Yesterday, CIMB, RHBCAP and MBSB announced that they have jointly submitted a proposal to BNM / MoF to merge. We understand the trio will now perform due diligence exercise prior to signing a definitive SPA in early 2015 and the deal is expected to complete by mid-2015. According to the proposal, RHBCAP is set to acquire CIMB’s assets and liabilities via a share swap exercise and concurrently, CIMB Islamic, RHB Islamic and MBSB will merge to form a mega-Islamic Bank (CIMB, RHBCAP and MBSB valued at RM7.27, RM10.03 and RM2.82 per share, respectively). Based on our findings: (i) EPS of the combined CIMB-RHBCAP entity will immediately be enhanced by 2%, (ii) the group’s ROE is expected to fall 300bpts to 8%, and (iii) CARs of enlarged CIMB-RHBCAP group is expected to fall 200-400bpts. Over the long-run, potential synergies from the merger is seen to outweigh the dis-synergies. In sum, MBSB is the clear winner here. The RM2.82 fair value ascribed to its share exceeds even our OUTPERFORM target price of RM2.65 (by 6.4%) and is 19.0% above current market price. Meanwhile, the fair values attached to RHBCAP (TP: RM10.00) and CIMB (TP: RM7.15) are very close to our target prices, and hence, we are NEUTRAL on both stocks. We drop RHBCAP from our 4Q14 list of Top Picks as we expect a long gestation period given bulk of the merger synergies are derived from cost saving which probably need some times for integration.

Submission to BNM for approval to merge. Yesterday, CIMB, RHBCAP and MBSB announced that they have jointly submitted a proposal to Bank Negara Malaysia (BNM) / Ministry of Finance (MoF) to merge. The submission of the proposal was made after the initial 90 days exclusivity period (10 Jul 2014 - 8 Oct 2014). We gathered that the trio will now perform due diligence exercises prior to signing a definitive Sale and Purchase Agreement (SPA) in early 2015 and the deal is expected to complete by mid-2015.

RHBCAP as the acquirer. According to the proposal, RHBCAP is set to acquire CIMB’s assets and liabilities via a share swap exercise (1 RHBCAP share for 1.38 CIMB share). This is premised based on a benchmark price of RM7.27/CIMB share and RM10.03/RHBCAP share; implying P/B of 1.7x and 1.4x, respectively, as at 30 June 2014. Upon completion, CIMB shareholders will own 70% of the merged entity while the remaining 30% belongs to RHBCAP shareholders. Concurrently, CIMB Islamic, RHB Islamic and MBSB will merge to form a mega-Islamic Bank. This will be executed at a price of RM2.82/MBSB share (implying 1.9x P/B as at 30 June 2014) where MBSB shareholders can opt to receive cash or CIMB Islamic shares. In any case, the newly created mega-Islamic Bank will remain a subsidiary of the enlarged CIMB-RHBCAP group (please see Table 2 for post-acquisition scenario analysis on CIMB Islamic’s shareholding structure).

Potential synergies outweigh dis-synergies. Based on our findings: (i) EPS of the combined CIMB-RHBCAP entity will immediately be enhanced by 2% given that MBSB is not purchased directly at RHBCAP level, entailing lesser issuance of new RHBCAP shares, (ii) the group’s ROE is expected to fall 300bpts to 8% on the back of higher P/B valuation attached to CIMB, and (iii) CARs of enlarged the CIMB-RHBCAP group is expected to fall 200-400bpts as a result of acquisition goodwill. Moving forward, it is envisioned that the potential synergies – 86% from cost & 14% from revenue – as consequence of the merger would outweigh the dis-synergies over the long run. Such synergies include: (i) economies of scale, (ii) the creation of a new growth engine – an enlarged Islamic bank with strength in micro-financing, and (iii) an increased retail presence in Singapore via RHBCAP which is currently a fully licensed commercial bank there. Meanwhile, potential dis-synergies include: (i) an overlap in the wholesale banking business, and (ii) higher cost-to-income (CI) ratio as a result of sticky costs due to inflated workforce and duplication in operations. As for post-acquisition shareholding structure, EPF is poised to become the largest shareholder of the newly merged group with 26% stake, followed by Khazanah 19%, Aabar 6% and OSK 3%.

How this development affects our recommendations. MBSB is the clear winner here. The RM2.82 fair value ascribed to its shares exceed even our OUTPERFORM target price of RM2.65 (by 6.4%) and is 19.0% above current market price. The fair value attached to CIMB (RM7.27 vs. our TP of RM7.15), on the other hand, is very close to our MARKET PERFORM target price. Hence, we maintain NEUTRAL on CIMB. In the case of RHBCAP, the RM10.03 fair value ascribed is also in-line with our OUTPERFORM TP of RM10.00 (implying an upside potential of 15.3%). However, considering that RHBCAP’s fair value is for transactional purposes only and our expectation of a long gestation period (given bulk of the merger synergies are derived from cost saving which probably need some times for integration), hence we turn NEUTRAL on RHBCAP. Hence, we drop RHBCAP from our 4Q14 list of top picks.

Source: Kenanga