Friday, April 13, 2012

CIMB ... Apr12

Alliance Research ...


A sound acquisition
We came out from the analyst briefing organised by CIMB Group, feeling optimistic about the potential synergistic benefits yielding from its upcoming acquisition of Royal Bank of Scotland (RBS)’s selective cash equities and associated investment banking businesses in the Asia Pacific region. We have tilted our expected sustainable ROE for the group to 16.8%. As such, we have raised our target price for CIMB Group to RM8.80 and our recommendation to BUY.

Acquisition of RBS’s selective equities businesses
 We came out from the analyst briefing organised by CIMB Group, feeling optimistic about the potential synergistic benefits yielding from its upcoming acquisition of RBS’s selective cash equities and associated investment banking businesses in the Asia Pacific region.

 The upcoming acquisition deal will see CIMB Group paying RBS a gross purchase consideration GBP88.4m (RM431.8m) coupled with further new capital injection of GBP85.5m (RM417.6 m).

 Although the total cash outlay amounted to GBP173.9m (RM849.4m), we observe that the net acquisition cost will effectively be low at around GBP47.0m (RM229.6m) only, since this acquisition comes with cash and receivables (consist mainly of cash and cash equivalents) from selective RBS business of about GBP113.1m (RM552.4m) and reimbursement from RBS of GBP13.8m (RM67.4m). The investment cost of this acquisition is detailed in Figure 5.

 We view this acquisition to be a sound bargain, since the total cash outlay of GBP173.9m (RM849.4m) will be equivalent to an effective Price to NTA (P/NTA) of 1.1x, where we understand that majority of the NTA consists of cash and cash equivalent. Given that RBS will pay CIMB a sum of about GBP13.8m (RM67.4m), the effective P/NTA ratio of the transaction will in fact be lowered to about 1.0 times.

 Despite the acquisition covers a broad Asia Pacific region, we gather that CIMB Group will effectively only acquire three legal entities in Australia. In other jurisdictions, the relevant businesses of RBS including selected staff, assets and client mandates, will be migrated to existing or new CIMB subsidiaries.

 Financial details of the selective businesses acquired are scanty, given that CIMB Group cherry picks from selected private entities and management does not wish to divulge too much information given the competitive landscape of the investment banking businesses and the deals will need various regulatory approval. Nonetheless, we understand that the acquisition could be mildly dilutive for its earnings and book value, as disclosed in Figure 6.

 Management is hopeful that the deal will be completed latest by Nov 2012.

A sound acquisition
 We believe that this is a sound acquisition. Other than the low P/NTA attached to this acquisition as highlighted above, we are optimistic that this acquisition strategy is in line with the aspiration of CIMB Group to be a regional champion, as per the objectives outlined in the GLC transformation program.

 We are positive this acquisition is expected to leapfrog CIMB Group from being ‘Asean for you’ to broadening their reach to the Asian region. With this expansion, the Group will:
• Strengthen its foothold in the key Asian markets, i.e. China, India, Australia, Taiwan and South Korea;
• Have seats on nine exchanges and partnerships in three others;

• Its research coverage will be expended to approximately 1,100 Asia Pacific-based companies;
• Expected to enjoy a surge in global institutional investor relationships;

 The potential synergies from this acquisition are highlighted in Figures 7 and 8.
Acquisition risks largely mitigated...

 Although a cross border acquisition does come with high risk factors, we believe that it is well mitigated by the management.

 The major risk being potential staff retention upon acquisition. We understand that management has renewed its offer to 94 key employees and so far 82 of them have accepted the offer, representing a good take up rate of 87.0%. Management expects about 350-400 RBS employees to join them going forward.

 The other risk highlighted is the potential customer attrition rate. Management guided that relationship manager will actively manage clients and process to mitigate such risk. Given that IB business is more people-oriented, we believe that customer attrition risk is not significant in view that key employees have been retained.

 Management also emphasises that although the acquisition is going to strengthen CIMB Group’s franchise in the Asian region, management team will not lose its core focus and will continue to tighten its grip in the Asean region.
Upgrade target price to RM8.80 and recommendation to BUY

 Although management has guided that this deal could be marginal earnings dilutive for FY12, we do not foresee any significant downside risk that warrants an earnings downgrade.

 We have tilted our expected sustainable ROE for the group to 16.8% (from 16.5%), to account for the potential long term earnings enhancement arising from this synergistic merger. Our target price for CIMB Group is subsequently being raised to RM8.80 (from RM7.80) based on Gordon Growth Model (implied 2.4x FY12 P/B, 16.8% ROE).

 We upgrade our recommendation for CIMB Group from trading buy to Buy.

 We believe that the key catalyst for the group remains its stronger earnings outlook and potential dividend upside.

 We wish to reiterate that the disappointing financial results over the past few quarters were mainly due to management deliberation to maintain strong asset quality, and to conserve balance sheet for potential regional acquisition, in view of the rising external uncertainties.

 As such, we view the lower than expected quarterly results in 2011 to be an exception rather than a norm. Therefore, it should not serve as an indication of forward earnings growth.

 We maintain our optimistic stance that 2012 should be a good year for CIMB given that it is one of the prime beneficiaries of rising business loans stemming from the rolling out of Entry Point Projects under the government’s Economic Transformation Programme. Given its strong investment banking foothold, we believe the group is also well positioned to capitalise on the increased deal flows this year.

 Downside risks to our recommendation include (1) persistent selling pressure if market continues to view the group as a well politically connected stock with perceived higher risk premium as general election draws closer, (2) slower than expected cost cutting exercise, (3) unexpected dried up in deal flows due to the volatility of the capital market, and (4) lower than expected topline growth due to a significant slowdown in loan growth.

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