Why the Barclays/ABSA Africa merger is a good deal
In many ways Africa has been the favourite story for South African equities in 2012. African expansion strategies have been richly rewarded by the market over the past 12 months. Companies with African consumer-driven strategies have done particularly well (just two examples are Shoprite and Tiger Brands, which have provided returns of more than 50% and 30% respectively for 2012).
For most of the first decade after 2000, Africa was talked about as an opportunity, but often dismissed by company management as “too high risk” and “logistically challenging…” How the world has changed since 2007, with the developed world and many parts of the developing world caught up in the global financial crisis.
When McKinsey published its widely read (and quoted) Lions on the move: The progress and potential of African economies in June 2010, the naysayers on Africa could no longer ignore the facts. Although many strategists and entrepreneurs had recognised this opportunity years ago, Africa very quickly and, almost universally, became recognised as the world’s last growth frontier.
McKinsey famously predicted that consumer spending on the African continent would grow from around US$900m to $1.4t in the decade to 2020. Growth of 5% a year over a decade makes for very attractive opportunities in a world where the major economies are facing deleveraging and stagnant or below trend growth for a prolonged period of time. These numbers now appear very conservative, as the IMF expects Africa to grow GDP by around 7% a year from 2015 to 2020.
When UK-based Barclays took control of South African bank ABSA in May 2005, they stated the intention to merge their African operations. Various obstacles in the form of management changes, regulatory issues and later the financial crisis meant that the deal was not always very high on the priority list. It thus did not come as a big surprise to the market when ABSA and Barclays announced in August 2012 that they are again looking at finally merging their African operations. This occurred after the effective merging of the two companies’ reporting lines and management structure over a year ago (“the functional integration”).
As investors mull over the circular in preparation for the general meeting on February 25, 2013, with some strong opinions doing the rounds, it is most appropriate to reflect on the merits of such a transaction. ABSA will be issuing 129.5m shares to Barclays in exchange for the Barclays’ African operations. Barclays’ stake in ABSA will increase from 55.5% to 62.3%. In exchange, ABSA will receive annual revenue of about R8bn ($898m) and profits of R1.8bn ($202m), generated from an asset base of R82bn ($9.2bn) and 2.2m retail customers. The organisation boasts 409 branches, 845 ATMs and more than 9,100 employees.
An analysis of any transaction simply comes down to what the purchaser is paying (or giving up) and what is received in return. As many a great entrepreneur has taught us, a good deal leaves both parties happy. This by implication means that not all of the terms will be in favour of any one party.
Let us put our cards on the table and say that, on balance as shareholders, we are excited about the transaction and happy with the terms. The two most negative aspects of the deal are obviously the fact that ABSA is issuing shares and minorities will now receive a smaller portion of any special dividend that ABSA might declare to shareholders.
So why do we think this is a good deal? Apart from the obvious growth expectations, there are three factors that stand out. We believe that the asset ABSA is buying is virtually impossible to replicate (at least over a short- to medium-term time horizon); it is a relative low risk acquisition and given these factors the price is fair.
Banking is a scale business. It is very difficult to achieve scale in any business if you start it as a greenfields project. This is even more difficult in Africa and to do this in seven or eight countries on the African continent at the same time is surely a Herculian task. In banking, as in many scale businesses, market share is critical. To compete effectively, you want to be in the top five positions and preferably in the top three. Kenya, Ghana, Botswana and Mauritius make up almost 80% of the profits of the acquisition. In Botswana, Barclays is number one, in Kenya and Mauritius number three and they are fourth in Ghana. In three of these countries they have been in business at least since 1925 and in Botswana since 1950. Barclays Africa was built over a period of almost a century from 1919 and it would simply be impossible to build a similar business, even over a 10 or 20 year period.
From a risk point of view, acquisitions in Africa are generally fraught with danger as reporting standards are very different, compliance procedures are unfamiliar and disclosures are certainly not standard. Management retention and alliances with business partners are crucial. Being part of the Barclays group and reporting structures for many years, these risks are greatly diminished in this case. Given that ABSA is buying a portfolio of assets spread across eight countries, diversification reduces these risks even further.
We have not spent too much time on the growth expectations as they are well documented. It is worth noting that 25% of the assets of this acquisition are in Tanzania, Ghana and Zambia. All three of these economies are on the list of the 10 fastest growing economies in the world (IMF expectations from 2011 to 2015 for countries with more than 10m people), with forecasts exceeding 7% growth a year. Although Barclays have smaller operations in these countries, they have the second and fourth largest banks in Zambia and Ghana based on banking revenues.
At a very high level, the aim of banking services is to facilitate economic activity. As economies grow the economic activity deepens and services in general begin to play a bigger role in the economy. For this reason, services tend to grow faster when developing economies have prolonged periods of economic growth. It is worth noting that ABSA provided numbers on expectations from industry experts that expect banking revenue pools on the African continent to grow by 11% a year between 2015 and 2020. This is more than one and a half times faster than expected GDP growth.
The South African banking sector is currently trading on average at a price-to-book value of two times, with average return on equity (ROE) at around 17%, expected to rise to around 19% over the next two years. We think paying a similar multiple for a portfolio of assets in Africa that are expected to achieve faster growth at higher ROE’s (ABSA disclosed the ROE for Barclays Africa at 22%) is a good deal and one we would support.
Jan Meintjes is a portfolio manager at SIM Unconstrained Capital Partners