On 16 September 2012, China Construction Bank (OTCPK:CICHY) announced that it would use up to $15 billion to buy a stake (30%-50% stake or full acquisition) in a European bank. CCB chairman Wang Hongzhang said he would target banks in France, Germany and the United Kingdom. He indicated that some of the European banks are "on sale." The most interesting candidates are to be found in the partly nationalized banks, because it allows the government to re-privatize the banks. This way, the treasury is allowed to recoup its investment after having bailed out the banks during the economic crisis.
The likely candidates are Royal Bank of Scotland (NYSE:RBS), Lloyds (NYSE:LYG) and Commerzbank (OTCPK:CRZBY). Today the U.K. government controls a 82% stake in the Royal Bank of Scotland (RBS) and a 41% stake in Lloyds. The German government holds a 25% stake in Commerzbank. If one of the deals were to go through, it would shatter the $5.5 billion record held by Industrial and Commercial Bank of China for its purchase of a 20% stake in South Africa's Standard Bank in 2007. The question is: which bank is more likely to be the target?
First, let's go over the buyout number. It would take about $40 billion to buy out RBS, given that it would take GBP 5 billion for the government to buy out the remaining stake of 18% in RBS. So with the $15 billion in cash, China Construction Bank could buy half of RBS. RBS has a market cap of $28 billion today. Lloyds has a market capitalization of $43 billion. If China Construction Bank were to bid on Lloyds with $15 billion in cash, it will most likely have too small a stake in the company. So Lloyds is an unlikely target for CCB. The other candidate is Commerzbank which has a market capitalization of $12 billion. With $15 billion in cash, CCB could initiate a full acquisition of Commerzbank. It is estimated that the full acquisition would cost 8 billion euro or $10 billion.
Another requirement of chairman Wang Hongzhang is that the target should have international presence. RBS is currently providing financial services over 40 countries, focusing mainly on the U.K. and the U.S. It has presence in Asia and Europe, but is exiting out of South America. For example, RBS dropped its investment bank plans in Brazil in October last year. Earlier, RBS sold its Chilean business to Nova Scotia and the RBS Argentina branch business to Banco Comafi SA. Commerzbank on the other hand has large international presence in 50 countries including South and North America, Africa, Europe, Australia and Asia.
The last requirement can be found in the earnings. If we compare RBS (Chart 1) to Commerzbank (Chart 2) it would be logical to choose for Commerzbank as they reported positive earnings quickly after the 2008 crisis hit. At the same time, Commerzbank's P/E ratio is pretty attractive at 9 while RBS's P/E ratio next year is estimated at 13. Additionally, Commerzbank's earnings will especially benefit from a strong German economic recovery. I believe it's more likely that Germany will outperform the U.K. in the coming years. One of the reasons is the unemployment rate between both countries. German unemployment is at 5.5%, while U.K. unemployment is at 7%. Another reason is that Germany is an export machine, posting current account surpluses while the U.K. is consistently posting current account deficits. The most important thing to consider though is the indebtedness of U.K. consumers, which are almost double of those in Germany.
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|Chart 1: RBS Earnings|
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|Chart 2: Commerzbank Earnings|
As earnings are starting to have positive momentum in the last few years, Chinese banks are eyeing acquisitions in the Western world, especially in Europe. This is because the valuations in Europe are very inexpensive at this time as I pointed out in this article. China Construction Bank recently said it would invest up to $15 billion in a European bank. Two banks clearly stand out as pointed out by analysts: RBS and Commerzbank. Of these two, Commerzbank seems the most probable acquisition to me based on international presence, earnings and ease of a full buyout.