The bid by China Development Financial Holdings (CDFH) for KGI Securities last week is the latest in a series of takeovers in Taiwan’s securities industry as participants struggle to cope with a stagnant market where daily trading volumes are no longer growing.
In that environment cost control and scale have become increasingly important and, according to a Taiwan-based banker, companies have no choice but to turn to M&A to defend their margins.
CDFH’s move, which aims to merge KGI with its own wholly owned brokerage subsidiary Grand Cathay Holdings, is the fourth major acquisition in the Taiwan securities industry in as many years and comes less than a year after Yuanta Financial Holding cemented its position as Taiwan’s biggest brokerage firm by acquiring Polaris Securities through a $1.7 billion deal.
The recent wave of consolidations among the top players in the industry kicked off in 2009 when KGI Securities paid about $876 million to buy Taishin Securities. However, the consolidation trend has been ongoing for the past 10 years and has seen the total number of brokers decline to 122 last year from 163 in 2002. The market share held by the top 10 firms has increased to 56.7% from 46.4% in the same period.
KGI is currently the second largest brokerage in Taiwan with a 7.9% market share (on the Taiwan Stock Exchange and OTC combined) in 2011, while Grand Cathay ranked as number 13 with a 1.6% market share. Together they will still be number two behind Yuanta, which had a 10.7% market share last year, but they will increase the gap toward the number three player, Fubon Securities, which had a market share of 6.1% last year, all according to stock exchange data.
Indeed, a key question now will be whether Fubon will also hit the acquisition trail. According to the Taiwan banker, Fubon has been wanting to do an M&A transaction for a long time, but so far it has been reluctant to pay up. Also, the two main available targets, Capital Securities and President Securities — number four and eight in terms of market share last year — are both commanding high valuations.
However, CDFH’s bid for KGI doesn’t seem to be primarily about strengthening the group’s position in brokerage, but to create a full-scale investment bank with a number one or two market position in key areas such as warrants, equity and debt underwriting, and M&A advisory. The new entity created from the merger of KGI and Grand Cathay is expected to become the market leader in underwriting, surpassing Yuanta/Polaris, and a top-three player in proprietary trading, a source said.
It also intends to capitalise on the cross-selling opportunities with China Development Industrial Bank, another wholly-owned unit, which is one of the largest venture capital investors in Taiwan with a portfolio valued at NT$52.5 billion ($1.78 billion) and investments in 299 companies.
According to an investor presentation on CDFH’s website, the bank plans to leverage China Development Industrial Bank’s direct investment experience over the past five decades to move into asset management, in the sense that it will manage external money through private equity and venture capital funds. One aim is to partner with leading local institutions in China to launch third-party renminbi-denominated private equity funds.
“We believe that a strong investment banking franchise is a critical success factor for the asset management business,” the bank said.
CDFH has launched a tender offer for KGI, which is valued at approximately NT$54.6 billion ($1.8 billion), assuming it is able to acquire 100% of the company. The cash and share offer is conditional upon receiving at least 50.1% of the outstanding shares.
The offer is valued at NT$16.71 per KGI share, which represents a premium of 46.6% over KGI’s closing price last Thursday — the day CDFH made its offer public. It also represents a premium of 32.7% versus the average closing price during the past 20 days and a 39.4% premium over KGI’s adjusted book value of NT$11.99 per share, as of the end of last year.
KGI’s shareholders will receive NT$5.50 in cash as well as 1.2 new CDFH shares for every KGI share they currently own. Citi is advising CDFH on the transaction, which is subject to regulatory approvals. KPMG has provided a fairness opinion to CDFH.
The market welcomed the offer, sending KGI’s share price 21.9% higher in the first three days. However, the share price pulled back slightly yesterday amid a correction in the overall market, and closed at NT$13.45.
CDFH’s share price gained 4.7% on Friday last week to NT$8.74, but has seen fallen to NT$8.31 — four cents below where it closed before the deal was made public.
On Monday, Standard & Poor’s put CDFH’s long-term counterparty rating of BBB- on credit watch with negative implications, expressing concern that the group “may not be able to sustain its capital strength at the current level after completing the transaction, given the purchase of KGI Securities involves 33% in cash.” “In our view, the securities business is riskier than the CDFH group’s current credit profile,” Taiwan Ratings analyst Chris Lee said in a statement. (Taiwan Ratings is a local unit of S&P.)
The agency said it may affirm the group’s ratings if its consolidated capitalisation doesn't deteriorate and the bank can sustain its return-on-capital ratio above 15%, either due to a prudent capital policy or a smaller acquisition size, or if the credit profile of the combined securities entity is commensurate with the group’s current credit profile.
CDFH argued, however, that the acquisition will enhance its earnings generation capacity straight away and will also “greatly improve” both the quality and stability of its earnings. It will also lead to cost savings related to capital expenditures, the elimination of duplicate backoffice functions and lower funding costs.
It acknowledged that its capital adequacy ratio will fall to 157.6% from 225.8%, while China Development Industrial Bank’s capital adequacy ratio will drop to 21.2% from 32.7% (as CDFH will reduce the bank’s capital by NT$16 billion to finance the acquisition). However, the bank's capital adequacy ratio will remain well above the regulatory requirement of 10%, it said.