Barclays In Trouble, And Temasek Feeling the Heat

Sometime last month, when it was announced that Temasek was taking a stake in Barclays in order to support the British behemoth's bid for ABN, I expressed scepticism about the wisdom of the deal. I thought it was rather unwise to make an investment in a bank that was engaged in a bidding war with a fierce rival, the Royal Bank of Scotland consortium, which would probably mean that Barclays would be paying a premium if it won the bid. About a month later, things are indeed turning out rather poorly for Barclays' bid for ABN, and for Temasek's investment in Barclays.

A senior Barclays banker recently lost his job due to the recent subprime squeeze in the credit markets. Meanwhile, The Times has recently published an article about the problems that the bank as a whole is facing due to sub-prime related losses:

"Barclays Bank was dragged deeper into the sub-prime mortgage crisis last night after Landesbank Sachsen, a major client, had to be rescued by a rival state-owned bank in Germany.

Barclays appears to have been responsible both for designing a complex fund that got Sachsen into difficulty and for helping to pull the plug on the bank by demanding margin calls in respect of another Sachsen investment." read more

As a result of the problems, Barclays' share price has dipped significantly, and this has had the double effect of causing Temasek's investment to dip by about 15%, while at the same time Barclays' bid for ABN has been diluted because part of the bid was made in stock. See this article for more information.

Now, it looks like Temasek's investment will quickly start off as a loser, and it also seems like it has taken a significant stake in a bank that will have a slightly poorer competitive position vis-a-vis the RBS-ABN combination, which looks more likely than not to be consummated sometime soon.

Indeed, as its size continues to grow and assets under management balloon, Temasek seems to be running into problems as it ventures overseas, beyond Singapore's shores. Only time will tell if this investment turns out to be the second major disappointment since the Shin Saga.

Temasek & Barclays

Earlier today, it was reported in many news sources that Temasek is taking approximately a 3% stake in Barclays, and that this injection of capital will allow Barclays to raise its bid in its acquisition battle with the Royal Bank of Scotland for ABN Amro. Well, I don't have the exact details of the transaction and I haven't done an exact valuation of ABN Amro, but intuitively, this doesn't look like a particularly good investment.

a. Firstly, there is no gaurantee that a Barclays - ABN combination will generate significant shareholder value over and above hurdle rates as a combined entity, than apart. Many mega-mergers have turned out to be big destroyers of shareholder value, think AOL-Time Warner or Daimler-Chrysler, see this post for more. Temasek is betting that 1. Barclays will be successful in its bid for ABN, and 2. an ABN - Barclays merger will go smoothly and transcend all the corporate culture and other execution issues that often plague mega-mergers.

b. Secondly, Temasek is injecting capital to fuel the 3rd bid in the Barclays-RBS bidding war. Thus, i think it would not be unfair to say that the bid is probably very close to the intrinsic value of ABN to Barclays, and there is quite a bit of a chance that Barclays is paying a sizeable premium. If that is the case, then not only does the Barclays-ABN combination not have to fail, it has to succeed wildly, with a very very narrow margin for error.

Put the two factors together, and intuitively Temasek's injection of capital into Barclays does not make sense to me. Of course I could be wrong, as I haven't done the actual number crunching. But this deal smells awfully foul.

DBS ends talks to buy S Korea's KEB

News just out - DBS has decided not to buy S Korea's KEB.

SINGAPORE - Singapore's DBS Group Holdings, Southeast Asia's largest bank, said on Monday that it has ended talks with Lone Star about buying a stake in South Korean lender Korea Exchange Bank (KEB) .

The statement came after Korea's Yonhap news agency on Sunday quoted Lone Star chairman John Grayken as saying that the US investment firm had stopped talks with DBS.

Mr Grayken didn't say why the talks ended, but said that the Dallas-based fund would keep looking for a buyer for KEB, despite a legal battle over the 2003 purchase of the bank.

'We notified Lone Star that we would not be going forward due to the uncertainties in the market surrounding the local issues that have been going on for over a year,' DBS said in a statement. -- REUTERS

Acquisitions are a major source of growth in the banking industry. However, it is not exactly clear why DBS should be seeking an acquisition in South Korea. South Korea is a well developed economy with a highly developed banking market so the growth and revenue enhancement opportunities of entering the South Korean market via an acquisition are not clear. Furthermore, it is not immediately clear where the synergies are between the South Korean banking market and DBS' main operations in Southeast Asia and its fledgling operations in China, which just opened earlier this year.

In order to justify the acquisition, there would need to be significant value-enhancing opportunities that the KEB acquisition would bring to DBS' international banking services, such as investment banking or trade finance. But given that there is rather small amount of international trade between Singapore and South Korea and the main opportunity in this deal for international finance is between China and South Korea, DBS should focus much more on its organic growth in the mainland rather than seeking an acquisition in a market that is non-core to its operations. Southeast Asian companies are unlikely to list on the South Korean stock market, and similarly South Korean companies are unlikely to list their shares on the SGX. M&A activity between the two regions is also unlikely.

Furthermore, given the Singaporean origins of DBS and its predominantly Chinese culture, there would probably be several integration issues when it comes to merging the corporate cultures of KEB and DBS, the least of which being the different languages being used.

All in all this is probably good news for DBS shareholders that Jackson Tai has pulled away from the deal as any prospective deal would likely be risky and involve the winner's curse - destruction of shareholder value.

Mergers and Acquisitions: Acquiring To Gain Market Access

Companies seeking to break into markets sometimes do so via acquisition. If the market is established and there are high barriers to entry, establishing a sizeable beach head through an acquisition is only the feasible way to do so, and can often be a costly exercise.

Take for example DBS Bank which acquired Dao Heng bank in order to gain access to the Hong Kong banking market. Or SingTel which acquired Optus to gain access into the Australian telecommunications market. Both paid high premiums to make the acquisitions, and both parent companies have taken large write-downs to their respective holdings.

A similar seems to have happened with OSIM. Osim acquired Brookstone, and paid a hefty 20x earnings to acquire the company. And now it looks like the acquisition is underperforming. Does the argument of acquiring to gain market access make sense?

Well the problem with doing so is that the acquiring company often pays too much for a second best asset that do not justify the premiums paid. The market leaders are hardly candidates for buyouts. Perhaps a better strategy is to pay a fair price for a smaller player and grow market share organically. Or the competitive nature of established markets may mean that a prospective entrant should stay away altogether.

Osim is likely to make a significant write-down of its acquisition of Brookstone in the future, if it doesn't divest the company at a loss.

A Tale of Two Mergers: Daimler Chrysler and OSIM International

Earlier this week, Cerberus Capital Management acquired an 80% controlling stake in Chrysler. In the process, the automotive manufacturing firm was de-merged from DaimlerChrysler in what has been called a 'divorce on earth', reversing what was hailed a merger that was termed a 'marriage in heaven' when Daimler Benz merged with Chrysler in 1998.

The performance if the merger, in retrospect, was abysmal. Daimler paid $36 billion for Chrysler, only to spin-off the company at a massive loss several years later. In the process, destroying shareholder value and grossly underperforming the market.


As we can see from the charts, in the years following the merger shares of Daimler lost 60% of their value, only recently recovering and experiencing a jump closer to the divestment of Chrysler. What went wrong?

In an earlier post, some comments were cited on why mergers go wrong:

"Mergers of equals seldom work because of ego and wallet issues. The target's top managers are not willing to get demoted, the target's corporate culture doesn't fit well with the buyer, the buyer doesn't have enough spare money to fix the unforeseen issues, etc."

The brand identity of Chrysler and Daimler did not really fit - Mercedes Benz cars are known to be quite a different breed from Chrysler automobiles. Further, there was the challenge of merging a company with two very different corporate cultures - American Chrysler and German Daimler. The economies of scale, collaboration of technologies, and project synergies between the two companies failed to materialise.

In Singapore, OSIM, an international lifestyle products retailer not too long ago made an acquisition of American retail chain Brookstone. And since the merger, OSIM's stock price has followed a similar trajectory to Daimler's after its acquisition:

The stock has crashed from its high of $2 to a dismal $0.70 of late. And there seem to be traits that the company has in common with the Daimler-Chrysler Merger. There are two very different corporate cultures operating here. An Asian corporate culture operating in OSIM, and an American culture in Brookstone. OSIM sells mainly high margin, upscale market products, while Brookstone sells many small, lower margin products. OSIM was also profitable all year round, while Brookstone only during the holiday season. To add to the problem, OSIM's core business suffered a set back earlier this year, when it posted its first quarterly loss in a long while. Also, it is pertinent to note that Brookstone and OSIM are about the same size. This is not a case of a big company making a small acquisition.

Does this seem to be history repeating itself, albeit in a different permutation? Will OSIM's performance continue to suffer up till the point when it decides to divest its stake in Brookstone? Only time will tell. But if I had to bet, I'd bet on this being a historical replay. We all remember what happened after AOL swallowed Time Warner, don't we?

Tips on Mergers and Acquisitions

"Successful M&A activities occur mostly when the target is a lot smaller than the buyer. This means:

1. The buyer can flood the target with its own staff to impose its corporate culture;
2. The buyer can spend more money to cope with unforeseen issues; or
3. The buyer is only interested in a key technology, a key market, or a key customer, and is willing to write off the rest of the target's business.

Mergers of equals seldom work because of ego and wallet issues. The target's top managers are not willing to get demoted, the target's corporate culture doesn't fit well with the buyer, the buyer doesn't have enough spare money to fix the unforeseen issues, etc.

There are many companies that have pulled off successful M&A exercises. Any time you see an announcement that the company has purchased another company for $X, and the transaction does not require shareholder approval, that's one M&A that is likely to work out. Too many such cases to count, really. But if the target is big enough to require shareholders' approval, it's probably also too big to pull off."

The Shin Saga: It takes two hands to clap

Singaporeans might accuse the Thais of being fickle and having a poor legal and regulatory framework when it comes to managing foreign acquisitions of their national assets. Indeed, prevention is much better than cure, and moving in using the Thai military to seize assets is not an action that instills confidence in foreign investors.

The U.S., for example has strong regulatory bodies which are required to give their approval when major acquisitions are made. Cases in point are that regulatory bodies intervened and oversaw both the proposed CNOOC acquisition of Unocal and the Lenovo acquisition of IBM's PC arm. Thailand would do well in learning from other countries in developing a strong mergers & acquisitions regulatory framework to oversee politically-sensitive business assets, and to raise confidence to promote foreign investments. Jil in Pattaya has a smartly written post on this issue.

Yet pointing the blame at the Thais without doing some introspection with its own investment process does no favours for Temasek. It doesn't matter that the Thais ****ed up, you still lose your money! Billions of dollars of it!

As a nationally owned corporation, Temasek has to factor in the unique political risks it faces when making transnational acquisitions. Insisting on running Temasek as a private sector investment company systematically ignores the political risks it faces, and exposes Temasek to the risk of another similar incident reoccurring. Temasek needs to revise and reconsider its approach as "just another commercial investment firm," and build a unique investment framework for the unique investment firm that it is.

Indeed, it takes both hands to clap. The Thais need to get their regulatory framework in order, and the Singaporeans need to recognise the unique nature of their politically-linked investment company.

Incidents similar to the Shin issue can be avoided if either party properly takes these points into consideration.