Mexico: Risks seen in Banorte’s M&A strategy

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By:
Rob Dwyer
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Acquisition of Interacciones would lead to high concentration in state lending; management’s rationale and forecasts seen as optimistic.


Banorte-shadow-R-600


Banorte’s proposed acquisition of Interacciones would create Mexico’s second largest bank – behind BBVA Bancomer – but it is unclear whether management will get the required backing from its minority shareholders to push the deal through.

Banorte expects to call for a shareholders’ meeting in early November, with voting expected to take place in early December.

Banorte has been growing organically at a fast pace in recent years and is closing in on its management’s goal of a return on equity of 20%.

However, the surprising addition of an M&A element to its growth strategy has been met with some scepticism: the day after the deal was announced – in a communication to the Mexican stock exchange on October 25 – the share price of Banorte fell by 9.1%, a loss of market cap 9% higher than its valuation of Interacciones.

That valuation, of around $1.3 billion in a cash-and-stock offer, was a 10% premium to Interacciones’ closing price before the merger announcement was made public.

The deal would also need regulatory approval, but, if it goes ahead, would create an institution with 15.5% market share in loans – up from Banorte’s 13.2%. The deal also envisages synergies worth 65% of Interacciones’ costs.

Competitive position

On a conference call, the bank’s management also argued the deal would give the combined organization a stronger competitive position in the infrastructure market, given Interacciones’ business platform and Banorte’s scale. Management also outlined its belief that its government lending businesses are a good, complementary fit.

However, this last item is contentious.

Credit Suisse financial analyst Marcelo Telles says the combination of the state business of both banks leads to concentration risks. A combined bank would take – assuming a simple addition of portfolios – Banorte’s share of central government revenues to 38.3% from 24.1%.

The concentration at the state and municipality levels would be even greater: from 28.0% to 47.8% – in other words, one of the 48 banks in the Mexican banking system would be holding nearly half of this credit portfolio, leading to possible lost revenue as these counterparties rebalance through counterparty diversification.

According to Telles: “Given the significant increase in concentration, we do not see a plausible strategic rationale that benefits Banorte’s shareholders, thus raising corporate governance concern.”


Banorte’s 'blue sky' scenario is “too blue” 
 - Marcelo Telles, Credit Suisse

The merger announcement noted that shareholder approval will be needed and the bank’s governance rules state that any acquisition worth more than 5% of its market cap needs to get more than 50% approval from a quorum of at least 75%.

As Banorte controls just 12% of these votes, there is considerable uncertainty in the outcome – especially as some might see a potential conflict of interest from the fact Banorte’s chairman Carlos Hank González owns 19.93% of Interacciones; though it’s held in a blind trust.

On the conference call, Banorte’s management forecast that the deal would be accretive by around 3% in 2018 and between 8.5% and 10.5% in 2019, with the long-term target of ROE at 20% unchanged.

Those Banorte’s forecasts are based on estimates of pre-tax synergies of Ps2.8 billion ($147 million) to Ps3.1 billion, comprised between Ps2.1 billion and Ps2.3 billion in cost reduction – a 5% reduction in the combined cost base, equivalent to 65% of Interacciones’ cost base – and an improvement in the cost of funding of between Ps700 million Ps800 million.

Telles argues that Banorte’s 'blue sky' scenario, as outlined on the conference call, is “too blue”. Management doesn’t include the loss of any revenues from its state business, despite the concentration in the segment that the merger would create.

Secular reduction

Telles also argues that the merger could increase the speed of secular reduction in the level of fees and commissions charged by Interacciones – not factored in by Banorte’s forecasts – and he is not alone in questioning whether a 65% reduction in the cost base of Interacciones is achievable.

“Last, but not least, management assumes no change in the status quo of Interacciones’ business, notwithstanding political and regulatory risks that may arise along the way during 2018 presidential elections,” argues Telles.

Despite the risks involved in the approval process – and with integration, should shareholder and regulatory approval be given – the strong recent performance by Banorte and the small relative size of the deal means this is likely to remain a sub-plot to the main narrative of a rapid expansion in growth and profitability.

In late October, chief financial officer Rafael Arana de la Garza revealed that Banorte achieved its best-ever efficiency ratio – coming in at 40.4%. This result reflects tight cost control after recent capex spending that is now producing strong revenue growth.

As Euromoney detailed at the time, the foundation of the recent strong performance – net income is up 10% quarter on quarter and 25% year on year to Ps6.22 billion – is the recent investment in its digital platform. 

Banorte has implemented an IBM Watson platform throughout the group, which initially raised the bank’s capex to the highest in the sector – comparable only with BBVA. 

The bank is now able to use real-time analytics to drive increased sales of new products to its existing customer base, and use its ATM network and online banking to cross-sell insurance, payroll loans, credit cards and auto loans.