Bank­ing on Dr Brown’s cure

Three-pronged strat­egy for build­ing on its re­tail base

Finweek English Edition - - Companies & markets - MICHAEL COUL­SON

WHEN MER­CAN­TILE LIS­BON Bank’s R555m rights is­sue was al­most to­tally ig­nored by mi­nori­ties in 2004 – tak­ing the hold­ing of the Por­tuguese Caixa Geral de De­pos­i­tos, which un­der­wrote the is­sue, to 91,75% – the mar­ket was in ef­fect say­ing that it didn’t think the trou­bled bank would sur­vive.

That wasn’t an un­rea­son­able as­sump­tion, given that bad debts of the old Bank of Lis­bon, con­trol of which Caixa ac­quired through its takeover of BNU, that com­pany’s own par­ent, had wiped out R1bn of share­hold­ers’ eq­uity. How­ever, it turned out to be pre­ma­ture.

Though re­sults are still far from sat­is­fac­tory the bank is back in profit. A share price of 33c, while off the year’s high of 38c, is al­most dou­ble the 18c at which the rights is­sue was pitched, let alone the sub­se­quent low of 11c. Most of the ben­e­fit, of course, ac­crues to Caixa, which in rand terms is show­ing a healthy profit on its in­vest­ment.

The rights is­sue was a core el­e­ment of the re­cap­i­tal­i­sa­tion and re­cov­ery strat­egy de­vised by CEO David Brown, who was in ef­fect in­stalled as a com­pany doc­tor by Caixa in 2003 though he joined full-time only with ef­fect from 31 March 2004. A year later a five-year plan was in­tro­duced, in­volv­ing both in­ter­nal and ex­ter­nal re­brand­ing and drop­ping the tainted “Lis­bon” from the com­pany’s name.

In 2003 and 2004 Mer­can­tile chalked up a com­bined loss of R270m. Helped by the re­cov­ery of loans pre­vi­ously im­paired, a head­line profit of R68m was re­ported in 2005, which ad­vanced fur­ther to R101m last year. How­ever, with a mas­sive 3,9bn shares in is­sue (some­thing else cry­ing out for at­ten­tion), head­line earn­ings per share were only 1,7c and 2,6c re­spec­tively in those years.

And there’s still some way to go. The cost:in­come ra­tio of 71% in 2006 was much bet­ter than 2005’s 91%, but the first hur­dle un­der the five-year plan is to bring it down to 60%. By most bank­ing stan­dards, even that will still be on the high side. And there’s still an ac­cu­mu­lated loss of R619m.

Mer­can­tile did bet­ter with its other tar­gets. Re­turn on eq­uity was 16,5% against the tar­get of at least CPIX + 10%, and re­turn on as­sets was 2,5%, against the tar­get 1%. Both those tar­gets will, as planned, be re­vis­ited this year.

One of Mer­can­tile’s prob­lems is that its pre­de­ces­sors pri­mar­ily served SA’s eth­nic Por­tuguese mar­ket. Brown points out that whereas in the Six­ties the clien­tele were first­gen­er­a­tion im­mi­grants, now their de­scen­dants are South Africans with a Por­tuguese cul­tural her­itage. Their ties to “Por­tuguese” in­sti­tu­tions have weak­ened.

Mer­can­tile can’t – and wouldn’t want to – jet­ti­son that mar­ket, es­pe­cially as a sub­sidiary of Por­tu­gal’s dom­i­nant bank. So the key is to try and keep that base but use it as a plat­form for ex­pan­sion into other ar­eas of busi­ness.

And Por­tuguese state-owned Caixa, whose growth op­por­tu­ni­ties in its home mar­ket are lim­ited, it­self has a strat­egy of in­ter­na­tional ex­pan­sion, par­tic­u­larly in ar­eas that were Por­tuguese colonies and where there are Por­tuguese-speak­ing pop­u­la­tions. SA still fits that tem­plate and Caixa has com­mit­ted it­self to re­main­ing the con­trol­ling share­holder.

The five-year plan ac­cepts that Mer­can­tile is a niche bank and has a three-pronged strat­egy for build­ing on its re­tail bank­ing base: busi­ness bank­ing, trea­sury op­er­a­tions and al­liance bank­ing. Brown cites as an ex­am­ple of the last-men­tioned the po­ten­tial economies of scale from us­ing the pay­ments and credit card in­fra­struc­ture for part­ners that want to is­sue credit cards but not be­come banks. By way of ex­am­ple, it pro­cesses the Wool­worths Visa card and Metropoli­tan debit cards.

The re­tail net­work now has 15 branches, which aren’t run­ning at full ca­pac­ity. Tak­ing up the short­fall is the pri­or­ity, though if the right op­por­tu­nity comes up Brown would be happy to ex­tend the bank’s foot­print. He reck­ons that about 50% of its re­tail busi­ness still comes from the Por­tuguese com­mu­nity, though that’s fall­ing.

So where does Mer­can­tile go from here? Ex­tend­ing profit growth this year may be harder than you might imag­ine, as there’s lit­tle legacy debt left, and more nor­mal pro­vi­sions will re­place re­cent years’ re­cov­er­ies. But there will be ben­e­fits from con­tin­ued ex­pan­sion into new ar­eas and a fur­ther im­prove­ment in the cost:in­come ra­tio.

How­ever, fun­da­men­tal is­sues have to be faced. Specif­i­cally, Mer­can­tile is com­mit­ted to SA’s Fi­nan­cial Ser­vices Char­ter so needs to im­ple­ment a black em­pow­er­ment deal, and the chronic illiq­uid­ity in the share de­tracts from its mar­ket rat­ing.

Whether both should be ad­dressed si­mul­ta­ne­ously or sep­a­rately is a mat­ter of tac­tics. But Brown points out that, what­ever lo­cal man­age­ment pro­poses, Caixa will take the fi­nal de­ci­sion. There are on­go­ing dis­cus­sions with Caixa on those is­sues. And he ar­gues that the iden­tity of an em­pow­er­ment part­ner is as im­por­tant as get­ting the struc­ture right.

More­over, un­til Mer­can­tile had shown that it had turned the cor­ner it didn’t have much to of­fer a prospec­tive em­pow­er­ment part­ner. So, not un­nat­u­rally, it was re­ally only last year that sig­nif­i­cant in­ter­est de­vel­oped. It fol­lows that in­ter­est should build up fur­ther this year.

Both an em­pow­er­ment deal and in­creas­ing liq­uid­ity in the share in prac­tice will en­tail Caixa di­lut­ing its stake and it would surely make sense to do both at the same time? As the mat­ter is ul­ti­mately out of his hands, Brown is re­luc­tant to com­mit to a timetable. How­ever, you sense that he’d like to see some ac­tion this year.

So, should SA in­vestors who shunned the rights is­sue at 18c now climb in at 38c? Net

as­set value is 17c and the price:earn­ings ra­tio 14,8, which sug­gests that the share price is dis­count­ing a mea­sure of fur­ther re­cov­ery. And div­i­dends are un­likely un­til the ac­cu­mu­lated loss is ex­tin­guished – which could also be a fac­tor in struc­tur­ing an em­pow­er­ment deal.

As so of­ten, it was the con­trar­ian thinkers who did buy the share at the bot­tom – when sen­ti­ment was at its worst – that have made the real money. And those who draw lines on charts may ar­gue that 38c has more than once proved a bar­rier on the up­side.

But what’s clear is that the re­cov­ery phase is over and that Mer­can­tile will in fu­ture be judged on much the same cri­te­ria as its big­ger SA ri­vals. And both Caixa and man­age­ment de­serve ac­claim for their per­sis­tence in not walk­ing away from a bas­ket case but nurs­ing it back to health.


Source: I-Net Bridge

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