MBSB has announced a conditional share purchase agreement to acquire Asian Finance Bank (AFB) yesterday. Based on the provided numbers, the merger exercises could result in a lower ROE and correspondingly lower valuations for the Group. Hence we are less positive although it’s on track to create the 2nd Islamic Banking entity. Pending final approval, we maintain our OUT PERFORM call with a TP of RM1.45.

Finally. MBSB finally announced the successful conclusion to its aspiration to become a fully Islamic banking entity with the announcement of a conditional share purchase agreement with the shareholders of Asian Finance Bank (AFB), namely Qatar Islamic Bank (QIB), Financial Assets Bahrain W.L.L (FAB), RUSD Investment Bank Inc (RUSD) and Tadhamon International Islamic Bank (TIIB) for the proposed acquisition by MBSB of the entire equity interest in AFB for an aggregate purchase consideration of RM644.9m or 1.3x Price to Book value (PBV) of the Net Assets of AFB as of 31 Dec 2016. The purchase is a combination of cash amounting to RM396.9m and the issuance of 225.5m new ordinary shares.

AFB a subsidiary of MBSB. The cash option of RM396.9m is valued at 1.2x of the agreed net assets (NA) of AFB while the shares option of 225.5m shares is valued at 1.5x of the NA. The cash consideration will be funded by internally generated funds. Upon completion of the proposed acquisition AFB will become a wholly owned subsidiary of MBSB. MBSB will transfer all its Shariah-compliant assets and liabilities (A&L) to AFB with the remaining conventional A&L to be converted and transferred to AFB subsequently. A bit pricey? The 1.3x P/B purchase consideration seems to be steep for small banking entity with the industry average trading at 1.4x but nevertheless the merger will create the 2nd listed Islamic banking entity after BIMB and cheaper than BIMB’s P/BV of 1.8x.

New products. The new Entity is expected to leverage on the strength of MBSB’s business and the banking license held by AFB is anticipated to provide a unique opportunity for the new Entity to emerge as a fullfledged Islamic banking franchise in Malaysia.

No significant impact. The merger is not expected to have any material effect on the earnings of MBSB for the financial year ending 31 Dec 2017. However, MBSB’s forward shareholders’ funds are expected to be higher by RM197m (from RM6.724b) to RM6.922b based on the proforma accounts. Hence, FY18E shareholders’ funds for the new entity is now expected to be higher, thus, our estimated FY18 ROE is expected to be slightly lower by 21bps to 8.26%. The lower ROE warrants a lower price-to book (PB) valuation for the new entity. At a lower PB/PE blended FY18E of 0.9x/16x (from 1.0x/16x) our new valuation is at RM1.30.

OUTPERFORM recommendation maintained. As approvals are yet to be obtained, we refrained from jumping the gun in terms of our recommendation on MBSB. Based on the illustrative number provided, we view the proposed development as neutral as earnings are unlikely to be significantly accretive in the short to medium term. We retain our OUTPERFORM call with an unchanged target price of RM1.45 based on a blended FY18E PB/PE ratio of 1.0x/16.0x. The PE is based on its 5-year mean (with a 0.2SD below mean) with the lower PB (1SD below its 5-year mean) to reflect our concerns on downside risk on earnings due to: (i) constrictive loans growth as it will compete with bigger established banks in chasing quality corporate loans, and (ii) a new cycle in deterioration of asset quality due to the higher ratio of corporate loans.

Source: Kenanga Research - 7 Nov 2017