OCBC is making a VGO for WHB shares as part of  its strategy to drive growth in its Greater China operations. While WHB will expand OCBC's Greater  China  loan  book  by  81%  and  raise  profit  contribution  to  16%, the  acquisition  will  likely  be  EPS-  and  ROE-dilutive  in  the  near  term, with  exact  impact  dependent  on  the  final  financing  structure.  Maintain NEUTRAL on OCBC, as we prefer DBS for exposure to Greater China.  

Acquiring  WHB  at  1.77x  P/BV.  OCBC  has  announced  a  voluntary general  offer  (VGO)  to  acquire  Wing  Hang  Bank  (WHB)  shares  at HKD125  per  share.  Full  acceptance  of  the  offer  would  cost  OCBC HKD38.69bn  (SGD6.28bn),  valuing  WHB  at  1.77x  its  book  value  as  at end-2013. This is not particularly attractive  given WHB's ROE of 10.6% and Singapore banks' 1.2x FY14F P/BV and ROE of 11.2%.  

M&A  fits  its  Greater  China  strategy.  The  acquisition  is  in  line  with management's strategy  to  have  a  bigger  presence  in  Greater  China  to benefit  from  Asian  mega  trends.  Based  on  financials  ending  31  Dec 2013, WHB would expand OCBC's Greater China loan book by c.81% to SGD49.3bn (or 26% of the enlarged entity's gross loans) and lift pretax profit contribution from Greater China to c.16% from 6% in FY13.  

Likely  to  be  dilutive  in  near  term.  While  management  has  yet  to finalise the funding details, we believe a cash call is necessary to sustain OCBC's current capital position. Without  fresh  capital,  CET-1  would  fall 350bps to 11%. Our calculations suggest neutral impact on EPS if 50% of  financing  is  via  a  rights  issue,  which  will  shave  a  smaller  180bps  off CET-1  to  12.7%,  while  ROE  will  dip  30bps  to  11.7%.  Management expects WHB to be accretive to OCBC's EPS and ROE by 2017. We are retaining our earnings forecasts for now.

Key  risks  from  this  acquisition  include:  i)  execution  of  strategies  to capture  offshore  CNY  flows  and  growth  of  its  wealth  management business,  ii)  management  of  OCBC's  capital  position,  and  iii)  a deterioration in WHB's asset quality, particularly its property loans.

Maintain  NEUTRAL.  OCBC's share price is down 6.3%  YTD  and  is currently  trading  at  -1SD  historical  P/BV.  At  this  level,  we  believe  the market  has  priced  in  the  WHB  acquisition  and  its  near-term  dilution impact.  Maintain  NEUTRAL  and  SGD10.30  FV.  We  prefer  DBS  (DBS SP, BUY, FV: SGD19.20) for exposure to Greater China prospects.

Acquiring  WHB  at  1.77x  P/BV.  OCBC  announced  that  it  is  making  a  voluntary conditional cash offer to acquire the entire issued capital of  Wing Hang Bank (WHB) at  HKD125  per  share  (WHB's  pre-suspension  price  is  HKD123)  and  to  cancel  all outstanding  options  and  unvested  awards.  Based  on  the  307.4m  WHB  shares  in issue,  the  cash  offer  would  amount  to  HKD38,428m  (SGD6,234m),  while consideration  for  cancellation  of  all  options  and  unvested  awards  would  be approximately HKD260m (SGD42m).  

Full  acceptance  of  the  offers  would  cost  OCBC  a  total  of  HKD38,688m (SGD6,276m),  valuing  WHB  at  1.77x  book  value  as  at  end-2013.  Although  this  is slightly lower than earlier reported price tag of "less than 2x P/BV", this  valuation multiple is not attractive given WHB's ROE of 10.6% and ROA of 1.06%. Singapore banks  are  currently  valued  at  1.2x  FY14F  P/BV,  with  ROE  of  11.2%  and  ROA  of 0.93%. In our view, the price tag incorporates a scarcity premium given that WHB is one of four remaining family-owned banks in Hong Kong.

As  at  31  March  2014,  OCBC  received  irrevocable  undertakings  for  approximately 50.66% of WHB's issued share capital -  20.76%  from  BNY  International  Financing Corporation,  24.03%  from  the  Fung  family,  and  5.87%  from  Aberdeen  Asset Management Asia Ltd. The VGO is expected to close in Aug 2014.

WHB focuses on retail banking in HK and Macau, SME financing in China. WHB is the eighth-largest bank in Hong Kong and  sixth-largest in Macau by total loans. It has a network of 70 branches in Hong Kong (42 branches), Macau (13) and Mainland China (15). In FY13, the bank derived 77.5% of pretax profit from Hong Kong, 16.6% from Macau and 6.8% from China. In Hong Kong, retail banking accounted for 54.6% of  its  total  profit,  while  treasury  comprised  32.7%  and  corporate  banking  12.7%.  In Macau,  WHB  is  focused  mainly  on  retail  banking  while  in  Mainland  China,  it  has  a good  franchise  in  SME  financing.  WHB  has  also  carved  a  niche  in  auto  and equipment financing in Hong Kong and Macau.  

As at end-2013, Hong Kong accounted for 66.5% of gross loans, Mainland China at 19.1%, Macau at 13.7% and others at 0.7%. In Hong Kong, WHB has high exposure to  the  property  sector  -  home  mortgages  made  up  28.6%  of  loans,  property investment  at  22.6%  and  property  development  at  2.6%.  However,  asset  quality appeared  healthy with sector's gross impaired loans  ratio  at  a  low  0.01%  at  end-2013. Instead, Mainland China loans had a higher impaired loans ratio of 1.5%.

Acquisition to augment Greater China strategy. Currently, OCBC has one branch in  Hong  Kong  and  another  in  Taiwan,  while  its  wholly-owned  OCBC  Bank  (China) has  16  branches  and  sub-branches  in  China.  Its  private  banking  unit,  Bank  of Singapore, has a branch in Hong Kong.

The acquisition of WHB ties in with management's strategy to grow OCBC's business by  riding  on  Asian  mega  trends  of  increasing  intra-Asian  trade  flows,  Hong  Kong's growing importance as a financing centre for China, and rising wealth among Asians. For management, rationale for the acquisition includes:

i) WHB's expertise in SME banking in Greater China (China, Hong Kong, Taiwan and Macau) will complement OCBC China's current focus on corporate banking;
ii) WHB's  stronger  presence  in  Hong  Kong  will  provide  OCBC  with  significant opportunities in private banking for Bank of Singapore;
iii) WHB will offer OCBC an established franchise and a sizeable platform to grow its CNY-denominated businesses;
iv)  OCBC  will  have  expanded  scale  in  product  capabilities,  network  size,  customer base and market coverage with minimal duplication; and
v) Opportunities for cross-selling wealth and bancassurance products and services to WHB's affluent retail customers and SME clients.

Profit  from  Greater  China  could  rise  to  16%  from  6%.  Based  on  its  financials ending  31  Dec  2013,  WHB  would  expand  OCBC's Greater China  gross  loan  by c.81%  to  SGD49.13bn  (or  26%  of  the  enlarged entity's gross loans) and lift  pretax profit contribution from Greater China to c.16% from 6% in FY13.  

OCBC's  Greater  China  loans  grew  at  a  CAGR  of  31.6%  between  FY08  and  FY13, while  pretax  profit  from  Greater  China  increased  at  a  CAGR of  83%  between  FY10 and FY13. In FY13, Greater China accounted for 16%  (FY08: 8%) of OCBC's loans and 6% (FY10: 1.2%) of group pretax profit. DBS Group derived 26% of group profits from Greater China while loans from this region made up 36% of its total loans.

CET-1  to  fall  unless  fully  funded  by  fresh  equity.  Before  taking  into  account  any external funding, management expects the acquisition to cut OCBC's CET-1 to 11% from 14.5% (Dec 2013), while total capital adequacy ratio (CAR) would be lowered to 12.5%  from  16.3%.  OCBC  intends  to utilise  a  funding  mix  of  internal  resources  and raising  new  debt  and  equity  capital  to  maintain  capital  ratios  at  prudent  levels. Management guided that it will finalise funding plans after it has a clearer indication
on the level of acceptance for its VGO.  

We  believe  a  rights  issue  is  inevitable  in  order  to  maintain  its  capital  position. Already, OCBC's fully-loaded  CET-1  of  10.9%  at  end-2013  is  the  lowest  compared with DBS Group's 11.9% and UOB's 12.5%.  

Assuming  OCBC  gains  full  control  of  WHB  and  undertakes  a  rights  issue  to  raise SGD3,308m (50% of total consideration), our calculations point to a CET-1 of 12.7% (a 180bps drop). CET-1 would remain at 14.5% should the acquisition be fully funded via fresh equity.

EPS  unchanged  but  ROE  to  dip,  if  financed  50%  by  rights  issue.  According  to management,  a low  hanging  fruit  from  the  acquisition  would  include  cross-selling  of treasury, wealth management and bancassurance products and services. That said, management  believes  WHB  would  only  be accretive to OCBC's EPS and ROE by 2017.  

Assuming the acquisition is 50% funded by fresh equity, the rights shares are issued at  a  10%  discount,  WHB  sustains  a  net  profit  of  HKD2.19bn  as  in  FY13,  and excluding merger synergies and integration costs, our calculations suggest EPS can be sustained at SGD0.85 but ROE would dip slightly to 11.7%. However, should the acquisition be funded entirely by a rights issue, EPS would be lowered by 7% while ROE would fall to 11.2% from 12%

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Source: OSK-DMG