First Active sale fails to ignite interest in banks

Investor: The agreed takeover of First Active by Royal Bank of Scotland (RBOS) through its Ulster Bank subsidiary is likely to proceed to completion early next year. Shares in First Active are trading at €6.10, just below the €6.20 offer price and indicates that the market expects the deal to be completed within the planned timeframe.

The combined Ulster/First Active entity will be in a stronger position to compete in the Irish marketplace (North and South). For example, the combined entity should have a market share of the domestic mortgage market of close to 20 per cent.

A surprising aspect of the take-over is that it has had very little knock-on impact on the rest of the quoted banking sector.

On the announcement of the deal, First Active shares moved immediately up to a level just below the €6.20 offer price indicating a high degree of confidence amongst investors that the deal would be successfully concluded. However, there was very little knock on effect on the overall sector, still by far the largest sector in the Irish stock market.

The sector could be affected if the combined entity were to engage in a price war to secure extra market share. Most commentators would agree, however, that the direct impact of this merger on the overall competitive landscape will be quite limited. A recent survey of competitive conditions across the European banking sector concluded that the Irish sector exhibited a "medium" level of competitiveness.

Whilst the merged First Active/Ulster Bank may sharpen the degree of competition, it is unlikely to radically alter the overall competitive landscape.

From the perspective of investors, the more immediately interesting aspect of merger and acquisition activity is that it usually has a positive impact on the share prices of companies in the same or related sectors.

This generally occurs through two routes. Firstly, shareholders in the company that is acquired receive cash for their shares and will usually seek to reinvest that cash back into the market. Secondly, one corporate deal in a particular sector often heightens interest in the sector, leading to speculation that further merger and acquisition activity may occur.

A surprising feature of market activity in the aftermath of the First Active announcement is how little impact it has had on the rest of the sector. In fact the share prices of Irish financial stocks have generally weakened relative to international bank stocks in recent weeks.

This is in spite of ongoing share buybacks from both Bank of Ireland and AIB. In particular, AIB has resumed its buyback programme since its results in July and since then it has repurchased approximately four million shares, equivalent to 0.5 per cent of total shares in issue.

There has also been some press speculation that another British bank such as HBOS may be interested in expanding in the Irish market through acquisition.

Despite these potentially positive influences the share prices of AIB, Bank of Ireland and Irish Life and Permanent have underperformed the overall ISEQ index so far this year. Of the three, AIB has been the weakest, underperforming the overall market by over 15 per cent. This sluggish share price performance means that the Irish financials now offer very good investment value (see table).

AIB and Bank of Ireland are now trading on a price-earnings ratio (PER) of just under 10 and AIB offers a dividend yield of 4 per cent. This compares with PERs of 11.4 and 11.9 for Barclays and HBOS respectively. On pure valuation criteria, the Irish quoted financial sector is now quite lowly rated, although the degree of undervaluation is quite modest.

However, given that the Irish economy is performing quite well and is forecast to perform well over the medium term, Irish financials should be able to deliver a growing stream of profits in coming years. Therefore, a credible case can be made that the Irish financial sector should enjoy a valuation premium given the favourable domestic economic outlook.

In this context, it is all the more surprising that the takeover of First Active and ongoing share repurchase programmes from AIB and Bank of Ireland are not having an obvious positive impact on share prices.

It may be the case that international investors in particular require firm evidence that the Irish economy has emerged relatively unscathed from the slowdown of recent years. If the economy does benefit from a global recovery in 2004 then this will almost certainly feed through into greater investor demand for Irish financials.