Mergers and Acquisitions

Since the 2008 global financial crisis, post intervention from the federal government, German banks have struggled for growth, in an era of low interest rates, volatile macro-economic sentiments, and different cross-border fiscal structures. 

Now two of the largest German private (investment) banks, Deutsche Bank & Commerzbank are holding preliminary merger discussions, which on paper would create the second-largest bank in Europe.   

“Buying Commerzbank would solidify Deutsche Bank's position in Germany's fractured retail banking market while satisfying politicians who want a national champion that can provide financing for German companies. The German government owns 15% of Commerzbank after a bailout in 2009.” (Riley, 2019)

If both parties agree merge, based on the current market values, its combined est. value –

• Equity (Market Value): €25.3B (+-10%) 
• Debt (Total): €193.1B (+-10%)
• Debt-Equity: 7:63% - “This ratio is used to evaluate a company's financial leverage from a pure risk perspective. Lower ratios (0.4 or lower) are considered better debt ratios”(HAYES, 2019)

Deutsche Bank (Deutche Bank, 2018)

• Founded in 1870
• Multinational investment bank & financial services company
• Operational presence in 58 countries, EMEA, Americas, APAC
• 15thlargest bank globally (2018, total assets)
• Two largest shareholders
• HNA Group – 10%
• BlackRock – 4.88%

Commerzbank (Commerzbank AG, 2019)

• Founded in 1870
• Corporate & markets financial services company
• Received a state bailout €18 billion (2008)
• Two largest shareholders
• Government of Germany – 15.6%
• Cerberus Capital Management – 5.01%

Fundamental Analysis

News relative to the potential merger between both German investment banks has had a positive short-term impact to the share price. (“Over a 12-month period, shares of both companies are down by around 40 percent.” (Taylor, 2019))

• Commerzbank share price has increased by approx.7%
• Deutsche Bank share price has increased by approx.4%

It has been warmly welcomed by both the German government and EU organisations, which seek too “compete for international business with the giant Wall Street banks.” (Ewing, 2019). It has been highlighted that this merger may lead to an increased risk associated with a merged total debt (liabilities). As with all risks, a recalculation of credit ratings will occur to affirm, the combined banks’ ability to withstand systematic macro / micro shocks. (a measure of an organization's short-term cash liquidity).

EU regulations stipulate “all EU member states, lays down prudential requirements for capital, liquidity and credit risk for investment firms and credit institutions ('banks').” (European Council Council of the European Union, 2019)

• Capital buffers – 4.5%
• Capital conservation buffer – 2.5%
• Countercyclical capital buffer (Basel III) – % undetermined.
• Systemic risk buffer – 5%
• Global systemically important institutions buffer – 2%

The merger will also lead to an alignment of services being offered domestically and internationally, potentially changing human capital requirements, by an estimated approx. 30,000, which conflicts with ongoing negotiations between the workers union and the government to increase wages by 6%.   “Walkouts are planned from Wednesday until Friday and would affect offices of Germany’s two largest lenders, Deutsche Bank and Commerzbank among others, Verdi said, adding that there would be further strikes during the following week.” (Hummel, 2019)

Plenty of scepticism is also apparent, by former government officials and analysts across the financial sectors, who view the merger as a combination of banks will create a zombie bank, rather than correcting the core issues which can affect their abilities to operate healthily as individual entities. 

“Let’s say (it takes) three, four, five years (to complete the merger) – it will take their focus away from restructuring the banks and global challenges. The banking system as it is now won’t be there in 10 years, and they (will) lose track,” (Taylor, 2019)

Technical / Valuation Analysis

All financial information was obtained from Yahoo Finance (US). All financial data is reported in Euro denominations (€), and can be found in the document appendix. 

Liquidity

• Liquid Ratio – Commerzbank has insufficient liquidity to manage short-term debt obligations.
• Cash Ratio – Neither bank has sufficient cash to pay off all its immediate liabilities. Deutsche Bank, at present can only meet 25% of current liabilities, with cash and cash equivalents.
• Interest Coverage – Both banks can meet its interest payments, from its pre-tax profit.

Asset Management

• Total Asset Turnover – Assets are underutilised by both banks. Deutsche Bank, at present for every euro in total assets, generates 0.11 cents in sales.
• Average Collection Period – Ranges differ between banks, with Commerzbank collecting repayments in 30-day cycles, and Deutsche Bank’s receivable’s averaging three years approx.

Debt Management

• Debt – No Comment.
• Debt-Equity – Both banks, are highly leveraging finances from the equity markets. E.g. for every one euro owned by the shareholder, Deutsche Bank owes €22 approx. to its creditors.
• Equity Multiplier – No Comment.

Profitability

• Net Profit Margin – Minimal net profits are being generated by either bank, after expenses.
• Return on Assets – Resources owned by both banks are not being utilised well, with regards to net profit margins. 
• Return on Equity – For every one euro of common stock, a very small return is earned. Deutsche Bank has generated a percentage profit, after three-year negative returns.

Market

• Shareholder Equity– No Comment.
• Dividend Yield– Dividends to shareholders are very low (on average 0% to 0.01 %).
• EPS (Earnings Per Share)– Earnings for both banks fluctuate (inconsistent).
• Book Value Per Share– Currently both banks market share price is undervalued, compared to its book value.
• Market Cap– Currently both banks market cap are undervalued, based on their book values (Equity).
• P/E (Price Earnings)– No Comment.
• Dividend Per Share– See Dividend Yield Comment.
• Enterprise Value– No Comment.
• Enterprise Value Multiples – Both companies market valuations and undervalued when compared to intrinsic values, based on multiple and projected future cashflows (DCF and EV Multiples), especially Commerzbank.

Conclusion

Strategic Decisions – 

Deutsche Bank (Deutsche Bank, 2018)

• Full implementation of Basel 3
• Total non-interest expenses excluding restructuring and severance, impairment of goodwill, plus other intangibles.
• “Shares in Deutsche Bank have slipped following reports that the bank is considering raising as much as €10bn as part of ongoing merger negotiations with smaller rival Commerzbank…” (Townsend, 2019)

Commerzbank (Commerzbank AG, 2019)

• Digitalisation is changing the rules in the banking industry. We will therefore reinvent Commerzbank as a digital technology business in the years ahead.
• Concentrate on two strong client segments: Private & Small Business Customers, and Corporate Clients.
• Provide a one-stop-shop service to large and institutional clients in the new Corporate Clients segment. We are integrating our investment banking business into the new segment.

Inconsistence earnings growth – All European banks have been struggling to generate sustainable profits, while central bank interest rates remain low. The lack of profits impacts the speed of improving the firm’s services and infrastructure (digital transformation) through reinvestments of revenue. 

Additionally, long-term investors have not seen high dividend yield from their investments. With the share price operating at a heavy discount, it will be a while before, a break-even price point is established, plausibly faster if operating on a monthly investment cycle, e.g. investment funds.   

Geo-political issues – The political changes in China, Europe and United States, has stalled economic growth; affecting investors’ appetite, creation of new jobs. From consumer perspectives a risk off approach has been adopted, hence spending less in the economy (If the economy slows, so does business revenues and tax receipts).

Financing Decisions (Leveraging) – Both banks are generating minimal returns over the last five years. They have been using the credit lending facilities from central banks to buffer its liquidity and improve / expand its balance sheets, rather than issuing debt (Bonds).

Assets – Unless both banks start to become more effective in generating revenues from their existing assets, any merger between both banks will compound the issue. How to generate revenues from assets, plus the overlapping duplication of services being provided and operational waste.

High Beta – Presently both have a beta average (above 1) and any falls or rises in the German stock market indices, will have a more volatile market valuation effect approx. 30% beyond to the respective index average return.

Appendix

All financial information was obtained from Yahoo Finance (US). All financial numbers are reported in Euro denominations (€)

Deutsche Bank Financial Statements Brief (2015 – 2018)

Commerzbank Financial Statements Brief (2015 – 2018)

Valuations (CAPM, WACC, FCF, DCF)

Financial Management Ratios

Liquidity

Asset Management

Debt Management

Profitability

Market