By Emmanuelle Moors De Giorgio.

On 15 November 1999, Nedcor Limited, a South African bank, made an unsolicited bid for Standard Bank Investment Corporation (Stanbic), its bigger rival. If the bid is successful, it will become South Africa's biggest merger in the financial sector.

Yet at the end of the first week of January, it seemed that it would take some time before South African regulatory authorities would make a decision on the proposed merger. The agencies involved, such as the Banks Registrar and the Competition Commission have still to agree on how they will co-ordinate work among themselves. Since the Christmas break, the two banks have remained fairly silent. But clearly, it is Stanbic that is on the defensive.

On 25 November Standard Bank Investment Corporation (Stanbic) tried earnestly to garner support in presenting its long-awaited defence against Nedcor's bid. But some of its arguments sounded desperate.

If fund managers signed irrevocable undertakings to support Nedcor's offer, threatened Jacko Maree, chief executive of Stanbic, they could be sued by policyholders for not carrying out their duties responsibly. A real threat? Maree must be pretty sure of himself that his repeated rejections of Nedcor's bid is in the best interest of Stanbic shareholders and his current strategy defensible if Nedcor eventually wins.

So far, Stanbic has put forward so many arguments for rejecting the offer that one finds it difficult to separate the wheat from the chaff. To be fair, Maree has rightly highlighted three muddy areas that ought to be cleared up before merger talks resume. These are: the low premium offered by Nedcor for Stanbic shares, the optimistic performance forecast for the proposed merged entity and the implementation risk.

Nedcor made a partial offer for 50.1% of the capital of Stanbic on the basis of one Nedcor share for every 5.50 Stanbic shares. Based on a closing share price of 117 Rand for Nedcor before the announcement, this offer valued each Stanbic share at R21.27 and its common stock at R29.2bn. An improved exchange ratio of 5.25 was proposed if the board of Stanbic recommended to its shareholders a full merger. Nedcor calculated that the partial offer represented a premium of 11% over the 30-day average of the ratio in the month to 28 September, when Stanbic made its first cautionary announcement. But the implied price of R21.27 was actually less than the closing price of R21.40 on the day that preceded Nedcor's announcement.

In its defence, Nedcor could argue that it was not seeking control but a full merger (for which it nevertheless offered a higher premium of 16%) and point to Banco Bilbao Vizcaya, Spain's second largest bank, which did not offer any premium at all to take over Argentaria, the third largest. Besides, the partial offer was at a 21.8% premium when compared with average price over a one-year period - a widely-used benchmark.

Nedcor also successfully warded off the revelation by Stanbic in late November that "far more generous terms were offered when Nedcor attempted to buy Liberty's stake a year ago". Nedcor listed several unfavourable events that had hit Stanbic over the past year and negatively affected its value. It argued that, if anything, the share price offered to Stanbic should reflect market expectations as to the effects of an eventual take-over or merger on its performance. It added that since Nedcor is proposing to pay with its own shares, the same scrutiny should apply to the effects of a successful bid on Nedcor's future performance.

In the two weeks after Nedcor's announcement, the share price of Stanbic remained fairly stable while the share price of Nedcor fell by some 3.5%. This reflected not only the de facto absence of premium for Stanbic shares, but also the fact that Nedcor's shareholders were actually more concerned about the consequences of the merger than their counterparts at Standbic.

This is not surprising, perhaps, given that the performance of Nedcor is superior when measured in terms of operating profits (a compound annual growth rate of 24% for Nedcor against 11% for Stanbic between 1994 and 1998), cost-to-income ratio (56% for Nedcor against 62% for Stanbic) and return-on-equity (ROE) (21% for Nedcor against 16% for Stanbic).

To further sell the idea, Richard Laubscher, Nedcor's chief executive, brandishes an attractive ROE of 30% for the proposed merged entity. Of course he does not clearly specify how this figure is calculated or when it will be achieved. Given that the combined financial statements of end-1998 presented by Nedcor show an ROE of 18% for the proposed merged entities, one wonders how 30% ROE can be achieved. This imponderable is even more curious when post-tax restructuring costs of up to R1.5bn and annual post-tax synergies (net of revenue losses) of R1.9bn by end 2002 are considered.

To further fuel the fire, Stanbic has been keen to remind its shareholders (referring to a recent study of US bank mergers) that earnings for the two years following completion of a merger are always below expectations. This being said, the respective share price adjustments observed in the two weeks that followed Nedcor's announcement, causing the ratio between the respective share prices to narrow from around 5.5 to around 5.25, also reflected marked expectations that the recommended offer of 5.5 Stanbic shares for one Nedcor share would go ahead.

These expectations had apparently not abated by early January, as the share price of Stanbic of R25.2 and the share price of Nedcor of R131.4 produced a ratio of 5.21. Meanwhile, the prices of both banks were bid up, reflecting market confidence that the proposed merger would have a positive impact on their operations.

With regard to merger risks, Stanbic has been pointing to numerous downsides to the plan. It argues that Nedcor does not have the required experience to integrate the computer systems of both banks. There is the threat of 10,000 job losses that will take its toll on employee morale and performance. Moreover, since only some staff reductions will take place through natural attrition, those threatened may choose to strike, a tool often used in South Africa, or key officers at Stanbic may leave the merged entity.

Stanbic is arguing that hostile takeovers are more likely to end up as partial or complete failures. But whose fault is it if the proposed merger is not "friendly and negotiated"? Nedcor argues it had "consistently expressed its desire for an agreed full merger with Stanbic" and had two meetings before announcing the offer but had found that Stanbic was unwilling to negotiate, at least on the basis of the price offered by Nedcor.

Still, Nedcor left the door open and, a few days later, Stanbic said it would accept a ratio of 4.35. Stanbic argued that it would bring to the merged entity 33% more capital and 14% more earnings, and thus its shareholders should get a majority of shares of the merged entity.

Not quite. If Nedcor accepted Stanbic's counter-offer, this would give its current shareholders a larger share of the merged entity but further dilute its capital because Nedcor would have to issue more shares to finance the acquisition. Moreover, one can only hope that 4.35 is enough to make Stanbic forget some of its most virulent defences against the merger. It has claimed that the deal is against the national interest, or the plan adds nothing or even destroys value in businessess representing 55% of Stanbic's earnings or even that "potential net benefits are half of Nedcor latest estimates".

All in all, does Maree think a merger between his bank and Nedcor is a good idea or not?

Observers argue that something is absent from Stanbic's list of shortfalls and risks involved in the proposed merger: a convincing alternative. Banks are merging the world over and have good reasons to do so.

Some of Nedcor's arguments have merit: cutting excess capacity and utilising lower cost-platforms and the stronger capital structure of the merged entity.

Few seem to have used the argument of synergy, a common word in Europe. Stanbic has built some successful international franchises and has far more successful operations in sub-Saharan Africa. These benefits would accrue to the merged entity, while Nedcor's stronger domestic operations could benefit Stanbic. To mollify the 60% of Stanbic shareholders that have still not signed, Nedcor may take note of Stanbic's call for a full cash offer and, perhaps, make a partial cash offer. Old Mutual could also help by taking a more conciliatory role in the proposed merger (Old Mutual owns 21.4% of Nedcor and 22.4% of Stanbic and is supporting the merger).

Stanbic minority shareholders should be glad that Nedcor offered them the same terms as it did for the controlling stake. Notably, Nedcor had to structure the merger offer in two stages because it believed the Stanbic board controlled about 24% of Stanbic shares, and thus Nedcor would have been unable to buy the 90% of shares needed to bring about an automatic purchase of the balance.

Domestic mergers remain the norm world-wide but the number of international bank mergers have increased. Building a national champion in South Africa with a market capitalisation of R57bn and assets of R270bn is not a bad idea. It had better happen soon otherwise an international player will notice that the cost-to-income ratio of South African banks remains unaccountably high and will grab the opportunity to develop its own network.