The first thing you want to get right in buying a business is price, writes Andile Khumalo.
There are many reasons why companies acquire other companies. The consultants and advisers will tell you it's about accelerating a vision, looking for cost-effective synergies or growing an existing customer base.
In African Bank’s case it needs to build rapidly in a fast-changing financial services market after it was rehabilitated by the South African Reserve Bank and other banks during a curatorship process.
The Reserve Bank has been clear that it wants to exit African Bank via a listing of the company, which makes a lot of sense, bar prevailing market conditions at the time.
But before African Bank can relist on the JSE, it needs to build scale in its banking operations.
Investors prefer to support banks with diverse operations and large customer reach.
Banking is a numbers game: the more customers banks get, the more profits they can generate, and the more diverse the customer base, the more opportunities to generate those profits.
In an attempt to build that scale, African Bank came across an opportunity to snap up Grindrod Bank and announced their R1.5bn deal last week. The timing of the transaction couldn’t be more ideal.
The Grindrod group didn’t want to inject more money into the bank to grow it and African Bank wanted to leap into the world of business banking — to broaden its customer base from middle-class retail customers to small businesses, pretty similar to what Capitec tried to do with Mercantile Bank.
The business banking space has become popular, with banks wanting to grow their exposure to it and offer services to small and medium-sized businesses.
Capitec paid R3.56bn for Mercantile Bank in 2018. But the purchase of Mercantile Bank hasn’t been a resounding success for Capitec or generated a demonstrable impact for it — at least not yet.
Mercantile Bank was a bit of a dud before Capitec purchased it: the former’s business customer numbers stagnated and so did its revenue-generation profile.
After buying the bank, Capitec’s management team has had to spend a lot of time restructuring it and implementing a new growth strategy.
Mercantile Bank is now focusing on the informal small business segment, which is largely unbanked — hardly a gold mine for banking services if you ask me.
This just goes to show that bank mergers are incredibly difficult. However, the first thing you want to get right in buying a business you’re going to integrate into your existing operations is price.
Capitec paid R3.5bn for a limping Mercantile Bank that was generating earnings of about R175m. African Bank paid R1.5bn for a well-run Grindrod Bank that was generating R152m in earnings.
That means African Bank CEO Kennedy Bungane and company paid an earnings multiple of just under 10 for Grindrod Bank while Capitec paid a whopping 20 times.
Mercantile Bank’s net asset value (essentially, the bank’s worth) amounted to R2.7bn, which I guess informed Capitec’s purchase price. But to make the deal happen, Capitec also paid goodwill of R795m.
Mercantile Bank’s return on equity (ROE) was really low at 6.3%. The big banks tend to achieve an ROE of above 15%, but this of course was no big bank.
By the end of 2021, Mercantile Bank was essentially loss-making, supporting views that Capitec overpaid for its purchase.
By contrast, the net asset value of Grindrod was R1.67bn, which means African Bank paid negative goodwill. It basically got the business for less than its book value.
Grindrod Bank was also making fewer losses on its lending activities, as seen in its credit loss ratio of 0.6% in 2021 compared with Mercantile Bank’s 3.5%.
It is not often that you have two companies in a similar market segment doing a similar transaction for similar reasons. It looks like African Bank did a better deal in getting into business banking than Capitec.
This article first appeared on https://www.timeslive.co.za/sunday-times on 05 June 2022