CBA tipped to offer 1:3 shares in NIC merger

NIC Bank #ticker:NIC shareholders are unlikely to accept anything less than three shares for each Commercial Bank of Africa share in the proposed merger transaction, analysts at Genghis Capital have cautioned.

The investment bank said in a new report that in the event that a share swap transaction comes up with four NIC shares for one CBA share, investors in the former will probably not approve the deal.

NIC Bank is currently undervalued, Genghis Capital said, considering its fundamentals and could actually fetch as much as 25 percent more in market price relative to its current price on the Nairobi Securities Exchange (NSE). The bank’s share price stood at an average of Sh26.15 at 3PM on December 13.

“Following the announcement of the merger, we expect that a share swap is on the cards. … We believe that any share swap ratio below or at 3:1 presents a favourable upside potential for an investor,” said Genghis. “A share swap ratio at 4:1 or above should be considered punitive, with limited upside and we expect such a proposal to be rejected by NIC shareholders.”

The analysts used the cost of equity or residual income model (compensation that a shareholders requires to put money in an institution) and flow of dividends (dividend discount model) in the valuation of the joint entity.

It assumed a risk-free rate of 13.1 percent, a beta (position relative to total market) of 0.9, market risk premium of 6.4 per cent, cost of equity of 18.9 per cent and price to book value of 0.8 times.

“We developed a joint entity model, which would value the combined effort of the joint businesses, with improved efficiency and stable growth prospects …Residual Income (RI) and Dividend Discount Model (DDM) methods of valuation were applied to the steady state model [for CBA and NIC) with weights of 70 and 30 percent, respectively.

“The implied price of a CBA share under this weighted approach is Sh101.06. Based on our valuation with the steady state model, the optimal share swap ratio should be approximately three for one (3 NIC shares for 1 CBA share) and this should translate to a value of Sh34.33 a share [for NIC) when incorporated in the joint entity model, a 24.6 percent upside from the current market price.”

In an interview, Genghis Capital analyst Patrick Mumu said the conclusion on the terms of the transaction, the three-to-one base case deal involving a share swap, had been arrived at after considering the valuation of the two companies.

“In reaching the conclusion that a swap was the most likely deal at no less than three-to-one share swap, we looked at the valuations of the companies. We looked at the implied share price for NIC. We also concluded that it was highly unlikely that one would buy the other, but a swap was the most likely option,” said Mr Mumu.