Bank of Cyprus, Piraeus among top picks by Deutsche Bank

“Ideal for merger, takeover in case of consolidation”

 

Piraeus and Bank of Cyprus would be the most attractive takeover candidates in case of domestic consolidation in Greece, and based on their fundamentals and prospects they are the top picks of Deutsche Bank in Greece.

Domestic consolidation has not been the main priority for Greek banks over the past few years — growth in Greece is still strong and the Greek business is still the biggest earnings contributor. However, Deutsche Bank analysts see an increasing need for the Greek banking system to intensify mergers and acquisitions. It would enable Greek banks to compete in terms of size with European banks, to reach sizeable market share in South East Europe (SEE), and to reach further economies of scale in Greece.

In a detailed report entitled “Time for domestic consolidation?”, Deutsche Bank analysts maintain the view that Greek banks are relatively small with an average market capitalization of EUR 10 bln, half the European banking average. Looking at the Greek banking market, the five largest banks control 66% of the assets versus 60% for the EU 25 average.  However, in other smaller European countries concentration is about 80%.

Moreover, the number of mid-sized players is still high – six banks control more than 9% market share in Greece versus 3.3 in Europe on average.

Greek banks have always said that one of the strongest barriers for domestic consolidation is cost synergy. Indeed, the labour market in Greece is not very flexible in terms of headcount reduction as the number of dismissals is limited. The only way to decrease the number of employee is to use voluntary exit schemes, which translate most often into early retirement plans. For most of the Greek banks, employees aged above 50 years represent at least 5% of total group employees.

Deutsche Bank analysts also take into account all the other sources of costs (such as G&A, funding cost, opening new branches and hiring new people in SEE). All things considered, the analysts do not think that cost synergy is a real barrier. Until now the main obstacle had been the lack of chemistry between management teams.

 

— Three prey and three predators

Deutsche Bank identified three prey – Piraeus, Bank of Cyprus and Alpha Bank – and three predators – NBG, EFG and Marfin. They have calculated that the average ROIC would be about 10% in year 3, assuming 20% premium on current share price of the targets.

DB analysis shows that the most attractive take-over candidates would be Piraeus and BOC. They have also analyzed that the most accretive deals would be a merger of equals between BOC and Piraeus, and all the deals where EFG is the predator.

Over the past two years, Bank of Cyprus, Marfin Popular Bank and Piraeus have been at the centre of talks concerning domestic consolidation.

June 12, 2006: Bank of Cyprus launched a bid for Emporiki.

December 20, 2006: Piraeus launched a bid for Bank of Cyprus.

January 17, 2007: Marfin intended to submit an offer for both Piraeus and Bank of Cyprus.

March 6, 2007: Marfin bought an 8% stake in Bank of Cyprus.

Although none of these initiatives has been successful, Deutsche Bank thinks that the Greek banking market should go through domestic consolidation sooner rather than later.

Recently, National Bank of Greece CEO Takis Arapoglou, mentioned that “there will be an ever-increasing need for the Greek banking system to intensify merger and acquisition activity although it is impossible to predict which combinations will emerge and when”.

The management of Marfin Popular Bank also expressed a few months ago its willingness to accelerate domestic consolidation next year.

 

— Top picks: Bank of Cyprus and Piraeus

 

Deutsche Bank’s top picks are Bank of Cyprus and Piraeus for their strong EPS growth, potential earnings revisions, and potential M&A story.

Bank of Cyprus (Buy, TP of Euro 17)

Attractive funding base with a loan to deposit ratio of 72%.

Cyprus benefits at the moment from high loan growth (+20% on the market) driven by mortgages as foreigners (mainly from UK and Russia) are buying a second home. In addition, Bank of Cyprus attracts clients from the cooperatives (it represents 30% of the new production for mortgages).

Bank of Cyprus is the strongest player on the offshore business and enjoys FX deposits growth of about 30% pa carrying a spread of about 200 bps. It still benefits from an immature network in Greece (50% of the branches are still immature).

The development of the Russian and Romanian operations is faster than expected and Deutsche Bank expects that outstanding loans coming from these two countries would be about EUR 3 bln at the end of 2009.

Piraeus (Buy, TP of Euro 33.2)

Strong EPS CAGR of 33% pa over 2006-2010E.

Piraeus enjoys one of the strongest growth rates in Greece (loan growth of 29% in H1 07 versus 20% for the market) due to an immature network (35% of the branches have been opened in the last five years) and attractive exposure in SEE bringing a ROE before tax of 13% (end of 2006).

The company is due to raise its 2010 guidance at the time of Q3 07 publications. This should lead to earnings revisions in the market as consensus is still in line with previous guidance.

Since the beginning of the year, Greek banks have outperformed European banks by 28% on average. They have been resilient during the summer crisis, having outperformed the overall sector by 7% on average.