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This article first appeared in The Edge Malaysia Weekly, on February 8 - 14, 2016

IT is back to the drawing board for both Malaysia Building Society Bhd (MBSB) and Bank Muamalat Malaysia Bhd now that they have aborted their plan for a merger, proposed four months ago, to create the country’s largest standalone Islamic bank.

It was disagreements over valuation and control that led to the breakdown in negotiations.

Sources close to the talks say Bank Muamalat’s 70% shareholder, conglomerate DRB-Hicom Bhd, had sought for the bank to be valued at between 1.4 and 1.5 times price-to-book value (PBV) in a share-swap deal, giving DRB-Hicom a stake of up to roughly 30% in the merged entity.

However, MBSB, in crafting the merger proposal, was only willing to accord it a valuation of between 1 and 1.2 times PBV, which would have translated into a 22% to 26% shareholding for DRB-Hicom in the merged entity.

It was initially expected that MBSB’s 65% shareholder — the Employees Provident Fund (EPF) — would end up as the largest shareholder in the merged entity with a stake of about 40% while DRB-Hicom would hold a stake in the mid 20% range, and Khazanah Nasional Bhd — Bank Muamalat’s other shareholder with a 30% stake — about 10%. But DRB-Hicom wanted a higher shareholding and at least equal control with, if not more than, the EPF.

The parties made a last-ditch attempt to reach a compromise on Jan 28, a few days before the Feb 2 deadline that the central bank had given them to hand in their submission. “But it ended up that neither side was willing to budge and so, on Feb 2, they called the merger off,” a source tells The Edge. MBSB is twice the size of Bank Muamalat in terms of assets.

When contacted, MBSB president and CEO Datuk Ahmad Zaini Othman and Bank Muamalat CEO Datuk Mohd Redza Shah Abdul Wahid declined to comment on the failed merger.

When asked about the group’s next step, however, Ahmad Zaini says MBSB is unlikely to pursue any other merger and acquisition this year. “At this stage, we’re not looking at another exercise. We’re just looking at further strengthening the company, so in the event we want to embark on a corporate exercise later on, we’re in a better position to do it.”

The Edge had reported as early as two weeks ago that the merger had hit a snag and was likely to be called off.

“We are not surprised with the news [of the aborted merger] but we view it as a lost opportunity for MBSB to expand its assets and deposit base. Based on earlier merger assumptions, the merged entity would have had total combined assets of RM63.5 billion and deposits from customers of about RM49 billion,” MIDF Research says in a research note on Feb 3.

Analysts say the merger would have helped MBSB address its high funding cost issue by utilising Bank Muamalat’s wide network of 60 branches. More importantly, it would have allowed non-bank lender MBSB to become a full-fledged Islamic bank that could tap the interbank money market for funds.

MBSB’s shares fell 2.7% to close at RM1.41 the day it announced the merger was off. Analysts have a “hold” call on the stock, with a 12-month target price of RM1.69. Bank Muamalat is not listed.

What now for the two lenders? For non-bank lender MBSB, which has been pursuing the M&A route to enable it to get on to a banking platform, it is its second failed merger in a year. It was only on Jan 14 last year that a proposed “mega bank merger” among CIMB Group Holdings Bhd, RHB Capital Bhd and MBSB was called off, after six months of talks, in view of deteriorating economic conditions.

Given that, it makes sense for MBSB not to jump into any other merger opportunity so soon. Merger talks take time and can be distracting for a bank’s management.

Analysts say it is likely that the group will embark on a capital-raising plan over the next few months. This was something it had been pursuing prior to getting caught up in the mega merger and, later, the Islamic merger talks.

In an interview with The Edge a few months before getting into the mega merger talks, Ahmad Zaini had said the group was considering “some form of capital raising, probably about RM3 billion” with its major shareholder, to strengthen its prudential ratios and for expansion. He said it would most likely be a rights issue.

MBSB is due to announce its fourth quarter results for FY2015 later this month. “Our team has already embarked on revised strategies in the fourth quarter of last year, taking cognisance of changes in the economy. We are also being more prudent in the sectors that we continue to lend and our impairment programme is running into its second year,” he says in the press statement.

As for DRB-Hicom, it will be interesting to see what it plans to do with Bank Muamalat, given the looming end-February deadline the central bank has given it to reduce its 70% stake in the lender to at least 40%.

Industry sources say they would not be surprised if the Tan Sri Syed Mokhtar Albukhary-controlled conglomerate, which is keen to remain in the banking business, has a few more months’ leeway to comply, given that the Bank Muamalat-MBSB merger did not happen.

“I wouldn’t be surprised if it may have another six months,” one tells The Edge. Interestingly, there will be a change of guard at Bank Negara Malaysia within that period, with governor Tan Sri Dr Zeti Akhtar Aziz expected to retire in April.

But with banks having to boost capital levels ahead of tighter regulatory requirements ahead, industry sources wonder if Syed Mokhtar will be able to support capital injections into Bank Muamalat in future. His DRB-Hicom is currently struggling amid a weaker economy.

Previous attempts to sell down its stake to several financial institutions, namely Affin Holdings Bhd, Bank Islam Malaysia Bhd and Bahrain-based Islamic lender Al Baraka, also failed. It is understood that this was because DRB-Hicom had wanted to maintain control of the bank and its price expectations were too high.

DRB-Hicom had bought its 70% stake from another Syed Mokhtar-related company in a RM1.069 billion deal back in 2008. 

The last Islamic banking transaction in the country, in December 2013, was done at a PBV of 1.8 times. This was when BIMB Holdings Bhd bought the remaining 49% stake that it did not already own in Bank Islam.

Bank Muamalat accounted for about 7% of DRB-Hicom’s RM13.687 billion revenue for the financial year ended March 31, 2015.

Meanwhile, for Khazanah, the failed merger is another missed opportunity for it to divest its stake in Bank Muamalat. The government’s investment arm considers its 30% stake in the lender as a non-core holding and has been looking to let go of it at the right price for several years now.

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