Citation
Gentle, C. (2005), "M&A: on the agenda again!", Journal of Risk Finance, Vol. 6 No. 5. https://doi.org/10.1108/jrf.2005.29406eaf.001
Publisher
:Emerald Group Publishing Limited
Copyright © 2005, Emerald Group Publishing Limited
M&A: on the agenda again!
On both sides of the Atlantic, mergers and acquisitions are back on the board agenda at most major financial institutions. The last five years have seen relatively few transactions in the finance sector. This lull in activity is coming to an end. Don’t expect a return to the days of the dot.com boom, however.
Today the drivers are different. First, financial services companies are under stress on both sides of the balance sheet due to rapidly maturing markets and pallid economic prospects – revenues and costs are under intense pressure. Second, the world of finance is gradually becoming international. Recent reported deals highlight this shift: Barclays’ purchase of a majority share in ABSA – South Africa’s largest retail bank – for instance. Also witness Citibank’s acquisition of KorAm bank in South Korea, while Bank of America, UBS and Royal Bank of Scotland are reported to be considering investing in China’s big four banks. Perhaps most interesting is the possible beginnings of consolidation on a pan-European level – Santander’s purchase of Abbey has been followed by a yet to be finalized deal between Unicredit (Italy) and HVB (Germany).
A pan-European market?
More than five years after the introduction of the Euro on January 1, 1999, cross-border retail banking mergers are finally beginning to create pan-European financial services institutions. Although we have seen the emergence of pan-European corporate banking competitors in investment banking, syndicated loans, and investment management, following previous sector-specific consolidation, cross-border consolidation in retail financial services has not happened. Indeed, chief executives have found acquiring branch networks across borders a far more daunting prospect – that is until now.
It is possible that by 2010 a handful of retail financial services firms will operate across the breadth and length of Europe. These institutions will have world-class scale and efficiency and they will be created through cross-border mergers – the opening round of which is already in motion.
The prime driver of consolidation is the pressing need to generate earnings growth in an environment where organic growth is hard to come by. Although this desire for growth is tempered by the mixed shareholder value creation record of retail banking M&A deals, there is a dawning realization among investors that highly efficient, operationally sound banks have a tremendous opportunity to “roll-up” poor performers in other countries via cross-border M&A. Equally important to the economic drivers behind these pan-European deals is the eroding political opposition to cross-border financial services mergers as the European Commission actively seeks to break down national barriers to consolidation.
This confluence of factors is resulting in the beginnings surge of cross-border retail merger activity in financial services. After many years of surprisingly few deals, the pace of cross-border retail/universal banking mergers has accelerated exponentially. Across the past 18 months, from the beginning of 2004 through the first half of 2005, six of the eight announced European financial services deals over €5 billion have been retail cross-border deals.
Consolidation: the path ahead
When considering the path of financial services consolidation, it is useful to compare the European experience with that of the USA, where inter-state banking mergers have already created some of the world’s largest pan-continental financial services groups. Both the European and the US banking industries have a similar history – fragmented banking markets with long-standing historical legal restrictions on inter-state mergers. Looking at the US market we see that bank consolidation activity reached a high water mark in 1995, when furious competition among local and regional banks led to 5 percent of the banks disappearing that year. This initial phase of increasing economies of scale and achieving the easy synergies from rationalizing overlapping branch networks created a number of powerful regional banks, but it was not until around 2000 that we began to see the outlines of the “endgame” – the emergence of truly national retail banking giants that spanned the USA.
Europe has a very different set of national interests and cultures that have, so far, hindered pan-European consolidation. But mapping the number of mergers in the USA and Europe shows the two geographical areas set on remarkably similar paths. For the peak of merger activity by number of deals in the USA in 1995, read Europe’s peak in 1999, when banks pursued in-country mergers with relatively straightforward synergy gains. Just as it took five years for mergers to start creating retail banking giants with pan-US operations, so we are now witnessing the creation of pan-European financial services giants in 2005. If history continues to be our guide, we might expect Europe’s path of consolidation to broadly mirror that of the USA. Indeed, this analysis, along with the other factors discussed above, is what underpins a belief that we could be present at the creation of truly pan-European retail banks; today, we may be witnessing the opening rounds in a five-year process of cross-border, retail banking consolidation.
Growing acquisition war chests
At the same time, however, financial services companies have substantial excess capital that needs to be either invested productively or returned to shareholders. According to calculations by Morgan Stanley, banks will have accumulated some €74 billion in excess capital by the end of 2006. What is more, this capital will continue to amass at a rapid rate going forward. With large amounts of idle funds sitting on bank balance sheets, expect many CEOs will be tempted to deploy those funds on a high-profile shopping spree, rather than simply returning that capital to shareholders.
Falling political barriers
The European Commission is currently investigating why there have been so few cross-border financial services mergers, and has repeatedly stated that national regulators should not stand in the way of the market. Historically, national central banks and politicians have sought to deter acquisitions by foreign institutions, both to protect domestic jobs and, often, to try to preserve the close relationships between local banks and companies.
An analysis of all merger activity in Europe across the past five years is revealing in terms of identifying the scope of the problem. According to the European Commission, only 20 percent of all European financial services mergers and acquisitions in the EU were cross-border deals, with the other 80 percent of deals being domestic acquisitions. This is very much at odds with all of the other industry sectors across the same period. Indeed, some 45 percent of all mergers and acquisitions in other sectors between 1999 and 2004 were cross-border, a cross-border activity rate that is over twice that found in financial services (see Figure 1).
Figure 1 European cross-border M&A: percentage of European M&A deals that are cross-border, 1999-2004
Differences in cross-border activity: FS versus other industries
Many observers have attributed much of this cross-border activity deficit to national supervisory agencies blocking any approaches from foreign acquirers. Yet, evidence in the market suggests that central bank opposition, which has been seen as an insurmountable obstacle to any cross-border deal, is no longer the deal-breaker it once was.
Finally, the tax treatment of European cross-border businesses appears slowly to be becoming increasingly favorable. A number of European Court opinions and judgments, such as the Marks & Spencer case, have ruled against the “discriminatory” treatment by the home country’s tax authorities of cross-border tax issues.
The reason the European Commission views the removal of obstacles to cross-border consolidation in financial services as so important is the positive effect that an efficient and competitive financial services industry has on the whole of the European economy. Speaking to a banking audience at the end of May 2005, Charlie McCreevy, European Commissioner for Internal Markets and Services, said: “There is empirical evidence to support the view that integration and consolidation in banking can enhance overall economic performance via macro economic stabilization, risk diversification, economies of scale, lower costs of capital and enhanced consumer welfare.”
Conclusions
So where does all this lead?
By 2010, cross-border retail banking mergers are likely to have created pan-European financial services behemoths similar to the national retail giants in the USA. Market concentration across the continent will increase significantly, with the biggest financial services companies controlling a larger share of the total retail market for banking and saving products.
For the acquiring financial services institutions, this should lead to higher earnings growth on the whole, although it would seem foolishly optimistic to suggest that all mergers will create shareholder value. Meanwhile, the shareholders in the acquired organizations will benefit, as these will typically only divest their holdings if their shares are bought at a price premiums.
Across Europe as a whole, financial services will become a more efficient industry, with large efficiency gains for the economy as a whole. Billions of euros that are currently spent in financial services will be saved through more efficient operating procedures. What is more, Europe’s consumers should gain from better value current accounts, savings accounts, mortgages, life insurance, and other products.
While there will still be room for national institutions, particularly in sectors where there are specific national product sets such as banc-assurance, the arena of competition will expand. Transcontinental and European banking champions are likely to build scale, sophistication and earnings power creating a growing divide between big and small. Many familiar names are likely to disappear as M&A appears – again.
Chris GentleDeloitte, London, UK