Concerns of ComBank-NDB merger plan

Point of View
By Dinesh Ranasinghe
A merger occurs when a firm with a new identity is created assuming all the assets and liabilities of two or more business entities. Thus, merged firms cease to exist and an entity with a new identity is created. For such a merger to materialize, a majority vote of shareholders is generally required to approve a merger as per Sri Lankan legislation.

A merger in the same industry is classified as a horizontal merger, where entities of the same industry form one consolidated entity as in the case of COMB-NDB if the talks succeed. Motives for a merger of this nature would be achieving economies of scale, combining complementary resources, garnering tax advantages, and eliminating inefficiencies. In today's business environment, companies may have to grow to survive, especially to compete with global giants like HSBC, Standard-Chartered and one of the best ways to counter this is by merging with another company or acquiring other companies.

Other reasons for considering growth through mergers include increasing market power by merging with competitors, shoring up weaknesses in key business areas, penetrating new geographic regions, to meet the capital requirement imposed by the Central Bank, cross selling and many more as sighted in the joint statement issued by the management of the subject companies. However, the main objective should be to generate long-term shareholder value. Thus, the entity after the merger should be more than the fair value of the two individual entities, that is, it should generate synergistic benefits in the long run.

Speculation rose in the financial services sphere with the announcement of the COMB-NDB merger talks recently. Share prices of both the firms’ appreciated sharply in considerable volumes forcing securities officials to suspend trading at the Colombo Bourse. Were investors rational, emotional, acting upon information where the outcomes were uncertain, but hoping for the best? However, the mere fact of announcing merger talks should escalate prices of stocks but should be a result in value addition.

Before speculating on stock prices, the benefits and risks of a possible merger should be assessed. Sound corporate governance calls such individual entities to inform their shareholders of advantages (as they have through a joint statement) and possible risks of a merger.

For instance in this situation, compatibility of the two entities should be analysed, the merger would not be successful if the IT systems do not integrate or if not compatible would be detrimental to clients, vis-a-vie detrimental to shareholders. Further analysis requires the effect on balance sheet components (assets, liabilities, equity) and profitability (profit margins, return on assets, return on equity) to ascertain the fair-value of share prices and to derive conclusion of shareholder value.

Other key concerns would be, who would comprise the executive management of the new financial institution, will there be any shareholder who could dominate the management of the new entity (of course COMB was under controversy of a probable ousting of the Chairman), etc. Also the economic effect of elimination of competition between the merging firms, which would depend on their relative size, that is unification of the merging firms' operations may create substantial market power.

After assessing the above criteria the fair value of the new entity and the fair value after the merger could be determined and based on those values and the share swap ratios should derive the fair value of the individual entities. However, in this case it is most likely to be emotional trading rather than trading based on fundamentals.