Shin Kong banks on Macoto

Consolidation in Taiwan''s financial sector inches further forward with the acquisition of Macoto Bank

Shin Kong Financial Holding Company (FHC) announced yesterday (April 19) that it has reached agreement to acquire Macoto Bank in a transaction valued at NT$20 billion ($633.5 million). The deal represents the first benchmark M&A deal from Taiwan's financial sector so far this year and both the government and investment bankers will be hoping it proves a catalyst for many more in a country where there are still 49 banks.

The acquisition will not remove excess capacity from the banking system. What it does mark is another instance of an FHC creating synergies and building a rounded financial services group through the acquisition of a complementary franchise.

Shin Kong has always had a strong presence in the insurance sector and is ranked the country's second largest life insurer. What it now gains is a banking arm that can act as a valuable distribution platform for its products. Together Shin Kong and Macoto will become the seventh largest by assets of Taiwan's 14 FHC's.

According to the terms of the deal, Shin Kong will exchange one of its shares for every 1.14 Macoto shares. Based on Shin Kong's 30-day average share price of NT$32.17, the transaction values Macoto at NT$28.20 per share, or 1.83 times adjusted 2004 book value.

This is the low end of the valuation range at which major Taiwanese bank M&A deals have been concluded over the past few years, although the transaction is smaller than the three big deals of 2003.

These saw: Cathay FHC - Taiwan's largest life insurer - acquire a banking arm via its acquisition of UWCCB at 2.4 times book; Fubon FHC acquire Taipei City Bank at 1.8 times book and Chinatrust FHC acquire Grand Commercial at 2.3 times book.

Shin Kong's ability to secure a reasonable valuation may, in part, have been helped by the fact that Macoto Bank is unlisted. This means its share price has not been subject to the same kind of M&A hype propelling listed potential acquisition targets.

The acquisition is an all share deal and specialists say it will result in dilution of about 20%. Shin Kong's controlling shareholder - the Woo family - will drop from the 50% to 40% range. Macoto's largest shareholder is the Lin family.

The deal is now subject to confirmatory due diligence, shareholder approval and regulatory approval. The two entities plan to secure shareholder approval at AGM's on June 10 and expect the deal to formally close in early October. Morgan Stanley acted as advisor to Shin Kong, whilst Macoto was self-advised.

Despite its poor profitability of recent years, Macoto is viewed as an attractive asset. This is largely because of its branch network, which is heavily concentrated in Taipei where the majority of the country's wealth is located.

Macoto Bank has the tenth largest bank network in the capital, ahead of leading private sector banks such as Taishin and Chinatrust. It currently has 29 branches in the city, 16 in the suburbs and 81 in total, including one branch in Hong Kong.

It will bring Shin Kong's branch network up to 108 and make it the country's fifth largest private sector bank by branch network. The group previously purchased UCCB in September last year in an acquisition that gave it 28 branches.

In order to encourage consolidation, the Taiwanese government stopped issuing new branch licenses over a year ago. This has forced groups like Shin Kong to acquire assets if they wanted to expand.

What Shin Kong also gains is a bank with a strong consumer franchise - accounting for two thirds of its loans - and the country's eighth largest credit card issuer.

Like many domestic banks, however, Macoto has been struggling under the weight of problem loans. Back in 2002, its NPL ratio stood at 10.23%, higher than the then industry average of 8.9%.

At the end of 2004 it had been able to bring the figure down to 4.26%, slightly better than the 4.5% industry average. Provisioning, on the other hand, still stood at an inadequate 29.63%.

Ridding itself of NPL's has had a detrimental effect on the group's profitability. A decision to amortise the write-offs over a five-year period reduced net income to NT$183 million ($5 million) in 2003 and NT$229 million ($7.2 million) in 2004. Revenue last year amounted to NT$11.448 billion.

Shin Kong now plans to take a one-off hit for the unamortized NPL losses, although this will affect shareholders equity rather than the P&L. It believes the write-off, which should amount to about NT$2 billion ($63 million), will be counterbalanced by undervalued property assets currently sitting on Macoto's books.

"Stated book value and adjusted book value should therefore come out at almost the same level," explains one specialist.

For Macoto's part, management are said to view the acquisition as an attractive proposition because they will not be subsumed within a much larger banking entity, but will retain a large degree of management control and autonomy.