It is said that merger and acquisition (M&A) is one of the two ways of corporate growth, the other being organic growth by increasing capital from internal sources. However, a good number of the banks in Ethiopia have opted for organic growth through rights issues, most of them resolving to increase their capitals by three to four folds to be implemented in the coming years. Quite invariably these capital increase resolutions rely on capitalizing dividends the companies expect to earn in the years to come – a rather slow process. Apparently, there is a clear lack of innovation in raising capital. The institutions are not the only ones to blame, however. Unfortunately, the banking (and insurance) regulation does not innovate. For instance, it outlaws the creation of varied classes of shares. One can issue only common shares in Ethiopian financial institutions.
Since the government expressed its intention to open the financial market to foreign providers, one of the hotly discussed topics has been the inability of domestic banks to withstand the ensuing competition from their foreign counterparts. This narrative is followed by a proposition for their merger towards creating a fewer number of larger banks. On many occasions, central bank regulators have indicated the need for mergers among the existing providers. While a merger is not the only survival mechanism for Ethiopian banks post foreign bank entry, it is the fastest route to growth and expansion.
However, M&A is easier said than done in the Ethiopian financial sector regulatory environment and market practice, where there appear many barriers to mergers. A few of the challenges are a lack of experience, regulatory issues, and possible management resistance.
First, there is an acute dearth of experience of mergers and acquisitions in the corporate culture in Ethiopia. To begin with, in corporate law parlance, the word merger represents three different options, i.e., amalgamation, acquisition and takeover. Amalgamation is the full combination of two entities to create one new entity while acquisition is the full absorption of one entity by another. A takeover refers to the acquisition of controlling shares in one company by another.
The call for consolidation in the financial sector refers to the first two only. Looking at market experiences in Ethiopia, amalgamations and acquisitions involving share companies with dispersed ownership are very few and far between. Most capital restructurings hitherto reported as mergers are simply takeovers, and of no useful lesson to what is being contemplated in the banking industry. If anyone thinks of the Commercial Bank of Ethiopia’s acquisition of the Construction & Business Bank as an important benchmark, they will soon be disappointed. That was merely a process of a sole owner (the State) merging its two properties. Perhaps the only known experience one can mention is the acquisition of Raya Breweries, and Zebidar Breweries by BGI a few years ago.
However, mergers in the banking industry will not be as easy as the acquisition of Raya by BGI because of the structure of share ownership. The nature and design of the institutions, the lack of experience, and resistance from executives at target companies will likely make mergers difficult, if not impossible, to implement.
Financial institutions in Ethiopia are widely held mainly because the NBE requirement limits the maximum holding to just five percent. In fact, NBE policies tended to discourage concentration of ownership by placing stringent requirements for ‘influential shareholders’ , a designation given to shareholders having stakes above two percent. However, the dispersion of ownership will come back to haunt the initiative for consolidation. In other words, this will prove a regulatory barrier. The fact that both the bidders and the targets are companies with dispersed ownership will make merger transactions too complex to handle. This means diffuse shareholders at both sides should be convinced of the merits of the transaction. The new Commercial Code clarifies the procedures, but that doesn’t mean it will be easy.
What is more, some of these institutions mean more than just business because they carry ethnic representations. Imbued in their value is their appeal among their respective ethnic or religious communities. Thus, while mergers should be rational market decisions, mergers between institutions carrying differing ethnic symbolism may appear to be a merger of two ethnic communities. This will limit the menu both for bidders and targets. In other words, if you are Bank A, you can’t bid to acquire Bank X, because Bank X symbolizes a different ethnic community. Even if there are a few non-aligned banks; their choices both as bidder or target will be, likewise, limited to the non-aligned groups.
There is another ‘who is who’ problem as well: valuation. M&A as a market transaction entails the exchange of values. How are the values of these institutions to be determined? From the price at which the shares of the banks are being traded on the informal market, it is evident that there is a valuation problem. What is the value of any given enterprise is a popular economics question. But beyond the historical dividend data, agreeing on the valuation of assets can be challenging. Some have good history in terms of the return on capital or asset, others have a strong asset base, others have invested heavily in agent networks, or in digital banking, etc. In this context, M&A can be problematic.
In view of the mechanics of effectuating mergers, the selection between amalgamation and acquisition needs careful considerations. Amalgamation is more disruptive and complicated than acquisition. It disrupts the operation of all the entities participating in the transaction, and until the new entity is created with its executives identified business operation will be slowed if not interrupted. Acquisition will be less disruptive, and more straightforward. It can be cash-for-shares acquisition (the bidder raises funding and uses the proceeds to pay the shareholders of the target; the target disappears, its shareholders go, and assets of the target become assets of the acquirer). Or such an acquisition can be a share-for-share transaction (the bidder exchanges x number of its shares for y number of the target’s shares. The target disappears, but its shareholders are allowed to remain shareholders of the acquirer, except those that reject the proposition which will be forced to leave taking cash compensation.) The transaction always increases the capital of the acquirer by as much as the capital of the acquired target.
Thirdly, like in all other countries, there will be managerial barriers. Executives at target companies are natural obstacles to mergers. This is especially true in companies with diffuse ownership like in Ethiopian financial institutions giving senior management and the board effectively full control of major decisions. Even if the decision on mergers is theoretically made by shareholders, practically it is only the management/board that can initiate such decisions. Minority shareholders can initiate decisions under the new commercial code, but the management/board can always dissuade the general assembly from taking any decision it doesn’t favor. So much so that, mergers that the management doesn’t like have less likelihood of success. Target management disfavors acquisitions because it means loss of position. In other countries, the market for corporate control has long introduced effective remedies for hostile target management such as golden parachutes, golden handshakes, etc. Under such arrangements, target management is paid generation compensation for job losses from the mergers. In fact, most senior management employment contracts will have such clauses. It is not clear how many bank CEOs in Ethiopia contemplated job losses from mergers and included such clauses in their employment contracts. Nevertheless, such clauses can be useful in as much as they can remove one of the potential barriers against consolidation in the financial sector. Post merger integrations are also problematic because each institution will have its own corporate culture.
Where does all this leave us? Mergers are not necessarily a must for all banks. Some can avoid mergers. Older banks that have surpassed the minimum capital threshold of ETB five billion can withstand the threat of merger. First of all, most of these have accumulated legal reserves which they can easily convert into equity. Second, most of these institutions have assets in real-estate, and other investments. Newer ones don’t have that luxury, and must plan for a merger.
The NBE should take the initiative and support them in providing guidelines, training and coordinating knowledge/experience sharing. In as far as compulsory mergers can’t be effective, guidelines will be more appropriate than directives. Such guidelines should explain procedures, identify issues of valuations and indicate possible methods of solving such issues. In M&A, due diligence is the most time taking and complex process. Here, the NBE can help greatly as it possesses a great deal of information about each of the financial institutions. NBE’s regulatory data about each institution is confidential. But in the interest of the broader economy, it can legislate to provide access to companies who are in M&A negotiations.
A mandatory directive is not the panacea; however, if the NBE decides to issue directives, such an instrument should not enforce compulsory mergers. A directive can be issued to clarify as to how merger can take place, how cash-for-share or share-for-share acquisitions can be made, how disruptions can be minimized during such transactions, disclosure and due diligence matters, etc. To ensure the optimum success of the consolidation program, in particular the post consolidation integration issues, there is the need for the NBE to sponsor training programmers’ on post-consolidation integration and corporate culture conflict management. This would assist to mitigate conflicts associated with consolidation, thereby facilitating the sustainability of the merged institutions.
Coordinating experience sharing with foreign counterparts can provide key lessons. The Ethiopian financial industry is probably unique because of dispersion of ownership and the presence of ethnic elements in some of the players. Maybe it is hard to find parallels for such elements in other countries. Yet, the experience of financial institutions in other countries can give us useful lessons. Bank mergers either market driven or policy driven such as that being contemplated in Ethiopia have occurred in many countries. Why not learn from them and avoid the errors they made and capitalize on the positives?
11th Year • Jan 2023 • No. 114