Many consider Public Bank Berhad (KLSE: PBB) the best bank to invest in among all the listed banks on Bursa Malaysia.
While I think it is the most prudently run bank, I wouldn’t agree that it’s the best bank to invest in, due to the premium valuation it currently trades at.
However, prices seem to have encountered some slight turbulences after a slew of news announcements last week.
Share prices of PBB has since corrected by around 10% from its YTD high.
Let’s take a deeper dive into the 2 major events, and hopefully consolidate our thoughts on the price reaction and revised valuation.
Public Bank to buy 44.15% of LPI, triggering MGO at RM9.80
Both PBB and LPI Capital Berhad (KLSE: LPI) share the same owner, as both are founded by the late Tan Sri Dato’ Sri Dato’ Dr. Teh Hong Piow.
Even though the insurance and banking business share plenty of synergies, with one party owning shares of the other related party, LPI has never been a subsidiary of PBB, nor vice versa.
With the latest news announcement, PBB will be buying the 44.15% stake in LPI currently owned by Consolidated Teh Holdings Berhad, the investment company owned by the Teh family, for RM 9.80 per share, amounting to RM 1.72 billion in cash.
The purchase by PBB will also trigger a mandatory general offer at RM9.80 per share, to buy out all remaining LPI shares that PBB does not already own.
PBB will officially own the insurance arm of its sister company by the end of the acquisition exercise.
LPI acquisition value and potential earnings accretion
With the acquisition of LPI at the price of RM9.80, LPI will be worth roughly RM 3.9 billion.
The initial 44.15% acquisition from Consolidated Teh Holdings will be via internal funds. However, the capital for the remainder shares through the MGO is still undecided. Looking at PBB’s latest cash on hand, it is still possible mathematically for the MGO to be fully funded by internal funds. But given the nature of banking and its cashflow requirements, there could be a possibility that PBB might undergo a capital-raising exercise to fund the MGO.
Assuming no changes in total shares outstanding and that the MGO is fully funded by internal funds, the acquisition of LPI would grow PBB’s revenue by around 10% and its earnings by 5%, using FY 2023 figures as comparison.
Earnings per share wise, it will be roughly an accretion of RM 0.016 per share.
Although the accretion does not seem much, the value that PBB is acquiring LPI for seems favourable to PBB shareholders. With a trailing earnings per share of RM 0.89 per share, a proposed acquisition of RM 9.80 per share ascribes a P/E ratio of 10x to LPI.
The flip side is that the acquisition price will not be favourable for LPI shareholders if the MGO proceeds.
PBB shares restricted offer for sale
Under the Banking and Financial Institutions Act 372, Section 46, no individual is allowed to hold more than 10% of interests in shares of a licensed institution.
This rule has been exceptionally waived for the late Tan Sri Dato’ Sri Dato’ Dr. Teh Hong Piow, where founding of PBB has help played a significant role in Malaysia’s economy. However with the passing of Dr Teh, the Teh family must trim their stake down to a maximum of 10%.
Rather than seeing off PBB shares on the public market, the Teh family has chosen to undertake the share sales via a restricted offer for sale (ROFS).
Under this restricted offer for sale, eligible employees, investors and directors will be offered to buy PBB shares, most likely at a discount.
The main concern that arises from this arrangement is share overhang, where related parties might take the opportunity to arbitrage on the discounted ROFS and offloading it at the market price. Most analysts think that it should not be a crucial concern, as the share sales will be spread over a five-year period, helping to cushion any potential impact on the market.
Valuation of PBB now
Fun fact: PBB has never traded below a price to book ratio of 1.0x. The highest trailing dividend yield it trades at is also just at 5.77%, which is during the peak of the pandemic selloff.
With a mean dividend yield of 3.36% and mean price-to-book ratio of 2.0x, PBB does not look attractive compared to its peers. As of its present day valuation, if we put less emphasis on the P/B ratio and focus purely on the dividend yield, the valuation is decent at best, as there are definitely better banks from a return perspective.
Yes, PBB is the most prudent bank. It sports a gross impaired ratio that even Singapore banks can’t match. But taking on default risk, managing credit scores of borrowers and returning the best risk free returns to depositors is what grows a bank.
This is where I observe and conclude to be lacking a bit from PBB. It remains largely a Malaysia-centric bank, with 90% of its business still concentrated within the country. The downside and risk might be well taken care of, but the growth and prospect will be slower due to this approach.
My verdict
The recent selloff and concerns on the share prices on the near term should not be crucial. The current management have a long track record of fulfilling and running PBB through the vision of the late Tan Sri Dato’ Sri Dato’ Dr. Teh Hong Piow.
The acquisition of LPI looks to be a game-changer to morph PBB into an integrated financial institution. However, the insurance business is congested and competitive, and as shown, the quantum in terms of top and bottom line improvement might not be much, assuming that no overhead reductions or cost streamlining.
Perhaps PBB falls into the bucket marked as “Good businesses, but not necessarily a good investment”?
Food for thought.
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