Bank of East Asia [23] announced on November 20 that it had struck a deal with the controlling shareholders of FPB Bank [717] to acquire their combined 75% stake. The 1.5 times book value price tag equates to HK$3.50 ($0.45) per FPB Bank share and is higher-than-expected. Bank of East Asia will also launch a general offer to acquire all the remaining shares at the same price.

StockHouse LogoThat the acquisition removes an obstacle in the way of Bank of East Asia's China aspirations has been well documented, but the impact on its Hong Kong operations and valuation have received less coverage and, according to analysts, is the greater rationale behind the deal. Judgment on this is less clear and will remain so until Bank of East Asia outlines how it will fund the acquisition and the synergies it expects to garner from the move.

Chris HoThe acquisition price of HK$3.50 per share represents a 12.9% premium to the last quoted share price of FPB Bank before the announcement and about two-and-a-half times its level in August when speculation of the deal first emerged. At 1.5 times book value, the price appears rich. FPB Bank's closest peers in the Hong Kong banking universe trade below 1.0 times book, although there has been a run up in the share prices of IBA [636] and LCH Bank [1111] since the announcement broke.

The move will lift Bank of East Asia's asset base above the $20 billion threshold required by Beijing for foreign banks to establish new branch offices on the mainland. It currently conducts Yuan business in Shanghai and Shenzhen and the move would allow it to convert its representative office in Beijing into a branch. But what has received very little mention is the effect the acquisition of FPB Bank will have on Bank of East Asia's Hong Kong operations.

"The market should be looking at FPB Bank's retail lending book: consumer finance, mortgages and transport finance – taxis and minibuses, rather than the China story," explains one banking insider.

"Bank of East Asia is very light on these types of loans and that is what it has bought," he adds.

One example would be in credit card receivables. FPB Bank has essentially the same amount of credit card receivables as Bank of East Asia despite the latter being more than five times larger. In one step, Bank of East Asia doubles its credit card outstandings.

Keith Irving, head of regional banking research at Merrill Lynch estimates that Bank of East Asia's mortgage loan book will be increased 20% following the acquisition. Mortgage lending accounts for 53% of FPB Bank's loans. In terms of mortgage lending market share, Bank of East Asia would see its position catapulted above Dao Heng Bank [23] into fifth place at 7.2% from sixth place at 6.0%.

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ING Barings Securities analyst Warren Blight says, "Bank of East Asia will also be able to source asset growth in an otherwise soft market." Injecting the operations of FPB Bank into Bank of East Asia would solidify the latter's position as the third-largest bank in Hong Kong by assets. Bank of East Asia had total assets of HK$146 billion as of June 30 2000.

Blight believes Bank of East Asia is particularly interested in FPB Bank's asset-backed businesses, such as taxis and public light bus financing which make up a combined 12% of its loan book.

But whether the move eventually warrants the price paid will not be known until Bank of East Asia outlines the synergies it expects to gain. In the announcement to the Stock Exchange, there was no mention of the number of branches to be closed, the plans for headcount and whether the computer systems could be integrated.

Merrill's Irving estimates that the acquisition would be "broadly earnings neutral in FY2001 and mildly (less than 1%) accretive in FY2002 assuming no revenue or cost synergies."

He adds: "For every 10% reduction Bank of East Asia can achieve in FPB Bank's cost base, the earnings accretion would improve by 1.5 percentage points."

He sees potential cost synergies as the rationale for the deal. Migrating FPB Bank's computer systems to those of Bank of East Asia would be a probable area of benefit. Much of FPB Bank's technology is currently outsourced.

Overall Irving views the acquisition neutrally. "Significant management attention will need to be devoted to the integration to drive out synergies which would appear to have only minor earnings potential."

Irving and Blight acknowledge that they will further revise their models once more complete data regarding the acquisition, particularly on the funding aspect, is made available.

A possible course of action on this front would be the issue of approximately HK$250 million of subordinated debt. Blight believes this would be a positive move for Bank of East Asia as it would gain the benefits of the purchase without issuing new equity that would dilute its return on equity.

Whether the sale of FPB Bank by First Pacific Co and Mimet Fotic signals another round of consolidation in Hong Kong's overcrowded banking sector, Irving says that FPB Bank, along with one or two others, is a special case due to its listed corporate owner rather than the case of a bank whose majority ownership is in private hands. Blight counters that a few more controlling shareholders may be tempted to sell out but that he does not expect a wholesale rush.

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