A merger move that can be a catalyst for more

In a region bereft of big-ticket M&A transactions over the past few years, the planned merger between National Bank of Abu Dhabi (NBAD) and FGB is a deal that could have seismic implications for the industry. By any measure, the proposed deal is big.

The combined lender will have assets worth around $175 billion (Dh642 billion), making it the largest bank in the Gulf Cooperation Council Region (GCC), according to NBAD’s official deal disclosure.

With more than 25 banks and a population of around 9 million, the case for industry consolidation in the UAE is a compelling one. But while the strategic merits for more mergers between UAE lenders has always been strong, actual deals have proved scarce.

In fact, the last blockbuster banking deal occurred almost a decade ago when Emirates Bank International and National Bank of Dubai joined forces to form Emirates NBD. But this time around, there are grounds to believe that the NBAD and FGB deal might prove the catalyst for further M&A activity.

The environment for more deals is certainly conducive. The International Monetary Fund, in its most recent Article IV consultation paper, noted that a protracted spell of lower oil prices has squeezed liquidity at banks in the UAE, crimping profitability as government deposits drop and net interest margins narrow. This makes the prospect of more M&A appealing to banks.

With the potential for revenue synergies through the cross-selling of banking products and cost-efficiencies from the economies of scale created by M&A, its small wonder there hasn’t been more deal activity in recent times.

Opportunities

What is noticeable, as we move through a slower economic cycle, is that we are seeing a widening gap between banks that have been very prudent and well managed, and the more aggressive or less efficiently run banks. This creates opportunities for M&A.

Periods of industry consolidation tend to be supportive of strong share price momentum within the affected sector. Increased M&A activity brings in fresh liquidity as investors betting on companies that could be next in line. It is worth mentioning that M&A deals usually help unlock hidden value in undervalued companies and often create benchmark valuations multiples for the remaining players in the Industry.

This proved especially true in the immediate aftermath of the deal announcement between NBAD and FGB when the share prices of a number of local banks traded higher.

One notable upside to a mega-deal such as the NBAD and FGB one is the implications it would have for the new lender’s weighting in the MSCI Emerging Market Index. A combined entity will become a much larger component of the MSCI stocks gauge, bringing with it the prospect of larger investment inflows.

Positive ripple effect

With a bigger influence in the MSCI EM Index, it becomes very hard for investors, particularly international ones, to ignore the merged bank. The potential for a positive ripple effect across the entire UAE banking sector shouldn’t be ignored as well, as global investors widen their search for investible stocks.

Although there is plenty of logic behind the move for more consolidation amongst UAE banks, generating real value from such transactions could take time and prove difficult. Deal execution is essential in making sure big ticket M&A deals work.

Ensuring proper integration between two companies and aligning both culturally can make or break a deal.

Many banks in the UAE have their own niche areas and are very individual in the way they do things, but the quality of management can sometimes vary. And as the industry contracts, it might be those with the weaker franchises, and management teams, who are left behind.

The writer is the chief investment officer of MENA Equities at Franklin Templeton Investments (ME) Ltd.