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What Does Oversea-Chinese Banking Corporation’s Latest Acquisition Mean for Investors?

Earlier this morning, Oversea-Chinese Banking Corporation Limited (SGX: O39) announced that it would be acquiring Hong Kong-based Wing Hang Bank with the purchase subjected to regulatory approvals among other conditions.

News of the potential acquisition first broke through in early January this year and since then, both banks – OCBC and Wing Hang – had been engaged in discussions over a suitable price, which newswires initially suggested could be up to 1.9 times Wing Hang’s book value.

In today’s news, it was made known that OCBC would be paying HK$125 per share for Wing Hang for a total sum of HK$38.4 billion (around S$6.2 billion) in cash. OCBC made it clear that it has “sufficient resources” to pay for the deal by using its own cash on hand and new borrowings from lenders who have committed to lend money to the bank. In any case, the deal works out to a premium of 1.77 times over Wing Hang’s book value.

The acquisition price might make it seem that OCBC’s not getting the best bargain available especially considering its own current price-to-book multiple of only 1.3. But, Wing Hang’s a bank that had performed well over the years on various important quantitative banking metrics such as its net interest margin, efficiency, and asset quality. In addition, Wing Hang’s book value per share had also grown at a fairly fast clip of 12% per year on average from HK$22.76 in 2003 to HK$70.59 in 2013.

So, there’s certainly something to be said for Wing Hang’s quality in regard to OCBC’s fairly pricey takeover. In any case, OCBC commented that the acquisition was made at “a fair price given the intrinsic value [OCBC] sees in [Wing Hang Bank’s] network, customer franchise and business capabilities.”

The acquisition is also something that OCBC believes would add to its earnings per share and return on equity figures by 2017 and thus provide incremental growth to the bank’s own intrinsic value. OCBC’s earnings per share had grown steadily over the past decade from S$0.36 in 2003 to S$0.78 in 2013, with a decent return on equity over the years (OCBC’s ROE now stands at 10.5%).

OCBC’s announcement regarding the deal also highlighted that it would be using cash in its coffers, new borrowings, and the issue of new shares to strengthen its balance sheet and “maintain capital adequacy ratios at prudent levels” after the acquisition’s completed. According to OCBC’s own number crunching, its Tier 1 Capital Adequacy Ratios (CAR) and Total CAR would be reduced to 11.0% and 12.5% respectively from 14.5% and 16.3%.

It should also be noted however, that even after the drop in CARs, the ratios are still a fair bit higher than the Monetary Authority of Singapore’s own Basel III requirements of 6% and 10% for the Tier 1 CAR and Total CAR respectively. This suggests that OCBC’s balance sheet would still remain strong despite a big outlay of capital for the acquisition.

In the announcement regarding the purchase of Wing Hang, OCBC also highlighted three key rationales for the deal: 1) OCBC would have greater ability to tap into the economic growth of Greater China (one of its fore core markets that includes Singapore, Malaysia, and Indonesia) which consists of the regions of China, Hong Kong, Macau, and Taiwan; 2) OCBC would be able to widen its product capabilities and access a larger funding base denominated in Chinese Yuan, Hong Kong dollars, and American dollars and; 3) the opportunity for “accelerated growth” for OCBC given “minimal duplication” in terms of product capabilities, network size, customer base and market coverage between the two banks.

While there might be concerns over extensive friction when consolidating operations for the two banks, OCBC laid out its previous acquisition histories to give strength to its ability to integrate and improve the operations of its acquired targets successfully. For instance, assets under management for OCBC’s private banking arm, Bank of Singapore, tripled to US$46 billion in 2013 after being acquired in 2010.

Foolish Bottom Line

This is a major acquisition by OCBC – a takeover price of S$6.2 billion as compared to its own market capitalisation of S$32.7 billion – which would see it having a stronger presence in the Greater China region and more fuel for growth in the years ahead if it pans out well.

By the looks of it, though the price OCBC paid for the acquisition can’t be termed an absolute bargain, Wing Hang does come with certain desirable banking qualities. It’ll be interesting times for OCBC’s investors to look upon how it would evolve in China following the acquisition and whether Wing Hang would be able to continue growing as it did in the past.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.