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ArchiveNovember 1 1999

To buy or not to buy

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Take your seats for the next act in the takeover bid for the UK's National Westminster Bank. But, as Michael Blanden writes, we hope you're sitting comfortably, as this saga looks set to run and run.

As Act I of the UK banking drama drew to a close, the audience was eagerly looking forward to the expected market scene.

So far, the action had been somewhat ponderous, though it had started excitingly enough when Bank of Scotland launched an audacious £21bn ($35bn) offer for the much bigger National Westminster Bank.

That move, on September 24, was sparked off by NatWest's vaunted though expensive agreement to buy life assurance group Legal & General (L&G), although Bank of Scotland insisted it had been thinking along those lines for some time.

Then it took a while before the bidder formally produced its offer document dated October 14. Meanwhile, NatWest had dropped both the L&G deal and its chief executive Derek Wanless, and revealed much of its planned defence in a series of statements.

Bank of Scotland, too, had shown most of its hand before the full offer was put on the table, with substantial cost savings claimed and plans for a wholesale reorganisation of the target's branch network. The air became thick with speculation about further possible moves. Would NatWest attract a rival bid? All sorts of possibilities were raised, though easily favourite is Bank of Scotland's Edinburgh rival Royal Bank of Scotland.

That group was keeping its own counsel. Would NatWest itself look for a white knight to ride to its rescue? The possibilities might include a number of continental European groups, though even the biggest among them would find the UK group a large lump to digest and expensive to buy. Or, just remotely, could Citigroup step in? That newly merged outfit has arguably enough to be getting on with integrating its existing businesses.

What is for sure is that the UK banking scene will never be the same again. The Bank of Scotland move has raised the possibility of a new round of consolidation within the UK banking sector. The UK banks have in the past few years been highly profitable by international standards. At the halfway stage this year, net returns on average equity at the big six ranged from 16.8 per cent at Barclays (after some heavy restructuring charges) up to a stellar 33.5 per cent at Lloyds TSB (The Banker, 9/99, p27).

They have achieved these results in most cases by concentrating on developing their home retail and corporate market. Both NatWest and its most direct rival Barclays have pulled out of unsuccessful attempts to develop a significant presence in investment banking. Only HSBC, which through its former Midland Bank subsidiary (bought in 1992) has a strong UK presence, has also retained an extensive business network outside the UK.

But can this last? The worldwide trend towards consolidation has raised the general argument that banks need sheer size to compete in a global banking environment. In the domestic UK market, the ranks of the banks have already been swollen by the arrival on the scene of the large former building societies, still essentially mortgage lenders but looking for new lines of expansion and generally cash rich.

Competition for retail banking business, too, has hotted up as new means of delivery have brought non-traditional competition into the market and the walls between banking and other financial sectors have broken down. In particular, the bancassurance concept - the attempt to bring insurance and banking together in one group and achieve important synergies as a result - has been gaining ground.

That was the motive behind NatWest's agreement with L&G. It was also the reason for the earlier acquisition by Lloyds TSB of Scottish Widows; that deal has aroused none of the criticisms attracted by the NatWest move. The issue now is what direction consolidation in the UK should take. The bancassurance concept itself is being called into question.

That point was examined shortly after the Bank of Scotland news by Thomson Financial Bankwatch. "The path down which UK bank consolidation was moving has suddenly become less certain. Less than a month ago the sector appeared to be heading down the route of bancassurance following the proposed acquisition of Scottish Widows by Lloyds TSB in June 1999 and subsequently NatWest's own deal at the beginning of September.

Although there are strong reasons for bancassurance mergers/acquisitions, the case has not yet been fully made." Specifically, the Bank of Scotland intervention has put a stop to the NatWest/L&G link-up. That leaves the life assurance group itself now rather in limbo, with indications from David Prosser, chief executive (who had been intended to play a leading role in a combined NatWest/L&G as deputy chairman with responsibility for retail banking and financial services and the wealth management businesses), that it might be open to acceptable new partners.

On the broader front, mergers or acquisitions among the big established banking groups have been talked about for some time now - not least by Sir Brian Pitman, chairman of Lloyds TSB. That has not happened yet. Nonetheless, the banks are undoubtedly sizing each other up, as well as other possible partners, and there has been no shortage of speculation about possible link-ups.

Over the last two years rumours and reported discussions have included for example: NatWest/Abbey National (still a possible contender); NatWest with insurer Prudential Group; Bank of Scotland/NatWest (that has now come to pass); Royal Bank of Scotland/Barclays; Barclays/Legal & General; Barclays/NatWest; and even Barclays with the UK-based overseas bank Standard Chartered.

You could perm any two out of 10 or so and come up with a convincing case. In realistic terms, however, the options are more limited. To start with, there is a much greater likelihood of an agreed deal going through than one which is hostile. It is generally assumed, moreover, that an offer by any of the other big three High Street banks, HSBC, Barclays and Lloyds TSB, would be ruled out on competition grounds.

Back in 1992 Lloyds lost out to HSBC when its counter-offer for Midland was referred to the Monopolies and Mergers Commission and HSBC's bid was not. Now in the background there is the forceful figure of Don Cruickshank, chairman of the banking review set up a year ago by Chancellor of the Exchequer Gordon Brown. He has strong views about the need for enhanced competition in the UK banking industry, particularly for the small business sector, and a potentially influential voice.

That narrows the field down. Shortly after the Bank of Scotland move, Salomon Smith Barney set out its views on possible contenders. "While analysts never say never, we think that the probability of Barclays, HSBC or Lloyds TSB being allowed to bid successfully for NatWest is sufficiently low to be excluded. Of the remaining large UK banks, the list of potential bidders for NatWest (in addition to Bank of Scotland) is Royal Bank of Scotland, Abbey National and Halifax.

On balance, we believe that Royal Bank of Scotland should be considered the favourite (by a small margin) over Bank of Scotland." The other possibility is a bid from abroad. "In terms of an overseas bank, the possibilities are numerous. NatWest represents a 'once in a lifetime' opportunity to acquire a leading (in market share terms, the leading) UK commercial bank. The list of potential acquirers includes several leading European banks." Putting probabilities on the list, the analysts gave RBS a 40 per cent chance, Bank of Scotland 35 per cent, Abbey National 10 per cent and Halifax 5 per cent, with 10 per cent for an overseas buyer.

Meanwhile, the two current protagonists have spared no effort. Bank of Scotland has made it clear that it sees large opportunities to save costs by reshaping NatWest's branch network, including smaller and more modest premises, and cutting back heavily on the London head office presence. It hammered its points home in large letters in the full offer document. "NatWest has consistently disappointed shareholders." "NatWest shares have underperformed Bank of Scotland ordinary stock units by 61 per cent in the 10 years prior to the day before the offer was announced." "NatWest has consistently failed to control costs." "NatWest has consistently failed to grow its business."

The bidder reckons that savings in combined annualised operating costs of the enlarged group of at least £1015m would be achieved within three years of completion of the merger. These are broken down as some £510m "from the application of Bank of Scotland's proven management practices to the cost base of NatWest (excluding IT)"; about £290m from reductions in IT costs and related expenditure; and about £215m from the elimination of duplicated functions undertaken by the two banks (excluding IT).

NatWest's response has been to argue, in effect, that it can achieve exactly what the bidder proposes on its own, in terms of cost savings and rationalisation. It has indicated that it too will be looking at its extensive branch network and considering floating off businesses which are not core to its activities - those could include, for example, the Ulster Bank subsidiary in Ireland which could be attractive to a number of buyers.

The biggest step in management terms was the ousting of Derek Wanless, chief executive since 1992 (who had just been elected the new president of the Chartered Institute of Bankers). The move, prompted by non-executive members of the board, brought significant changes at the top. Sir David Rowland stayed as chairman but became group chief executive. Ron Sandler, a former deputy of Sir David at the Lloyd's of London insurance market, came in as chief operating officer. They now have the task of fighting off Bank of Scotland.

In response to the full offer document, the bank said: "The document does nothing to change the Board's view that the offer significantly undervalues NatWest and that Bank of Scotland's proposal is ill-thought out." It went on: "Bank of Scotland's arguments that its management could achieve better value for NatWest shareholders are unconvincing. Its claims about cost savings are heavily qualified and the arguments purporting to back those claims are insubstantial." Sir David said: "New leadership, a great business and total commitment to customer service and shareholder value will deliver far more to our shareholders than this offer. The offer is long on risk and short on value."

The outcome remains to be seen, but the impact will be lasting. "To buy or not to buy, that is the question.".

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