Editorial»
Costly marriage of a bank
JAN 21 - In Nepal’s financial service industry, we
are going to observe a marriage between
a two-year-old commercial bank and a nine-year-old finance company very soon. The lucky commercial bank is Laxmi Bank Limited (LBL) whilst the lucky finance company is Hisef Finance Limited (HFL). Both the financial institutions have put forward special resolution seeking approval for merging HFL with LBL in their forthcoming annual general meeting.
The Finance Companies’ Act presently governs the operation of HFL whilst the Commercial Bank Act governs the operation of LBL. These acts have provision for pure horizontal merger only, i.e., a finance company can be merged with another finance company and a commercial bank can be merged with another commercial bank. In these acts, there is no provision for merger between a bank and a finance company. Therefore, these companies have taken the assistance of section 135 of the Company Act as the institutions are also registered in accordance with this act.
For HFL, the objective behind merger seems to be the survival i.e. preventing it from dying. The table shows that NPA of HFL is far higher than the accepted norms. The net worth of the company has been eroded significantly. There seems to be no possibility for the company to increase the business without recapitalisation. On the other hand, the only benefit available to LBL from the take over of HFL is that it may be allowed by Nepal Rastra Bank (NRB) to operate in Kathmandu by relaxing capital norms.
Most of the merger deals is justified by the synergy achieved through redeployment of assets and other resources of the organizations. Synergy can be classified into operating synergy, managerial synergy and financial synergy. In case of merger under discussion, the operating synergy may be achieved if the merger allows LBL to operate in Kathmandu. The managerial synergy can be achieved if the efficiency level of the management of HFL is brought up to the level of LBL. The merger may not bring financial synergy to LBL considering the capital base, quality of assets and cost of deposits of HFL.
LBL has decided to issue one share for each share held by the holders of equity shares of HFL. This exchange ratio of 1:1 could hold well only if intrinsic values of shares of both the companies are equal. If we take the net worth per share of the companies to determine the exchange ratio, the holder of each share of HFL should get only 0.59 shares of LBL. HFL may argue that the exchange ratio of 1:1 may be justified on two grounds: its shares are traded in the market above the par value, and the appreciation in the market value of fixed assets owned by it may offset the erosion in net worth of the company.
The fact that the shares of HFL were traded above par cannot be accepted as a valid justification for the exchange ratio of 1:1. The reason is that the prices in Nepalese capital market are determined by the factors of demand and supply. To that extent the functioning of Nepalese capital market is similar to any primitive capital market in economics where demand and supply are the sole determinant factors of price. Unlike an efficient market the price has little relation either to the revenue generating capacity, or to the economic value or future potential of the company. In such a scenario one can easily manipulate price of shares by creating false demand.
When a company acquires another company it acquires business of the latter on a going concern basis. Market value of assets of the company has little concern on valuation of business of the company. Therefore, logic of the company that the appreciation in the market value of fixed assets owned by it may offset the erosion in net worth of the company may not hold good. As in the case of other mergers, the exchange ratio should have been determined by the intrinsic value of shares of both the companies.
The intrinsic value of a share is equal to the present value of the benefit associated with it which is justified by the assets, earning power, company prospects and the competitive advantage created by the company. LBL has a lot of prospects and far better earning power than HFL. LBL can enter into wider range of business than HFL. On the other hand, financial indicators of HFL show that it is going downwards and has little future potential. The intrinsic value of shares of LBL should be far higher than the shares of HFL. Therefore, shareholders of LBL are going to suffer from the merger deal.
The proposed merger is going to be first of its kind in Nepal. We should encourage the steps initiated by the companies and extend best wishes for the success of the merger. The only concern is that the shareholders of one company should not get unduly benefited at the cost of shareholders of another company. Posted on: 2004-01-21 02:56
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