Hong Leong Group founder Tan Sri Quek Leng Chan is on the prowl again. This time, his hunting ground is the domestic banking sector. Hong Leong Bank, the banking arm of the Hong Leong Financial Group, has proposed to acquire EON Capital Bhd. The proposed takeover has many parallels with CIMB Group's 2005 hostile takeover of Southern Bank. Why does Quek want EON Cap? Will he have an easy victory or will resistance come from Primus Pacific Partners?

Even as the possibility of a hostile takeover of Hong Kong-listed Bank of East Asia (BEA) by his Hong Kong flagship, the Guoco Group, is still waiting to be played out, Tan Sri Quek Leng Chan is on the prowl again.

Quek, founder of the Hong Leong Group of companies, is now stalking another prey — EON Capital Bhd (EONCap).

Just before Christmas last year, Hong Leong Bank Bhd (HLBB), the jewel in the crown of the Hong Leong Financial Group, said it had received approval from Bank Negara Malaysia to begin negotiations with certain shareholders to buy assets and liabilities, including equity, in EONCap.

The two major shareholders are Tan Sri Tiong Hiew King and Rin Kin Mei, who collectively own 32.57% in the country’s seventh largest domestic banking group through their respective vehicles RH Development and Kualapura/Lintang Emas Sdn Bhd.

For some time now, the talk is that HLBB has been eyeing a takeover and merger with EON Bank. Still, when the announcement was made on the evening of Dec 18, insiders say it took the EONCap board by surprise — it came when directors and shareholder representatives were in the midst of a 2010 budget planning meeting.

Last week, HLBB took the proposal one step further when it received approval from the central bank to begin negotiations with the boards of both EONCap and EON Bank.

Now it is awaiting EONCap’s board to seek Bank Negara approval to commence negotiations before any “hard bargaining” on price can take place.

The board of EONCap is expected to meet this Wednesday (Jan 14) to discuss the matter, says a source. Once Bank Negara approval is obtained, HLBB will make a formal offer, which would entail the offer price and method of rationalisation, he says.

Industry observers say it is not usual for the acquiror to begin talks with both the individual major shareholders as well as the board at the same time. In HLBB’s case, it has announced from the beginning that it is looking to buy assets and liabilities in EONCap as well as equity. “To buy assets and liabilities of the company, HLBB will need to negotiate with the board,” an industry observer explains.

Why are Rin and Tiong selling?
For some time now, it is an open secret that Rin has not been seeing eye to eye with Ng Wing Fai, the managing director of Primus Pacific Partners Ltd. One of his main beef with Primus, according to an industry source, is that there has been no value creation in assets since the entry of the private equity fund.

Indeed, there was also unhappiness that Primus failed to deliver on some of its promises, which included capital injection into the banking group. Rin also opposed a capital-raising exercise proposal involving a rights issue by EONCap, an exercise that would further dilute his shareholding in the banking group.

The stage, it appears, is set for what could potentially be a tussle for control of the EON banking group.

This is because while Rin and Tiong are willing sellers, its other major shareholder, Primus, which holds a 20.2% stake, may not be.

The Employees Provident Fund and Khazanah Nasional Bhd, with 12% and 10% stakes in EONCap respectively, could turn out to be either dealmakers or deal breakers.

A replay of CIMB-Southern Bank takeover battle
Indeed, the proposed takeover of EONCap by HLBB has all the makings of a replay of the hostile takeover of Southern Bank Bhd (SBB) by the CIMB Group back in 2005.

“Fascinating”, a banker comments on the proposed deal.

Recall that in the SBB takeover battle, CIMB first began talks with two major shareholders — Sultan Sharafuddin Idris Shah and Datuk Syed Yusof Syed Nasir, who wanted to exit the bank. Its other shareholders — Tan Sri Tan Teong Hean, the Yeap family and Straits Trading — did not.

What ensued was a protracted takeover battle that involved many twists and turns, removal of directors from SBB’s board, court actions and even the courting of a competing bid from Malayan Banking Bhd by Tan.

In the end, what swung the deal was Straits Trading selling its block in Killinghall to Chua Ma Yu, a party friendly to CIMB.

This time around, HLBB’s proposed takeover of EONCap story becomes more intriguing when CIMB was appointed its adviser. An industry player makes the tongue-in-cheek observation that Quek could not have appointed a more suitable adviser in CIMB, given its experience dealing with SBB.

As if that was not enough spice added to the story, EONCap has hired as its advisers Goldman Sachs and Ethos Capital. Goldman Sachs was SBB’s adviser, and what was most memorable about its role in the takeover battle was its assessment that SBB’s intrinsic value was worth RM5.50. CIMB eventually paid RM4.25 a share for SBB or 2.1 times book value.

Goldman Sachs, according to an industry player, was appointed for its ability to source competitive bids, as has been shown in the case of RHBCapital and the acquisition of Bank Indonesia Internasional, which was eventually bought by Maybank. Ethos Capital’s appointment, though, came as a surprise, as it does not have a track record in advising M&As in the banking sector.

Meanwhile, K&N Kenanga is advising Rin, Tiong and Khazanah.

Will Primus sell?
So, will the proposed acquisition of EONCap turn out to be a protracted takeover battle, involving multiple bids or will it be a quick wrap-up by Quek?

Industry observers say Quek and his team are in for some tough negotiations in the weeks ahead. As in all transactions, everything comes down to the price.

Primus is unlikely to sell unless the price offered is nothing less than the RM9.55 it paid in 2008 for its 20.2% block in EONCap. And given that Quek isn’t known for overpaying for anything, Primus may have to explore other options to protect its investment in the banking group.

Thanks to Bank Negara allowing multiple bids following the CIMB-SBB saga (at that time, it was one bid at a time), Primus can now look to team up with potential allies and make competing bids. Indeed, there is already market talk that Primus has approached certain parties, and a name being bandied about is Temasek Holdings. This probably implies a merger with Alliance Bank if this is indeed true.

The Singapore sovereign fund, incidentally, also featured in the CIMB-SBB takeover battle when it accumulated a stake of around 7% in SBB during the early stages of the battle. At that time, speculation was rife that it was on the side of Tan.

Primus also has other options. It can buy out Rin and Tiong, which means its stake will increase to more than 50%. To do this, it will have to get approval from Bank Negara. A precedent had been set when the EPF was allowed to hold  a stake of more than 50% in RHB Capital, although with the condition that it pared it down to 20% over a certain period of time.

The Hong Kong-based Primus can also opt for shares in the merged HLBB-EONCap group. “Quek may agree because it will involve a smaller capital outlay,” notes an industry observer.

An industry source says for Primus, a stake in the merged bank would be a good proposition because it would enable EONCap/EON Bank to have access to the deeper pockets of HLBB, especially given the need for financial institutions to shore up capital under the strengthened Basel 2 framework.

Quek’s game plan
What is Quek’s game plan?

Banking analysts say an asset and liabilities sale is the easiest route, because under the Companies Act, HLBB needs a 50% +1 vote from shareholders to push it through. However, HLBB will first have to make the offer to the board, which, if accepted, will take it to the shareholders for a vote in an extraordinary general meeting (EGM). But this may not always be the case because if the board does not accept the proposal, a group of consenting shareholders can still call for an EGM to get the asset sale approved.

In this regard, Khazanah and EPF will have an important vote, which industry observers believe are willing sellers as long as a good offer is made. “For these two institutions, there is no sentiment involved — at the right price, they will sell,” says an analyst.

The combined stake of Rin, Tiong, Khazanah and the EPF comes to about 54%. Khazanah, for example, has been divesting its non-core assets and, given that its investment in EONCap has not been yielding good returns, it will sell as long as it can exit at a good profit.

An industry source says the EPF, though, could be a “wild card”. This is because being the biggest and controlling shareholder in RHBCap, the provident fund may have plans of its own to merge the two banking groups. EPF chairman Tan Sri Azlan Zainol has spoken of EPF’s ambition to make RHBCap one of the top three banks in Asean by 2020, and to do this, it will have to take the merger and acquisition (M&A) route.

Thus, there is nothing to say that it cannot team up with Primus to come up with a competing bid for EONCap.

EONCap board to meet
The EONCap board is scheduled to meet on Wednesday or Thursday to discuss the matter and sources close to the proposed M&A say they do not expect resistance, given that the majority of the seven-board members are not aligned to Primus.

HLBB will have to wait for the EONCap board to seek approval because if it makes a takeover offer now, it would be tantamount to a hostile takeover.

In the last couple of weeks, industry observers say there have been indications that HLBB isn’t willing to pay anything above 1.3-1.5 times price-to-book value (PBV) for EONCap, based on its rather low return on equity (ROE) of 4.2% and return on assets of 0.3% in FY2008.

Thus, based on its 2008 book value (BV) of RM4.62, this works out to between RM6.15 and RM7.10 a share. EONCap’s projected BV for 2009 is RM5.05 — which means that the price that Quek may be willing to pay is anything between RM6.76 and RM7.50 a share.

Banking analysts generally concur that EON Bank is “over- capitalised vis-à-vis its earnings”. In FY2008 ended Dec 31, EONCap reported a net profit of RM133.8 million, compared with RM217 million in FY2007. Still, FY2008 was the year that the bank undertook a kitchen-sinking exercise with the entry of Primus as a major shareholder.

For FY2009, EONCap is expected to turn in a better performance, and projections are for net profit to come in at between RM320 million and RM360 million. Its FY2009 ROE is expected to improve to slightly above 10%, a banking analyst says.

Going by recent M&A transactions, CIMB paid 2.1 times PBV for SBB, while Temasek paid 1.7 times PBV for Alliance Bank. SBB, it must be said, had a very strong consumer banking franchise.

“We believe the acquisition PBV for EONCap is unlikely to be above 1.3-1.4 times. This is because of HLBB’s robust value creation culture — in the past, HLB had demonstrated that it would prefer to expand organically rather than pay a significant premium for an acquisition. There is no compelling thesis for HLBB to pay more than this for a target franchise in the domestic market where ROA is only 0.8%,” opines AmResearch in a report. It notes that the historical PBV means EONCap is only 1.2 times.

But will Rin and Tiong be willing to accept anything below RM8?

Not likely, according to industry sources close to Rin. They believe that EONCap warrants a higher PBV of around 1.7 to 1.8 times, which values the banking group at between RM8.50 and RM9 based on FY2009 projected BV of RM5.05.

For one, the higher PBV is because there is a scarcity premium attached to EONCap, according to an industry source. There are not that many medium-sized Malaysian banks up for sale. Furthermore, he opines that for HLBB, the biggest value creation is from banks that are nearer to the home base, largely because HLBB already knows the landscape well.

Although EONCap’s earnings have been lacklustre in 2008, the bank has undergone a major transformation and rebranding exercise under the new management team put in place since the entry of Primus. Generally, banking analysts are of the view that EONCap’s earnings could see a significant improvement from FY2009 onwards.

As for Khazanah and EPF, the more competitive the bids are the merrier it will be, as this will drive up the offer price.

Why Quek wants EONCap
Of course, how high a price Quek is willing to pay for EONCap will depend on how badly he wants to merge the two banking groups.

Banking analysts say that in terms of synergy, there is very little value-add that EONCap will bring to the table for HLBB. EONCap is a mid-sized bank that is strong in auto finance, although in the last one year, it has been aggressively diversifying its loan base into consumer loans and the small and medium-scale enterprises (SME) segment.

Analysts say HLBB, however, isn’t too keen on auto finance as it isn’t a very profitable proposition. Still, with the recent agreement by banks to raise hire-purchase (HP) rates, auto-finance has become more attractive.

Perhaps, the biggest attraction for Quek is that a merger between HLBB and EONCap will enable the merged group to compete in an environment where competition is heating up very fast as liberalisation gathers pace.

By 2011, there will be six more foreign banking groups in the domestic market. The merger will enable HLBB to become the fourth largest banking group in the country, with total assets of RM111 billion, behind Maybank, CIMB and Public Bank. Currently, HLBB is ranked sixth, with total assets of RM77 billion.

Its branch network will immediately balloon to 338. HLBB currently has 199 branches while EON has 139. According to a research report by Maybank Investment Bank, “apart from size, EONCap offers no compelling reason for a merger”.

There is, however, a view that Quek could be bulking up his banking operations domestically for bigger things in time to come. The merger will immediately raise HLBB to a higher platform, perhaps putting it in a strong position to acquire Public Bank should the opportunity arises, an industry observer notes.

Be that as it may, banking analysts say Quek has been making some really aggressive moves of late to propel both the Hong Leong Financial Group and Guoco Group to a higher platform regionally. HLBB has been making inroads into China and Vietnam, and there are rumours it is trying to get into Thailand as well. HLBB is the only Malaysian bank with a licence to operate a bank in Vietnam.

Quek’s strategy, according to an industry observer, is that for HLBB to become a significant player in the region, it has to be a bigger and stronger domestic player first. This is more so when under the new Basel 2 framework, financial strength is key. “This is why he wants scale for HLBB — it will give him the financial muscle to expand regionally… the move to buy EONCap and merge it with HLBB is all part of this bigger picture,” he says.

How will Quek pay?
Banking analysts concur that financing the purchase will not be a problem for HLBB.

Some research houses have estimated that HLBB has excess capital of some RM2.5 billion. The bank has a core capital ratio of 14.9%, which is substantially higher than the industry average of about 12% to 14%.

At RM8 a share, HLBB would have to fork out RM5.5 billion for a 100% stake in EONCap, says OSK Research. The purchase, though, may not be entirely in cash, and could be in the form of equity and cash.

“Funding should not be an issue as the Hong Leong Group’s robust Tier 1 capital ratio of 15.3% consists entirely of core equity, which leaves substantial room to raise more capital,” the report says. It adds that judging from the group’s capital structure as at end-September 2009, it can raise up to RM6.3 billion in additional capital forms.

So, for Quek, it is not about funding. The question is whether he can wrap up the deal with EONCap quickly and at a price that is agreeable to all. Or will Primus or other shareholders be able to get in competitors to spark a bidding war? The banking sector has got off to an exciting start in 2010, and the momentum is set to gather pace in the weeks ahead as all the parties involved in the proposed HLBB-EONCap merger come to the negotiating table.

This article appeared in Corporate page, The Edge Malaysia, Issue 788, Jan 11-17, 2010