For Barclays to succeed in the new South Africa, it must strengthen newly acquired Absa's efficiency and then both must learn how to tap the country’s burgeoning black middle class. Meanwhile, their efforts are shaking up a heavily concentrated banking sector.

If you are going to take the fight to the competition, it is nice to know you have an ex-US marine leading the charge. Barclays has cranked up the competitive pressure on its rivals in South Africa, most recently unveiling a re-branded and re-energised investment banking arm of Absa, the local bank it bought control of last year.

The under-performing Absa Corporate and Merchant Bank (ACMB) has been renamed Absa Capital, reflecting its close links to Barclays Capital. Barclays' man in charge is John Vitalo, a straight-talking American who saw active duty with the marines in Beirut.
Already the Barclays-Absa tie-up is showing up the old ACMB, doing deals the latter could never have contemplated. In April, Absa, together with Barclays Capital, placed €300m of fixed-rate notes for Imperial Holdings, South Africa's largest vehicle retailer. The issue, which has a seven-year maturity and pays a coupon of 4.75%, was the longest-dated investment grade Eurobond issued by a South African private sector company.
One year after the exchange of shares made the deal official, Barclays' creeping influence is also starting to show elsewhere in Absa. Early on, Barclays recognised an opportunity to bolster Absa's card division. Though Absa is still second to market leader Standard Bank, it has grown its book at twice the rate of its rival this year.
South Africa has enjoyed a record-setting 30 uninterrupted quarters of economic growth, with the pace of expansion accelerating over the past three years. Combined with falling interest rates, it has been a banking bonanza. And with positive economic prospects ahead, the good times are expected to roll on with plenty of business for everyone. In such an economic climate, local bankers can afford to be wary of the Barclays threat rather than terrified by it. As Jacko Maree, group chief executive of Standard Bank, notes, it was not like Absa was some sickly child. "On the retail side, it has always been a very strong competitor."
If there is a serious worry about Barclays, it is the UK bank's ability to attract the best talent in the marketplace. South Africa suffers a severe shortage of high level skills and the ability to attract and retain the brightest minds can be the difference between stellar and middling performance. Brian Kennedy, managing director of Nedbank Capital, speaks for the industry when he notes the pull of Barclays' international brand, particularly Barclays Capital on the investment banking side where skills are even more crucial to performance. And Absa Capital is recruiting energetically, seductively dangling the Barclays Capital connection in front of candidates.
Barclays' incursion
Last year, Barclays (market capitalisation £38.5bn, €56.4bn) paid R30bn (€3.7bn) for a 56% stake in Absa, South Africa's second biggest bank. The deal was the single biggest foreign investment in the country, in itself a conspicuous endorsement of the country's economic policies and prospects, and was enthusiastically welcomed not least for its promise to shake-up South Africa's heavily concentrated banking.
For the five months to December 2005 (the shares were exchanged on July 27), Absa contributed £335m to Barclays' full-year, pre-tax profits, just less than half the total pre-tax earnings from international retail and commercial banking operations. Without Absa, Barclays derives less than 7% of pre-tax profits from its international operations; a full-year profit contribution from Absa will be between 10% and 15% of group profits, indicating its significance to group chief executive John Varley's stated ambition to increase international earnings to more than 50% of group earnings by 2008.
At the end of 2005, Absa had a 21% share of South Africa's total banking sector assets of R1680bn, second to market leader Standard Bank with 26%. In asset terms, the market grew by 12% in 2005 and 9% in 2004, compared with gross domestic product (GDP) growth of 4.9% and 4.5% respectively.
The four biggest banks, all of them full-service, universal banks including FirstRand and Nedbank, constitute 84% of the banking system. Another 30 banks, including a number of foreign banks, vie for the remainder of the market.
Synergy strategy
According to Dominic Bruynseels, chief executive of Barclays Africa and Middle East, the acquisition is a bet on South Africa and Absa. "We found the deal inherently attractive. South Africa was and still is enjoying a significant consumption boom and as the biggest retail bank, Absa has exhibited good growth across the business. When we looked at Absa we saw significant opportunities to improve, by using the best of what Barclays has with the best of what Absa has."
Topping the list of Absa's attractions was its retail franchise, where it is the undisputed leader in the profitable mortgage finance arena.
With 750 branches, close to 6500 automatic teller machines, sophisticated telephone and internet banking services and nearly eight million customers, Absa is at the top or near the top of all retail segments. And with interest rates falling to 25-year lows, retail banking has boomed. According to the central bank, the South Africa Reserve Bank, total non-bank loans and advances (which includes corporate loans) grew 9.5% in 2003; 15.8% in 2004 and 21.4% in 2005, far exceeding GDP growth. Mortgage loans, by far the biggest component of total non-bank loans, grew 15.8%; 25.6% and 28.6% over the same period. Instalment finance, including vehicle and asset financing, grew only modestly slower.
The reason for the surge in credit has been the steady fall of interest rates from 17% in June 2003, bottoming out at 10.5% and remaining unchanged from April 2005 until June this year. The result was a household investment and consumption binge. In the three years since June 2003, house prices rose more than 85%, according to Absa's own influential house price index, equivalent to nearly 23% a year on average. In part buoyed by the wealth effect of rising property prices, household consumption spending grew on average 11% a year over the same period, while spending on durable goods rose more than 16% on average a year. New vehicle sales, in unit terms, were up 26% in 2005 and more than 21% in the first quarter of 2006 compared with the year before.
Little wonder Barclays wanted in on the action, with growth potential still out there despite the interest rate cycle turning. In June, the Reserve Bank stuck up rates by 50 basis points, responding to the rand's weakness, rising oil prices and a gaping current account deficit of 6.4% of GDP. Unlike past cycles, however, economists do not expect rates to return to recent highs.
Absa's head of retail, Louis von Zeuner, concedes the bank will feel the impact of rising interest rates. "As the biggest player in the market, we are affected by the movement of the market." But he is not predicting any kind of crash, least of all property prices. "The market has been playing catch-up to decades of under-performance," he notes, referring to the period of stagnation first during the violent death throes of apartheid and latterly the initial, uncertain years of African National Congress rule.
What Barclays and Absa are keeping their eyes on is the rise of the black middle class, the beneficiaries of the South Africa government's grand, ongoing project to undo apartheid inequalities. Affirmative action hiring, particularly in the public sector; procurement spend favouring black businesses; and industry charters obliging partial transfer of ownership to black interests, have started to yield results. Research conducted by the Unilever Institute at the University of Cape Town found that the black middle class – the so-called ‘black diamonds' – numbers more than two million consumers, roughly 10% of the black adult population of South Africa. Already, this segment accounts for 23% of total consumption, and it is growing by 50% a year.
Aside from just the growth in numbers, these ‘black diamonds' are also playing catch-up in terms of consumption and asset accumulation. One study by local economist Servaas van der Berg found, for example, that only 77% of affluent black households had a car compared with 98% for similar white households; just 36% had PCs compared with 67%; and a paltry 15% had tumble dryers compared with 61% in white households. In other words, South Africa's consumption splurge still has momentum. And with debt servicing costs at about 8% to household income, there is still room for credit growth.
Smooth integration
Buying control of Absa gave Barclays instant market share; it now hopes to exploit Absa's dominance. Robert East, sent by Barclays to head the deal implementation, is quick to emphasise that Absa was already a sound retail operation. It is a sentiment that is half true and half designed to not alienate Absa staff amid unsettling change. Mr East says Barclays and Absa are working well together, and are on track to meet the R1.4bn in synergies promised inside of four years. He declines to confirm (or deny) comments from Barclays insiders that the R1.4bn target will be easily exceeded ahead of schedule' but long-time Absa staff that The Banker spoke to generally confirmed that the integration was proceeding smoothly.
Contrary to predictions, there is little evidence so far of any confrontation between Barclays' British culture and Absa's predominantly Afrikaans culture. Colonial-era rivalries linger after Britain went to war with and defeated the Afrikaners, the mostly Dutch settlers to South Africa, at the turn of 20th Century. Good relations are helped by the fact that the deal did not demand branch closures and staff redundancies. Mr East also points out that Absa's workforce is now 52% black, up from just 15% in 1994, the year of South Africa's political transition to non-racial democracy. Mr East comes with experience of foreign cultures, having led Barclays' integration of Spanish bank Zaragozano. Lessons learnt there are being applied to Absa.
Raising the pace
Obvious synergies are being exploited – Absa will save millions of rands by leveraging Barclays' preferential supplier agreements to lower its procurement bill. Areas of duplication are being eliminated and technology platforms integrated.
As much as Mr East stresses it is about the best of Barclays and Absa, there is a clear sense that Barclays thinks Absa is in the slow lane. He talks about raising Absa's "metabolic rate", reflecting Absa's ponderous, almost bureaucratic manner. Much has been made about Absa's corporate ethos that favours consensus over decisiveness, a legacy of Absa's origin, a consolidation of four separate banks in 1991/92. Commentators have long since felt it would require an outside acquirer to get Absa to full speed.
Absa is being nudged towards Barclays' "value-based approach" to customers, a simple principle to focus on more profitable products. "Before, Absa was about volume; we are now getting staff to understand it is better to sell one more-profitable product than two of the less profitable ones," says Mr Von Zeuner, a longtime Absa veteran.
The comment reflects why Barclays and Absa are complementary. Because of its huge customer base and large retail footprint, Absa has been very good at accumulating customer data, just not very good at exploiting it. Barclays thinks it can show the way. "We have been very impressed with Barclays' ability to deal with the wealth of information we have and we have already learnt a lot about how to manage data better," says Mr Von Zeuner. The outcome is better targeting, more valuable sales leads and more effective sales prompts for frontline staff.
Quick improvements in Absa's card division highlight the potential of the tie-up. Barclays' Chris Sweeney, managing executive of Absa card, says what he found was a card business that was "very solid but conservative, and lacking imagination, innovation and ambition." The infrastructure was good but Absa had never really tapped the market. Indeed, South African banks have historically been slow to market cards beyond their existing customer bases and even then were not very good at that. Mr Sweeney found plenty to work with.
"We have not had to do anything to the systems; it was more about reengineering the process," says Mr Sweeney. New measures include changing the channel mix (85%-90% of card recruitment was happening inside Absa branches), moving applications away from slower paper-based processing, updating sales techniques and conceiving promotions more cleverly, such as running campaigns around high expenditure periods such as Christmas.
For Barclays, which derives 13% of its pre-tax earnings from Barclaycard, there are many trade crafts it can offer Absa but Mr Sweeney is finding too that simply raising the "metabolic rate" offers substantial operational improvement. "Early on we recognised we would need to increase our capacity to handle applications. I needed a step change and asked for a fourfold increase in processing capacity within eight weeks. Everyone thought I was mental but we did it," he says. It is symptomatic of just how much efficiency there is to unlock in Absa.
Bizarrely now, Standard Bank has the Barclaycard franchise in South Africa, a deal struck long before Barclays imagined returning in force to the country. That's had to be unwound but not before Standard learnt more than a thing or two. "We learnt a lot about Standard Bank too," says Mr Sweeney.
Earnings potential
Getting Absa Capital up to full speed is a more challenging proposition but the earnings upside is a juicy carrot. In the full year to end-March, 2005, Absa's wholesale banking division contributed just 14.5% of earnings. In contrast, Standard Bank's corporate and investment bank was its biggest earnings contributor, accounting for 45% of total earnings.
Mr Vitalo was not surprised Absa Corporate and Merchant Bank was underperforming. "It was more like a corporate bank, making loans and doing some vanilla FX and so forth. The infrastructure was not really that of an investment bank, to do value-added capital raising, structuring and derivatives. We saw a business that had not been enabled – if you send a boxer into the ring with one hand tied behind his back, the chances are his win-loss record will be dismal," says Mr Vitalo.
On paper, what Mr Vitalo is putting in place to reverse the fortunes of Absa's investment banking arm sounds compelling. His model – which is unique in the marketplace – is to create an investment bank that is "fully local and fully global". What that means in practice is to twin Absa's strong domestic presence and balance sheet with Barclays Capital's global franchise. "If you look at the foreign banks here, they have very little capital in the country, limiting them to what they can do in the rand market. Conversely, the domestic banks are very strong in the rand market. They have full local capability, deep knowledge and relationships, and a strong balance sheet, but if you want to do something outside South Africa, it gets very challenging very quickly," he says.
To deliver this, Mr Vitalo has broken new ground in the group to create what he calls a "single virtual firm". Absa will be responsible for all rand products across the group; Barclays Capital for everything else. The client will see just one face to the Barclays-Absa offering but will have the benefit of a best-fit solution that can draw on local and worldwide capabilities.
The model is untested and goes only some way to address the problem caused by Barclays' partial ownership of Absa. Deciding the revenue split between Absa and Barclays Capital is the sort of problem profit-conscious investment banks are not normally good at resolving. And it remains to be seen whether investment bankers at Barclays Capital will be happy to be pulled in on smaller South African deals. Mr Vitalo is adamant Barclays Capital is fully behind the idea, citing the strong backing given by Barclays Capital head Bob Diamond and co-president Jerry del Missier.
"Validation [of the model] is evident in the kind of deal flow we are already seeing, the numbers we are turning in and the feedback we are getting back from clients," he says, adding that Absa Capital is exceeding its own targets.
Absa's competitors are unconvinced. David Munro, deputy chief executive of Standard Bank's corporate and investment bank, believes the model does not provide a sustainable competitive advantage. "The global players compartmentalise their capital requirements, looking for a local solution for their local needs and an international solution for their international needs. They are already in very strong relationships," says Mr Munro, adding that Standard Bank has operations and relationships outside South Africa to execute these sorts of deals.
"Look behind those statements," says Mr Vitalo, "There's really not a lot there. Maybe they have got a small office in London. Behind my statement is an affiliation with Barclays Capital, which is one of the most renowned and successful investment banks in the world."
Standard Bank, which has an office in London, has recently formed a joint venture with Credit Suisse, primarily focused on global equity research and distribution. Rand Merchant Bank, part of FirstRand, has a similar relationship with Morgan Stanley. Such joint ventures reflect the competition's acknowledgement of the need for global capabilities; whether they can be made to work remains to be seen.
Too many cooks?
Like Mr Munro, Investec chief executive Stephen Koseff is quick to concede Barclays-backed Absa Capital will be a stronger competitor than before. But he wonders how long it will take for the culture to gel. Absa Capital has an American at the helm, a senior team recruited from various different houses, a creative tension between the Barclays Capital style and the legacy Absa approach, and is operating in an environment characterised by dynamic change. Mr Vitalo, by his own admission, had to undergo a crash course in black economic empowerment; he is necessarily without an intuitive roadmap of South Africa's corridors of corporate power.
For now, there is a lot of posturing and eye-balling. The competition is sizing up the Barclays threat. South African banks are known for not competing until they have to, and they have substantial resources to launch a counter offensive if the competitive threat materialises.
Barclays has already learnt not to expect an easy ride in South Africa. Minority shareholders holding out until the end forced Barclays to increase its offer price while the banking regulator denied Barclays automatic approval to sell its African business to Absa, a key motivation for doing the deal.
Indeed, despite public pronouncements from Barclays of a "second phase" to the deal, that being the sale of Barclays' Africa interest to Absa, banking regulator Errol Kruger has made it clear this will require separate approval. He is concerned that Barclays and Absa successfully see through the deal implementation in South Africa before management gets distracted by integrating the business in nine other African countries outside South Africa. Barclays' Africa assets were non-material in the group balance sheet but will be substantiated on the Absa balance sheet.
The black middle class market
To succeed, Barclays must find a way to strengthen Absa's effectiveness and efficiency while not diluting its essential ‘South African-ness'. The market's lucrative opportunities necessitate delving into the relatively unknown emerging black middle class market on the retail side, a segment not well understood even by the South African banks, as well as building relationships with powerbrokers and leading lights among the country's black political and business elite, on the corporate and investment banking side. It remains to be seen whether the Barclays know-how is flexible enough to contend with these unique dynamics.
Prospects for the South African market look good. The country will host football's 2010 World Cup, with substantial investment set to be made in the lead up to the event. The South African government has allocated R375bn, or roughly 25% of GDP, over five years to infrastructure spending (Barclays experience in public-private financing initiatives will come to good use). In addition, the government has launched its Accelerated and Shared Growth Initiative for South Africa, a programme led by the deputy president to lift economic growth to 6%. Consensus forecasts peg growth as 4.6%-5% growth this year.
But against this rosy backdrop, Barclays will still have to contend with normal emerging market risks. After May's emerging market re-rating, plus jitters about South Africa's current account deficit, the rand was trading in mid-July 21% weaker against the pound from its 2006 high (and more than 12% weaker from the date the deal was approved). The translation effect should keep Mr Varley on the hop explaining to investors why the Absa deal was a good idea.

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