s strength is within the more affluent consumer segment, which provides for a strong retail deposit base.
“In terms of structural similarities, both banks have a fairly strong liquidity franchise and cost discipline, with HLB having a slightly stronger asset quality edge,” UOBKayHian said.
However, the brokerage conceded, there would be challenges in the potential M&A between AFG and HLB. The stumbling blocks could involve pricing, which might affect the impact of goodwill from the acquisition of HLB; and the foreign-shareholding cap of 30% in Malaysian banks, as it was estimated that Temasek Holdings Pte Ltd, which is Singapore’s sovereign wealth fund, would see its stake in AFG increase from 14.2% to 57% post-merger.
There have been numerous rumours on various potential M&A angles relating to AFG ever since the indirect 14.8% equity stake sale in AFG by Lutfiah Ismail (a close associate of Tun Daim Zainuddin) to three individuals (Ong Beng Seng, Ong Tiong Sin and Seow Lun Hoo).
Initial rumours involved the potential entry of DBS Bank of Singapore. However, the inability to seek a reciprocal understanding/approval for DBS to own a 100% stake in AFG from banking regulators could have been a key stumbling block, as an associate stake would be highly punitive from a capital deduction angle for DBS Bank, UOBKayHian said.
The brokerage has maintained a “hold” rating on AFG with a lower target price of RM4.10, compared with RM4.20 previously, on the back of its earnings forecast revision.
The brokerage expects AFG to register a lacklustre earnings growth of 1% for the financial year ending March 31, 2018 due to the upfront investment costs. This would imply a marginal decline in return on equity.
Nevertheless, UOBKayHian said the stock’s commendable cash dividend yield of above 4%, vis-a-vis the sector’s less than 4%, could provide support to AFG’s share price.