Case study

The Ipoh-Kelantan Bank Merger

by Professor Ian H. Giddy
New York University

As part of the consolidation of banks in Malaysia, Bank of Ipoh and Kelantan Bank Holdings Bhd are planning a merger. The proposed merger will occur through an exchange of shares, with Kelantan paying 1.5 shares for each share of Ipoh. Ipoh shares are currently trading at RM55, while Kelantan shares are priced at RM40.

The following are the details of the two potential merger candidates (RM figures in millions):

Ipoh Kelantan
Revenues RM4,800.00 RM3,325.00
Cost of Goods Sold 
(w/o Depreciation)
as % of Revenue 
87.50% 89.00%
Depreciation RM200.00 RM74.00
Tax Rate 32.00% 32.00%
Working Capital 10% of
10% of 
Market Value of 
RM1,900.00 RM1,450.00
Outstanding debt RM360.00 RM450.00

Both firms are in steady state and are expected to grow by 5% a year in the long term. Capital spending is expected to be 90% of depreciation. The beta for Ipoh is 1.7, and for Kelantan 1.5, and both firms are rated BBB, with an interest rate on their debt of 8.5%. The US government bond rate is 6%. Malaysian bonds yield approzimately 2% over US government bonds. The market return is about 7% over the risk-free rate.

As a result of the merger, the combined firm is expected to have a cost of goods sold of only 86% of total revenues. Earnings will grow faster, at 6%. On the other hand the merger is expected to involve additional costs of RM200 million in the first year, and 100 million and 50 million rupiah in the second and third year after the merger, respectively. The combined firm does not plan to borrow additional debt.

Estimate the value of Ipoh and of Kelantan, operating independently. Then estimate their combined value, assuming no synergies. If it does not increase debt, the combined firm's rating will be A+ (with an interest rate of 7.75%)

Now estimate the value of the merged bank, assuming synergies.

Finally, assume that, as a result of the merger, the Ipoh-Kelantan Bank's optimal debt ratio increases to 20% of total capital from current levels. (At that level of debt, the combined firm will have an A rating, with an interest rate on its debt of 8%.)

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