Running head: VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP
VALUATION OF MBANK AS A POTENTIAL ACQUISITION TARGET OF PZU GROUP
A Thesis
Presented to the Faculty
of Finance Programme at
ISM University of Management and Economics
in Partial Fulfillment of the Requirements for the Degree of
Bachelor of Management
by
Arnas Zygmantas
Advised by
Assoc. prof. Dmitrij Katkov
December 2020
Vilnius
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 2
Zygmantas, A., Valuation of mBank as a Potential Acquisition Target of PZU Group.
[Manuscript]: Bachelor Thesis: Finance. Vilnius, ISM University of Management and
Economics, 2020.
Abstract
The objective of this paper is to estimate the value of mBank as a potential acquisition target of PZU Group. To achieve the aim of the thesis, the target company and the acquirer are overviewed. Additionally, the situation in the Polish banking sector is presented and the macroeconomic environment in Poland is analyzed in detail covering the effect of the COVID-
19 pandemic on the economy. Based on the research performed, a combination of the DCF method using FCFE (75%) and relative valuation (25%) is chosen for the estimation of mBank value. The total value of equity of mBank calculated using the FCFE valuation method is equal to PLN 12452.78 million. The estimated mBank share price using the FCFE valuation method is
PLN 294.04. Moreover, the sensitivity analysis is performed to check how the equity value of mBank would change if different risk-free rate, beta, and growth rate would be used. The average share price of mBank using relative valuation approach equals to PLN 361.72. The determined final share price of mBank obtained utilizing the set weights for each of the selected methods is equal to PLN 310.96. Consequently, the final estimated value of mBank is PLN
13,169.31 million. Accordingly, the value attributable to Commerzbank accounts for PLN
9,127.61 million, which could be paid by PZU Group when acquiring mBank.
Keywords: Valuation, discounted cash flow, relative valuation, banking sector, free cash flow to equity, mBank, Poland
Word count: 16151 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 3
Table of Contents Introduction ...... 7 Relevance of the topic...... 7 Problem of the research...... 8 The aim of the thesis...... 8 Thesis objectives...... 8 Research methods...... 8 Situation Analysis ...... 9 Overview of the target company...... 9 Overview of the acquirer...... 10 European banking industry analysis...... 10 Polish banking sector analysis...... 12 Overview of economic situation in Poland...... 15 PESTEL analysis...... 15 mBank business segmentation analysis...... 23 Financial risk assessment of mBank...... 27 Profitability...... 27 Efficiency...... 29 Capital structure...... 29 Cash flow management...... 30 Shareholders’ return of mBank...... 32 Summary of situation analysis ...... 33 Theoretical Justification and Research Methodology ...... 34 Value definition, valuation approach and purpose of valuation...... 35 Challenges in bank valuation...... 36 Overview of valuation methods...... 38 Discounted cashflow valuation approach...... 39 Asset-based valuation approach...... 42 Relative valuation approach...... 43 Contingent claim valuation approach...... 44 Valuation approach for mBank...... 44 Inputs of discounted cash flow valuation approach...... 46 Discount rate...... 46 Free cash flow...... 49 Growth rate...... 49 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 4
Terminal value...... 50 Sensitivity analysis...... 50 Valuation of mBank ...... 50 DCF valuation method application...... 51 Cost of equity...... 51 Risk-free rate...... 51 Beta...... 52 Equity risk premium...... 53 FCFE and growth rate...... 54 FCFE valuation method results...... 57 Sensitivity analysis...... 58 Sensitivity analysis of risk-free rate...... 58 Sensitivity analysis of beta...... 59 Sensitivity analysis of steady growth rate...... 60 Multiples analysis...... 61 Value of mBank...... 63 Consideration of synergies...... 64 Conclusions ...... 65 References ...... 68 Appendices ...... 74 Appendix A. Formulas of financial ratios ...... 74 Appendix B. mBank S.A. Group consolidated income statements ...... 75 Appendix C. mBank S.A. Group consolidated balance sheets ...... 79 Appendix D. Forecast of mBank S.A. Group consolidated income statement ...... 85 Appendix E. Forecast of mBank S.A. Group consolidated balance sheet ...... 86
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 5
List of Figures
Figure 1. Share of net interest income of mBank Group by source ...... 24 Figure 2. mBank historical stock price performance ...... 32 Figure 3. Daily changes in mBank share and WIG20 index prices, November 2, 2015 – October 30, 2020, % ...... 53
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 6
List of Tables
Table 1. Leading banks in Poland by total assets as of December 31, 2019, in million PLN Client analysis: benefits sought ...... 12 Table 2. Net financial wealth (excluding liabilities in shares & other equity) in the euro area, 2017-2019, percentage of gross domestic product, based on four-quarter-cumulated sums ...... 13 Table 3. Herfindahl–Hirschman Index for credit institutions in the EU (index ranging from 0 to 10,000), 2015-2019 ...... 14 Table 4. Changes in the assets of mBank Group, in million PLN ...... 25 Table 5. Changes in the loans and advances of mBank Group, in million PLN ...... 26 Table 6. Profitability ratios of the largest banks by total assets in Poland, 2017-2019 ...... 28 Table 7. Activity ratios of the largest banks by total assets in Poland, 2017-2019 ...... 29 Table 8. Leverage ratios of the largest banks by total assets in Poland, 2017-2019 ...... 30 Table 9. Liquidity ratios of the largest banks by total assets in Poland, 2017-2019 ...... 31 Table 10. Main inputs of the FCFE valuation method, 2020-2025 ...... 56 Table 11. Historical data of own funds and total loan receivables, 2014-2019, in million PLN ...... 57 Table 12. Forecast of own funds and total loan receivables, 2020-2025, in million PLN ...... 57 Table 13. FCFE valuation method results...... 58 Table 14. Sensitivity analysis of risk-free rate...... 59 Table 15. Sensitivity analysis of beta ...... 60 Table 16. Sensitivity analysis of steady growth rate...... 61 Table 17. Multiples for relative valuation...... 62 Table 18. Relative valuation results ...... 63 Table 19. Final mBank value estimation ...... 63
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 7
Introduction
Relevance of the topic. Many companies enter into merger and acquisition activities as it allows them to achieve growth as well as diversify their business profile. Since insurance is non- essential good and many of the products offered by PZU are in mature markets, the Group is looking for new opportunities to expand its business operations. Accordingly, the management team of PZU Group considers mBank to be a new acquisition which could improve the overall financial performance of the Group. A successful acquisition of mBank presents a direct impact on PZU’s operational strategy as additional physical units of 353 various retail outlets and 46 points of corporate service offices in Poland would lead to increased distribution of insurance products by cross-sale through mBank’s network of 5.67 million existing clients. In addition, the innovative mobile banking platform offering a wide range of products is expected to contribute to increased efficiency by slowly integrating into already owned systems operated by Alior Bank which is partially owned by PZU Group - approximately 32% of Alior Bank's shares belongs to
PZU S.A.
Even though Commerzbank officially admitted that it is withdrawing from further attempts to sell mBank, the chance for this transaction to be performed in the foreseeable future remains as Commerzbank's financial position is rather weak and Commerzbank does not manage to achieve the financial goals set in the strategy. The main reason for the withdrawal of
Commerzbank from the sale of mBank was a wave of sell-offs that flooded global equity markets, including Poland. What is more, mBank itself lost 53 percent of the value from January
2020 till May 2020, indicating that Commerzbank's part, which is nearly 70% of mBank’s capital, was only worth PLN 5.5 billion, compared to PLN 11.4 billion at the beginning of
February 2020, before the fear of the coronavirus started to lower the quotes. Moreover, there VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 8 were concerns about a lower than expected real interest in the sale of mBank due to the spread of the coronavirus. Consequently, after the coronavirus crisis will be over, the possibility that PZU
Group will acquire mBank endures.
Problem of the research. What is the intrinsic value of mBank?
The aim of the thesis. To determine the theoretical value of mBank as an acquisition target of
PZU Group.
Thesis objectives.
1. Overview the current situation in the Polish banking sector and provide analysis of the
macroeconomic environment in Poland.
2. Outline the main challenges of valuing the companies within the banking industry.
3. Provide theoretical overview of methods used for valuation of banks and select the best
methods as well as the inputs for the valuation.
4. Value mBank using the chosen methods, historical and current financial information as
well as forecasts and make recommendations for PZU Group based on the results.
Research methods. The thesis is based on the theoretical valuation methods of the company.
The discounted cash flow method using free cash flow to equity (FCFE) and relative valuation approach are applied for the valuation of mBank. The data retrieved from the official website of mBank is used as the basis for the FCFE estimation. Moreover, sensitivity analysis is conducted by using different inputs for the risk-free rate, beta and growth rate.
Practical value of the paper. The conducted research provides a comprehensive analysis of the
Polish banking sector and identifies key trends of the industry. Thus, this research could be valuable for the financial analysts. What is more, the valuation might have a practical value to the management of PZU Group and mBank as well as to potential investors interested in stocks VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 9 of PZU S.A. as they would know the value of mBank in case PZU Group would decide to acquire the before mentioned financial institution.
Situation Analysis
While estimating the value of the firm, it is crucial to understand the company itself as well as to study the industry and the environment in which the business operates in as this information is necessary to apply the most appropriate valuation methods for the selected company. Consequently, general overview of the target company as well as the acquirer, the outline of the Polish banking industry, the analysis of macroenvironment in Poland, and the financial risk assessment of the company are provided in this section of the paper.
Overview of the target company. mBank started its operations in 1986 as a joint-stock company called Bank Rozwoju Eksportu (BRE Bank). In 2000, mBank was established, the first fully online bank in Poland, operating in the segment of individual clients. Moreover, MultiBank was launched in 2001 with the purpose to service customers in the outlets in the biggest cities of
Poland. In 2007, mBank started its foreign expansion of retail operations by opening its branches in the Czech Republic and Slovakia. In November 2013, the brand was unified and the mBank name replaced not only the name of the company, but also the BRE and MultiBank brands.
Nowadays mBank Group is the fourth largest financial institution in Poland by total assets, headquartered in Warsaw. The shares of mBank are quoted on the Warsaw Stock
Exchange (WSE: MBK) since 1992. It is the first fully digital bank in Poland offering comprehensive services within the scope of retail, business, corporate and private banking through the mobile and online banking systems. What is more, mBank has around 5.67 million customers in the retail segment and 28,420 corporate clients, while more than 33% of total customers (~1.9 million people) are using the mobile application of mBank. Interestingly, VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 10 mBank is the market-leading player regarding the share of mobile app users in the client base, proving its strength as an online bank.
Overview of the acquirer. The Powszechny Zakład Ubezpieczeń Group (PZU Group, or PZU) is the first insurance company in Poland, headquartered in Warsaw and listed on the Warsaw
Stock Exchange (WSE: PZU). Currently it is the largest financial services providing group in
Central and Eastern Europe, offering life, non-life and health insurance, asset management, banking and other services. Before its initial public offering on the Warsaw Stock Exchange in
May 2010, PZU was operating as a joint-stock company, with the Poland State Treasury always being as the main shareholder. The company expanded its operations to Lithuania (2002),
Ukraine (2005), Latvia (2014) and Estonia (2014), and currently serves more than 22 million clients in total across all the segments. Through acquisitions of Alior Bank (WSE: ALR) in 2015 and Bank Pekao (WSE: PEO) in 2017, PZU has also commenced operations in the banking industry, helping to ensure higher growth level.
European banking industry analysis. The competition level in European banking sector is relatively high weighing on the banks' profitability prospects. However, a downward trend in the number of banks operating within the EU has been observed since 2009, leading to the consolidation of the banking sector. Consequently, based on the data of structural financial indicators for the banking sector in the EU for the end of 2019 provided by the European Central
Bank (ECB), the number of branches decreased by 6.3% on average in most EU Member States during 2019. The total number of branches operating within the EU area amounted to 163,265 by the end of 2019 (ECB, 2020a). It is worth noting that 25 out of 28 EU Member States observed a diminishing trend in the number of branches with a decline rate ranging from 0.9% to 37%
(ibid.). The data also indicate that the concentration of banks in the EU measured by the share of VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 11 assets held by the five largest banks significantly differs between the Member States ranging from 28% to 97%, depending on a country (ibid.)
The market players of the banking industry in Europe have been strengthening their financial positions by increasing the capital level since the 2008-09 financial crisis as the EU has implemented the Capital Requirements Directive IV after the crisis, aiming to strengthen its banking sector. Subsequently, in 2018, the level of liquidity coverage ratio of all European banks was above the minimum, while the shortfall of all classes of capital remained at the lowest positions in 2018. What is more, in 2018, the leverage and net stable funding ratio (NSFR) shortfalls deteriorated from EUR 2 billion to EUR 1.50 billion and from EUR 51 billion to EUR
49.1 billion, respectively. In addition, in 2018, the value of total assets held by EU banks increased by approximately EUR 500 billion compared to 2017, amounting to EUR 43.35 trillion
(EBF, 2019). The upward trend was observed in the share of deposit liabilities over total assets with an increase of 0.8% in 2018 (from 53.4% to 54.2%), indicating the shift towards deposits as an easily accessible source of funding (ibid.) Looking at the ROE across the EU, the largest EU economies managed to maintain positive ROE measures, while the average ROE has declined to
3.5% in 2018, reaching the lowest level during the 10 year period (ibid.).
The coronavirus crisis had a significant negative impact on the economy, negatively affecting the banking sector at the same time. Even though credit institutions were not at the epicenter of the coronavirus crisis (unlike the financial crisis of 2008-09), bank valuations decreased significantly to the record lows (ECB, 2020b). Importantly, growth in the costs of bank funding was observed despite the enhanced resilience of banks operating in the EU. This indicates a high level of uncertainty concerning the EU economic growth and the profit prospects of European banks. On the other hand, COVID-19 pandemic might positively affect the banking VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 12 industry in Europe by accelerating digitalization in the sector, which improves the efficiency of the firm’s processes and leads to lower costs and higher financial results as well as better measures of profitability ratios. However, due to relatively high transformation costs and lower profit levels, plans for implementation of technological advances may be delayed.
Polish banking sector analysis. The Polish banking industry strongly reflects the general trends observed in the European banking sector. At the end of 2018, the financial sector in Poland constituted of 32 commercial banks, 543 cooperative banks, and 31 branches of credit institutions (EBF, 2019b). The TOP 5 largest banks by the total assets as of December 31, 2019, dominating the Polish banking sector are provided in the table below.
Table 1
Leading banks in Poland by total assets as of December 31, 2019, in million PLN
Bank Total assets as of December 31, 2019 PKO Bank Polski 317.13 Bank Pekao 194.65 Santander Bank Polska 181.47 ING Bank Śląski 153.92 mBank 149.23 Source: prepared by author, data retrieved from Statista
What is more, at the end of 2018, the share of domestic investors in the Polish financial sector accounted for 54.1%. Interestingly, five out of thirteen banks controlled by domestic investors belong to the State. The total value of the assets of the Polish banking sector accounted for EUR 442.92 billion, indicating a growth of 6.7% in comparison to 2017 (EBF, 2019b).
However, at the end of 2018, the overall size of the Polish banking sector, relative to GDP, was rather low compared to the other EU Member States accounting for 89.6% (ibid.). Data of net financial wealth of financial corporations in the euro area for 2017-2019 is provided in Table 2.
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 13
Table 2
Net financial wealth (excluding liabilities in shares & other equity) in the euro area, 2017-2019, percentage of gross domestic product, based on four-quarter-cumulated sums
2017 2018 2019 Q1 247.9 241.8 240.7 Q2 248.1 243.0 240.4 Q3 245.5 242.0 245.7 Q4 246.0 232.0 245.6 Source: prepared by author, data retrieved from Eurostat
Additionally, based on the data of structural financial indicators for the banking sector in the EU for the end of 2019, the number of branches in Poland during 2019 decreased by approximately 3.03%, indicating that the shrinkage of the local units in the financial sector was lower compared to the EU average (ECB, 2020a). The data also specifies that the concentration of the Polish banks measured by the share of assets held by the five largest credit institutions slightly increased throughout the year from 49.5% in 2018 to 49.8% in 2019 (ibid.).
Furthermore, the data of structural financial indicators for the banking sector in the EU provides the Herfindahl–Hirschman Index (HHI) measures which show market concentration and competition among the market players. The index is calculated by adding together the squared market shares of each market participant. Subsequently, the resulting number ranges from 1 to a maximum of 10,000. When the number is close or equal to 10,000, it implies a highly concentrated monopolistic market, whereas the number close to 1 indicates that the market is very competitive and dominated by a large number of equally-sized market players. It should be noted that the HHI is a useful measure as it helps to determine the post-merger market concentration. According to the European Commission, it is very unlikely to identify any horizontal competition concerns in the post-merger market with the HHI below 1,000. As stated by the European Commission, it is also unlikely that competition concerns would be identified in VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 14 the post-merger market if the index is ranging from 1,000 to 2,000 and the change in the index value after the merger is below 250. Based on the data provided in Table 3, the concentration in the Polish banking sector has been rather stable from 2015 to 2019 (ECB, 2020a). The data also implies that there is not much market concentration in the Polish banking industry compared to the other EU Member States as the HHI in Poland accounted for 688 in 2019 (ibid.).
Table 3
Herfindahl–Hirschman Index for credit institutions in the EU (index ranging from 0 to 10,000),
2015-2019
2015 2016 2017 2018 2019 Belgium 998 1,017 1,102 1,218 1,246 Bulgaria 919 939 906 939 992 Czech Republic 994 1,016 1,039 1,070 1,082 Denmark 1,180 1,224 1,123 1,069 1,170 Germany 273 277 250 245 277 Estonia 2,409 2,406 2,419 2,698 2,545 Ireland 672 636 658 632 665 Greece 2,254 2,332 2,307 2,304 2,382 Croatia 1,396 1,405 1,387 1,554 1,564 Spain 896 937 965 1,138 1,110 France 589 572 574 663 654 Italy 435 452 519 579 643 Cyprus 1,443 1,366 1,962 2,379 2,276 Latvia 1,035 1,082 1,237 1,583 1,596 Lithuania 1,939 1,938 2,189 2,278 2,289 Luxembourg 321 260 256 261 277 Hungary 763 787 802 801 920 Malta 1,620 1,602 1,599 1,518 1,548 Netherlands 2,104 2,097 2,087 2,178 2,039 Austria 397 358 374 369 369 Poland 670 659 645 683 688 Portugal 1,215 1,181 1,220 1,203 1,225 Romania 860 903 915 962 978 Slovenia 1,077 1,147 1,133 1,020 1,008 Slovakia 1,250 1,264 1,332 1,383 1,404 Finland 3,160 2,300 1,700 2,570 2,420 Sweden 866 845 914 785 787 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 15
2015 2016 2017 2018 2019 United Kingdom 438 422 453 353 349 Source: prepared by author, data retrieved from the ECB report on Structural Indicators for the
EU Banking Sector, June 2020
Overview of economic situation in Poland. In overview, Poland is considered as a developed economy. However, there is some uncertainty of where exactly the economy stands for now that contributes to some turmoil and instability related to macroeconomic characteristics, to which financial sector is especially reactive.
PESTEL analysis. To examine the macroeconomic environment in Poland, the PESTEL analysis is applied covering political, economic, social and demographic, technological, environmental and legal factors.
Political factors. These factors are related to the intervention of the government in the economy and may have a significant impact on the banking sector.
Inner politics sustain “re-polonisation” of capital. The Law and Justice Party (PiS) of political left currently occupies majority, 235 out of 460 seats, in the lower house (Sejm), and minority in the upper house (Senate). This conservative party supports the quasi-centralization of factors of production, hence, a strong consolidation of State ownership is seen in multiple sectors. Such “re-polonisation” of capital pressures foreign owners to sell their holdings and creates an economic turmoil in which numerous mergers and acquisitions materialize, all overseen by the State. Likewise, privatization has been slowing down in the country in the recent years. Augmented central steering is generally not beneficial for economic expansion and may be a persistent factor contributing to the deceleration of the economy both in the short run and long run. At the same time, better organization at the regulatory level could appeal to foreign VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 16 investors valuing stability, transparency and ample industry supervision, which assists in making efficient decisions and accurate predictions about the future.
Monetary policy. Monetary policy is conducted by the National Bank of Poland (NBP) which currently maintains a target inflation rate of 2.5%. Poland accommodates a free-floating exchange rate regime. Since Polish zloty (PLN) relative average stability against EUR is expected to endure for now, rising rates are not anticipated before 2021 (EIU, 2020). In 2021 the
European Central Bank is expected to begin a tightening cycle, which may induce NBP to raise interest rates in Poland accordingly. Adoption of EUR is not likely in the forecast period as the prevalent currency regime supports Poland’s competitiveness in exports (EIU, 2020).
Economic factors. Banking industry is extremely sensitive to numerous economic indicators, resulting in a number of drivers. Consequently, tendencies in GDP growth, labor market, inflation, consumption, and business and consumer confidence analyzed.
GDP growth capacity is approaching its limits. Economic growth in Poland plummeted due to the outbreak of coronavirus at the end of 2020 Q1. Nonetheless, intense domestic expansion in the second and third quarters of 2020 is highly likely to cushion the slowdown of the economy, however, the impact of coronavirus on the economy is inevitable. According to the study conducted by the NBP, GDP growth on a year-over-year basis is expected to be -5.4% in
2020 mostly due to the decline in investment rate resulting from high level of uncertainty, unfavorable financial situation of companies and decrease in EU funds absorption (NBP, 2020a).
The GDP growth decline could also be fueled by tightening of state control, observed in not only banking and insurance but also in chemical, coal, gas and other sectors. Capital owners are deterred from investing as they face larger uncertainty and higher risk. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 17
While the strong growth of global economies appears to have been amplified in the
Polish economy till the beginning of 2020, there was limited potential for growth. Strong GDP numbers observed in the past two years were unlikely to continue in the long term because of naturally recurrent economic cycles and a slight recently observed decline in industrial production, trade and construction sectors. Moreover, Poland GDP depends largely on the government’s policies as it has the tools and capacity to affect GDP through spending and enacting regulations, but the State’s policy patterns are difficult to predict for the long horizon.
Moreover, the forecast for 2021 and 2022 are more optimistic as the expected GDP growth rate is 4.9% and 3.7%, respectively (NBP, 2020a).
Low interest rates burden investment returns and solvency. Interest rates are expected to remain low for at least several more years (Moody's, 2020). It worth noting that from March 5,
2015, until March 2020, the effective reference rate (minimum money market intervention rate) set by the NBP was 1.50%. Since May 29, 2020, the effective reference rate in Poland is at the historic low of 0.10% (NBP, 2020b). In order to ensure sufficient returns, investors may engage in more risky investments, which is generally not acceptable to conservative financial firms prioritizing stability. As for solvency ratios, interest rates are not the only drivers of change but they play an important role. Solvency takes into account how well the expected future cash inflows and outflows are balanced including adjustments for investment risks. Any fluctuations in interest rates undermine the cash flows of affected investments, therefore, with the decline of interest rates the exposure to solvency risk increases, with long-term investments being more vulnerable.
Labor market is strong. Until 2018 the unemployment rate in Poland has declined, and in
October 2019 (at 5%) even reached its lowest point since 1990. However, there are strong VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 18 anticipation that unemployment will recover in the long term because of the coronavirus. In addition, the COVID-19 pandemic had a negative impact on the situation in the `polish labor market. Based on the information provided by the Statistics Poland, unemployment rate at the end of June 2020, accounted for 6.1% of the economically active people in Poland being 0.7% higher compared to the first quarter of 2020 and 0.8% higher compared to the same period of the previous year (Statistics Poland, 2020b).
Consumption boosts domestic demand. In overview, the volume of consumption in the public sector has been increasing in the first half of 2020 mostly due to higher expenditure for health care, while the level of private consumption has been decreasing during the same period
(NBP, 2020a). The drop in the economic activity in the labor market weakens consumer confidence, thus, private consumption is expected to decrease strongly in 2020 (European
Commission, 2020). It should be noted that private consumption is forecasted to grow gradually, however due to the high level of uncertainty, worse situation in the labor market and changes in the consumers’ preferences, the level of private consumption observed in 2019 Q4 is expected to be reached only in the second half of 2021 (NBP, 2020a). Subsequently, banking sector might be impacted mostly through less credit demanded as a result of lower consumption needs. Hence, banking revenues could decline due to diminished consumption rates, although a slow-down is unlikely in the very short-term perspective.
Fluctuations in inflation. Historical consumer prices seem to have moved more or less in accordance with prices in other EU countries. In the first quarter of 2020, likely because of strong labor market and solid income growth, inflation in Poland has accelerated to 4.5% (NBP,
2020a). However, in 2020 Q2 inflation accounted only for 3.2% due to lower food and energy prices dynamics. As for the longer term, i.e. the period of 2021-2022, inflation in the country is VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 19 expected to be as low as 1.5% in 2021 and will gradually grow to 2.1% during 2022, indicating that inflation is forecasted to be lower than the NBP target inflation rate of 2.5% by the end of
2022. It is worth noting that low level of energy commodities’ prices on the global markets, decrease in demand mostly related to the COVID-19 pandemic, and government’s reduction of electricity tariffs are putting downward pressure on prices (NBP, 2020a).
Fluctuations in confidence. The expectations of consumers and businesses reflect in consumer confidence index (CCI) and business confidence index (BCI), respectively. Consumer confidence in Poland has been above the OECD average since 2016 and increasing tendency is observed until mid-2019 (OECD, 2020a). In 2018 and 2019 confidence index growth has slowed, and the numbers were fluctuating between 101 and 102. Values above 100 signal a positive outlook by the majority of households. As for business confidence, from 2015 to the end of 2017, Poland’s confidence index has been performing close to the OECD average (OECD,
2020b). In the following years, the OECD average has dropped significantly, while Poland displayed a smaller decline. Lower confidence signifies a potential slow-down in economic growth and higher reluctance to tolerate risks. Nonetheless, the outlook in Poland until the end of
2020 Q1 has been more positive than the OECD average, possibly due to the carryover effect from strong GDP and labor market expansion in the previous periods. Furthermore, businesses in
Poland tend generally to prefer raising capital from banks rather than through bonds and commercial papers (EIU, 2020), inferring close relationship between the banking sector and businesses. Even though the extent has been smaller than it was a few years ago, the data of confidence indices at the beginning of 2020 was signaling that consumers’ and businesses’ outlook on the Polish economy was optimistic, however, the situation has changed since the beginning of March when the coronavirus outbreak started. Both consumer confidence and VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 20 business confidence indices dropped significantly in March 2020 and were decreasing till May
2020. Nonetheless, after the first wave of coronavirus, both indices started to increase, however, by the end of September 2020, they still fluctuate around the lowest levels observed during the
10 year period (NBP, 2020a). What is more, the situation is not expected to improve significantly in the foreseeable future due to the high uncertainty level that is prevailing in the world.
Social and demographic factors. Banking sector is somewhat reactive to demographic trends that determine costs, pricing, advertising, value chain, and overall business strategy.
Diminishing number of residents and increasing median age. Since 2015 the growth of population has been negative, suggesting potential shrinkage of the domestic target market, a similar tendency is observed in many EU countries (Worldometer, 2020). Median age, at 41.7
(2020), has been moderately growing since 2015, likely due to the advancements in the healthcare sector and overall aging population. The life expectancy at birth is 79.3 years (83 for women and 75.5 for men) (ibid.).
As in most other EU countries, Polish society is aging. In 2019 there were 28 elderly people per 100 working-age population, and there is a very high probability that the ratio will increase further (Statistics Poland, 2020a). Banking sector might be impacted, as older people usually use less of private banking services.
Moreover, in age groups from 0 to 54 the number of males in the country is only slightly greater than females. Above the age of 55, women are more numerous than men (52.30% and
47.70%, respectively), and beyond the age of 65 females constitute 60.31% of the age group
(Statistics Poland, 2020a).
Diminishing population in Poland indicates a potential decrease in the number of new customers attracted by mBank in the long-term. Gender patterns are significant determinants of VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 21 demand for private banking services as well. For instance, mBank is known for the banking services provided through mobile and online banking systems, however, higher age people tend to be more conservative. Consequently, that could lead to a deterioration of banking operating results.
Technological factors. Technological advances and associated consumer behavior trends are vastly changing financial services industry, especially banking sector, as fintech companies have already started reshaping banking activities.
The future of payments is expected to be closely linked to cashless transactions and other digital payment systems, and the supply side (mostly represented by the government) is encouraging transparency through elimination of large banknotes. However, despite all the efforts, cash remains an important method of payment. In fact, according to Deutsche Bank, cash remains extensively used in many advanced countries, including Western Europe and the US
(Deutsche Bank, 2020). Cryptocurrencies, as an alternative, are still in the early stage of adoption and, for the moment, are not very relevant to the banking sector.
All in all, technological factors are gradually changing the environment of banking sector as banks are implementing new digital features allowing contactless payments and opening bank account remotely. On the other hand, nowadays traditional banking services and cash payments are still present, however, banks have to develop and implement technological solutions that are needed moving towards cashless society.
Environmental factors. Environmental factors are also called ecological factors and refer to climate change, sustainability, and renewable resources issues as well as consequences of these problems. At first, it may seem that banking sector companies may have nothing to do with VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 22 environmental factors, however, nowadays each firm is exposed to climate change and sustainability challenges.
Climate change. The EU is paying close attention to climate change issues to create a more sustainable economy. Even though most of the banks in Europe are engaged in the topic of climate change by outlining sustainability objectives in their business strategies, financial institutions will be obliged to take additional actions regarding climate risk management in the foreseeable future. It is worth noting that by the end of 2021, the ECB is planning to publish a disclosure of climate-related risks and guidelines that would determine supervisory expectations on the management.
The impact of sustainability, ranging from corporate social responsibility (CSR) in companies to the preferences of investors, may affect the perception, attitudes of consumers and investors, as well as influence government strategies and foreign politics.
Legal factors. Legal factors consider the regulatory environment in which businesses operate. For financial service firms, legislation plays an important as it directly affects the level of reserve requirements and the minimum capital requirements as well as has an impact on day- to-day activities.
Local and regional regulatory environment. The Polish Financial Supervision Authority
(PFSA), or in Polish the Komisja Nadzoru Finansowego (KNF) carries most of the responsibilities with regard to ensuring proper regulatory environment of Polish financial market.
The institution is in charge of the supervision of the national financial sector including overseeing of banking activities, capital, insurance and pension market, financial conglomerates
(such as PZU). VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 23
What is more, the EU aims to strengthen its banking sector so it could better absorb economic fluctuations and shocks while ensuring that banks continue financing economic activities. As a result, the Capital Requirements Regulation and Directive IV (CRR/CRD IV) comprising of Capital Requirement Regulation No 575/2013 and Directive 2013/36/EU was implemented after the 2008-09 financial crisis (EUR-Lex, 2018). CRR/CRD IV was introduced concerning the standards and ambitions of the Basel III framework. Consequently, these rules help to increase the quality and amount of capital required by the regulatory authorities.
Moreover, CRR/CRD IV harmonizes the application of prudential regulations within all EU
Member States, ensuring financial stability and integration in the EU. Lastly, the requirements set in place give flexibility for macroprudential authorities to implement measures that would help to mitigate systematic risk.
Money laundering and terrorism financing. Money laundering and terrorism financing impose additional risks to the banks that they have to reduce to the minimal level to avoid legal issues and fines set by the supervising authorities. What is more, the European Commission is considering strengthening the EU legal framework on anti-money laundering and counter- terrorist financing by harmonizing the rules and transforming the Directive into EU regulation
(ECB, 2020c). mBank business segmentation analysis. mBank offers its services in three main business segments including corporate and investment banking, financial markets services as well as retail banking, which accounts for the largest share of the business. Total income generated by mBank
Group increased by approximately 8.8% to PLN 5,524.4 million in 2019, compared with PLN
5,079.5 million in 2018. It should be noted that the growth was mainly driven by improved net interest income, net trading income, and other income. In 2019, similarly to the previous VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 24 financial year, net interest income generated by mBank Group remained the largest source of income accounting for 72.5%. What is more, a growth of 14.5% was observed in net interest income reaching PLN 4,002.8 million, compared with PLN 3,496.5 million in 2018.
Moreover, in 2019, net interest income accounted for PLN 5,071.7 million growing by
PLN 553.5 million or 12.5% and compared to 2018. With a share of 78%, loans and advances were the main source of the Group’s interest income (Figure 1). In 2019, interest income from loans and advances increased by 16.7% accounting for PLN 3,953.9 million. The growth resulted mainly from the increasing volume of loans and the change in the structure of the loans portfolio, i.e. growing volume of the loans with higher margin and simultaneously decreasing the share of mortgage loans in foreign currencies, which have lower margin. In 2019, interest income from investment securities increased by PLN 12.9 million, i.e. 1.9% and so did the value of the portfolio. Interest income from debt securities held for trading decreased by PLN 23.8 million or
32.9% due to the lower average value of the portfolio in 2019 compared with the previous year.
Figure 1
Share of net interest income of mBank Group by source PLN 4 518 M PLN 5 072 M 75,0% Loans and advances including the unwind of the impairment provision discount
78,0%
Investment securities 15,3%
13,9% Cash and short-term placements 1,2%
Trading debt securities 1,6% 1,1% 1,0%
Interest income on derivatives classified into banking book 4,0% 3,6%
Interest income on derivatives concluded under the fair value hedge 1,9% 1,5% Interest income on derivatives concluded under the cash flow hedge Other 0,9% 1,0% 0,1% 0,0% 2018 2019 Source: prepared by author, data retrieved from Management Board Report on Performance of mBank S.A. Group in 2019 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 25
The assets of mBank Group increased by PLN 12,940.0 million, i.e. 8.9% in 2019. Total assets stood at PLN 158,720.6 million as at December 31, 2019. The changes in the assets of mBank Group observed during 2019 are provided in Table 4.
Table 4
Changes in the assets of mBank Group, in million PLN
31.12.2018 31.12.2109 Change Change, % Cash and balances with Central 9,199.3 7,897.0 -1,302.3 -14.2% Bank Loans and advances to banks 2,546.3 4,341.8 1,795.4 70.5% Financial assets held for trading 2,091.6 2,693.3 601.8 28.8% and derivatives held for hedges Net loans and advances to 94,765.8 105,347.5 10,581.7 11.2% customers Investment securities 3,469.7 34,305.2 835.5 2.5% Intangible assets 776.2 955.4 179.3 23.1% Tangible assets 785.0 1,262.4 477.4 60.8% Other assets 2,146.7 1,918.0 -228.7 -10.7% Source: prepared by author, data retrieved from Management Board Report on Performance of mBank S.A. Group in 2019
Loans and advances to customers remained the largest asset category of mBank Group at the end of 2019. What is more, at the end of 2019, loans and advances to customers accounted for 66.4% of the total balance sheet compared with 65% observed in the previous year. The net volume of loans and advances to customers increased by PLN 10,581.7 million or 11.2% in comparison to the balance sheet as at December 31, 2018.
Moreover, gross loans and advances to retail customers grew by PLN 7,435.3 million or
14.0% on a year-on-year basis. In 2019, loans and advances to individuals increased by 13.4%, excluding the foreign exchange (FX) effect. Moreover, gross loans and advances to retail customers grew by PLN 7,435.3 million or 14.0% on a year-on-year basis. What is more, the volume of mortgage loans increased by 77.0% from PLN 4,618.3 million in 2018 to PLN 8,176.4 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 26 million as at the end of 2019. Additionally, in 2019, mBank Group observed an upward trend of
PLN 10,260.0 million or 14.9% in the sale of non-mortgage loans in comparison with 2018.
In 2019, the volume of gross loans and advances to corporate clients increased by PLN
3,552.6 million or 8% compared to the balance sheet as of December 31, 2018. It is worth noting that in 2019 net of the FX effect, the value of loans and advances to corporate clients increased by 11.2% in comparison to the figures for the previous year. Additionally, the volume of gross loans and advances to the public sector decreased by PLN 258.4 million or 39.8% in 2019.
Changes in the loans and advances of mBank Group are provided in Table 5.
Table 5
Changes in the loans and advances of mBank Group, in million PLN
31.12.2018 31.12.2109 Change Change, % Loans and advances to individuals 52,925.4 60,360.7 7,435.3 14.0% Loans and advances to corporate 44,233.1 47,785.7 3,552.6 8.0% entities Loans and advances to public 649.8 391.4 -258.4 -39.8% sector Total (gross) loans and advances 97,808.3 108,537.8 10,729.5 11.0% to customers Provisions for loans and advances -3,042.5 -3,190.3 -147.7 4.9% to customers Total (net) loans and advances to 94,765.8 105,347.5 10,581.7 11.2% customers Source: prepared by author, data retrieved from Management Board Report on Performance of mBank S.A. Group in 2019
Despite heavy regulatory restrictions imposed on the banks, in 2019, mBank demonstrated good financial results. Total income accounted for more than PLN 5.5 billion, hitting the historical high, while net profit reached the level of PLN 1,010.4 million. mBank observed upward trends in the balance sheet and profitability measures as deposits increased by approximately 14%, while net loans grew by 11%. These financial figures indicate that mBank VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 27 still has growth potential in terms of total income, net profit as well as the number of retail and corporate clients, making it a favorable investment opportunity.
Financial risk assessment of mBank. When determining the value of the company, it is useful to study the overall financial performance of the company. Therefore, ratio analysis is used for the analysis of the company’s financial situation as it is a critical tool helping to identify trends over time, measure the overall financial position of the firm and compare them with the ratios of the peer companies. Financial ratios are traditionally grouped into profitability ratios, asset management ratios, long-term solvency, or debt, ratios, and short-term solvency, or liquidity, ratios. It is worth noting that the main ratios from the groups mentioned before are analyzed in this section. What is more, for peers comparison a combination of 3 banks was selected based on value of their assets including PKO Bank Polski, Bank Pekao S.A., as well as Santander Bank
Polska S.A.
Profitability. Profitability ratios, including net interest margin, cost-to-income ratio, return on assets (ROA), and return on equity (ROE), have been used for the following analysis.
Since most of the banking activities are funded through deposits, a significant share of banks’ costs come from the interest paid to the customers. Consequently, the net interest margin is a critical measure in valuing banks, which determines the difference between interest income collected from interest on loans and interest expenses as a share of total assets. Moreover, the cost-to-income ratio is particularly important in analyzing credit institutions as it measures the costs of the company to its turnover. What is more, ROA and ROE measures are usually used as a benchmark to determine profitability level of the company.
The net interest margin of mBank has been constantly growing during 2017-2019, implying that the net interest income increased more than the total assets. PKO Bank Polski has VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 28 also ensured the stable growth of net interest margin during the analyzed period, while the net interest margins of Bank Pekao and Santander Bank Polska have been fluctuating, indicating unstable growth of returns from loans. The cost/income ratio of most of the industry peers, including mBank, decreased between 2017 and 2019, indicating that the operating expenses of the firms are managed more effectively and increases and a slower pace than the operating income. However, the cost/income ratio of Santander Bank Polska S.A. has been constantly increasing during 2017-2019, implying that the management of the company’s operating expenses should be revised and improved. What is more, the ROA and ROE measures of mBank have been growing from 2017 to 2018. However, they decreased in 2019, mostly due to the significant increase in assets and a decrease in net income. Additionally, the peers of mBank have higher both ROA and ROA ratios indicating that the management team of mBank should more efficiently utilize the resources they have to increase the profitability level of the company.
Profitability ratios of the largest banks by total assets in Poland for the period of 2017-2019 are provided in the table below.
Table 6
Profitability ratios of the largest banks by total assets in Poland, 2017-2019
Net interest margin Cost/income ratio 2017 2018 2019 2017 2018 2019 mBank S.A. 2.21% 2.24% 2.38% 53.07% 51.73% 50.51% PKO Bank Polski S.A. 2.84% 2.84% 2.93% 48.62% 49.09% 48.74% Bank Pekao S.A. 2.46% 2.64% 2.26% 58.15% 57.25% 57.47% Santander Bank Polska S.A. 2.85% 2.21% 2.65% 48.61% 53.22% 54.49%
ROA ROE 2017 2018 2019 2017 2018 2019 mBank S.A. 0.86% 0.99% 0.68% 7.63% 8.62% 6.09% PKO Bank Polski S.A. 1.01% 1.15% 1.24% 7.71% 8.69% 9.49% Bank Pekao S.A. 1.18% 1.26% 1.19% 9.38% 10.59% 9.98%
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 29
ROA ROE 2017 2018 2019 2017 2018 2019 Santander Bank Polska S.A. 1.45% 1.37% 1.16% 9.20% 9.14% 8.74% Source: prepared by author, data retrieved from financial statements of the respective banks
Efficiency. The efficiency ratio is the main activity ratio used to analyze the performance of commercial banks and measure how well the bank controls its overhead expenses as for banks this ratio is calculated by dividing non-interest expenses by the generated revenue. The lower efficiency ratio means that the operations of the company are more efficient in comparison to its peers. The efficiency ratio of mBank has decreased from 47.33% in 2017 to 45.42% in 2019.
That indicates that mBank manages its operations properly and successfully pursues to increase efficiency, which is one of the key objectives set in the strategy of mBank. What is more, the efficiency ratio of PKO Bank Polski S.A. has been constantly increasing from 2017 to 2019, while Bank Pekao S.A. managed to maintain a rather stable level of the efficiency ratio throughout 2017-2019. Santander Bank Polska S.A. manages the operations most efficiently compared to its peers as it ensured the lowest efficiency ratio during 2017-2019. Activity ratios of the largest banks by total assets in Poland for 2017-2019 are provided in Table 7.
Table 7
Activity ratios of the largest banks by total assets in Poland, 2017-2019
Efficiency ratio 2017 2018 2019 mBank S.A. 47.33% 48.15% 45.42% PKO Bank Polski S.A. 52.31% 53.09% 53.78% Bank Pekao S.A. 56.45% 55.63% 56.00% Santander Bank Polska S.A. 43.49% 44.38% 44.16% Source: prepared by author, data retrieved from financial statements of the respective banks
Capital structure. Leverage ratios are usually used to address the company’s ability to meet its long-term financial obligations. There are two main ratios, i.e., Tier 1 capital ratio and VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 30 total capital ratio, concerning banks’ ability to meet their long-term obligations. The total capital ratio measures the available capital of the bank as a share of the bank’s total risk-weighted assets. The total capital ratio is utilized to protect depositors and ensures stability in the financial system. It should be noted that all largest banks by total assets in Poland managed to maintain higher than required leverage ratios. Even though both the common equity Tier 1 capital ratio and the total capital ratio of mBank have been decreasing throughout 2017-2019, the bank managed to maintain the highest leverage ratios compared to its peers. That implies that mBank has a strong financial position and gives a sense of security to customers in case of default.
Unlike the analyzed leverage ratios of mBank, the common equity Tier 1 capital ratio, and the total capital ratio of the peers of mBank have been growing between 2017 and 2019. Leverage ratios of the largest banks by total assets in Poland for 2017-2019 are provided in the table below.
Table 8
Leverage ratios of the largest banks by total assets in Poland, 2017-2019
Common Equity Tier 1 capital Total capital ratio ratio 2017 2018 2019 2017 2018 2019 mBank S.A. 21.51% 20.46% 19.42% 24.62% 24.20% 22.84% PKO Bank Polski S.A. 18.62% 19.80% 19.21% 19.59% 21.33% 20.66% Bank Pekao S.A. 16.10% 15.80% 15.00% 17.10% 17.40% 17.10% Santander Bank Polska S.A. 17.37% 15.85% 17.38% 18.95% 18.04% 19.58% Source: prepared by author, data retrieved from financial statements of the respective banks
Cash flow management. Liquidity ratios determine the company’s ability to meet its short-term obligations and pay bills over the short run without unnecessary stress. The most widely ratio used to assess liquidity of the banks is loan-to-deposit ratio. This ratio compares total loans of the bank to its total deposits. A non-performing loan (NPL) ratio is determined VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 31 dividing loans upon which the debtors do not make payments for a specified period of time by the total loan portfolio. The high NPL ratio could indicate inappropriate risk management procedures or economic downturn in the respective country.
Firstly, it should be noted that the four largest banks by total assets in Poland managed to maintain the optimal level of loan-to-deposit ratio from 80% to 90% during 2017-2019.
The loan-to-deposit ratio of mBank has been constantly growing throughout 2017-2019, indicating that the bank uses its resources more efficiently since the deposits received are better utilized. What is more, the NPL ratio has been decreasing from 2017 to 2019, implying that the creditworthiness of the customers of mBank has been increasing. Furthermore, the loan-to- deposit ratios of the peers of mBank have been constantly decreasing throughout the analyzed period, indicating that the banks use their resources less efficiently as they have issued fewer loans in comparison to the deposits collected. The NPL ratios of PKO Bank Polski S.A. and
Santander Bank Polska S.A. have been shrinking during the period of 2017-2019, whereas the
NPL of Bank Pekao S.A. has been growing, implying that the loans were issued to customers having a lower level of creditworthiness. Liquidity ratios of the largest banks by total assets in
Poland for 2017-2019 are provided in Table 9.
Table 9
Liquidity ratios of the largest banks by total assets in Poland, 2017-2019
Loan-to-deposit ratio NPL ratio 2017 2018 2019 2017 2018 2019 mBank S.A. 80.03% 82.92% 83.05% 3.49% 3.51% 3.32% PKO Bank Polski S.A. 87.93% 82.70% 81.42% 2.88% 2.34% 1.96% Bank Pekao S.A. 89.56% 83.17% 84.47% 4.13% 5.05% 4.83% Santander Bank Polska S.A. 90.60% 85.10% 84.42% 3.38% 2.32% 2.74% Source: prepared by author, data retrieved from financial statements of the respective banks VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 32
All in all, the financial position of mBank is rather strong concerning its peers as it has high leverage and activity ratios. The profitability measures are a bit lower compared to its peers, however, the growing net interest margin ratio and decreasing cost/income ratio indicate that the bank has the potential to increase its net income in the foreseeable future. Moreover, favorable loan-to-deposit ratio and NPL ratio imply that mBank is able to increase the value of loans issued to the customers of higher creditworthiness. As a result, the interest income of mBank is expected to grow, while the impairment allowances for non-performing loans are estimated to drop down positively affecting the net income and shareholders’ returns.
Shareholders’ return of mBank. As it has been mentioned before, the shares of mBank are quoted on the Warsaw Stock Exchange (WSE: MBK) since 1992. The share price on October 14,
2020, was 156.10 PLN per share. mBank historical stock price performance from January 4,
2010, until June 30, 2020, is provided in Figure 2. Based on the information retrieved on October
14, 2020, it can be seen that the peak of mBank stock price was reached on November 25, 2013, when the share price was equal to 568 PLN, while the lowest stock price of 182.3 PLN was observed on May 12, 2020. During the analyzed period from January 4, 2010, until June 30,
2020, mBank stock price decreased by 14.03%.
Figure 2 mBank historical stock price performance
PLN 600 PLN 500 PLN 400 PLN 300 PLN 200 PLN 100
PLN 0
4-Jul-16 4-Jul-10 4-Jul-11 4-Jul-12 4-Jul-13 4-Jul-14 4-Jul-15 4-Jul-17 4-Jul-18 4-Jul-19
4-Jan-15 4-Jan-17 4-Jan-10 4-Jan-11 4-Jan-12 4-Jan-13 4-Jan-14 4-Jan-16 4-Jan-18 4-Jan-19 4-Jan-20
4-Oct-11 4-Oct-13 4-Oct-10 4-Oct-12 4-Oct-14 4-Oct-15 4-Oct-16 4-Oct-17 4-Oct-18 4-Oct-19
4-Apr-15 4-Apr-17 4-Apr-10 4-Apr-11 4-Apr-12 4-Apr-13 4-Apr-14 4-Apr-16 4-Apr-18 4-Apr-19 4-Apr-20 Source: prepared by author, data retrieved from The Warsaw Stock Exchange VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 33
It is worth noting that the downward trend in mBank stock price was also observed from
July 2020 until mid-October 2020, mostly related to the cancelation of the sale of
Commerzbank's 69.3% stake in mBank and the overall uncertainty caused the second wave of coronavirus outbreak. What is more, after the official announcement of Commerzbank to sell its stake in mBank, the latter stock price increased significantly and has been growing for a few months till the CVID-19 pandemic started.
Additionally, the ability to pay out dividends is determined in the strategy of mBank
Group set for 2020-2023. However, the recommendations provided by the PFSA concerning dividend payments by banks identify that before distributing the profit banks have to meet certain criteria such as financial leverage level higher than 5%, Tier 1 capital ratio, and total capital ratio not lower than the minimum values of 6% and 8% respectively, increased by 1.5%.
What is more, the final decision regarding the distribution of profit is made by the shareholders of mBank at the General Meeting. During the last 10 years from 2010 to 2019 the profits of mBank were distributed only three times in 2012, 2013, and 2017. Consequently, discounted dividend model should not be considered as the most appropriate method for the valuation of mBank as the Company does not pay out dividends regularly.
Summary of situation analysis. All in all, in 2019, private consumption and investments were the key drivers of the Polish economy at the same time stimulating lending and contributing to the growth of the banking industry. On the other hand, during recent years, Polish banks have been operating in the low interest rate environment as the reference rate set by the NBP has not changed since 2015 till March 2020. What is more, the effective reference rate was lowered in
March 2020 and it is expected to remain at the historic low of 0.10% in the foreseeable future. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 34
Heavy regulatory requirements imposed by the legal authorities on the banking sector firms make it difficult to achieve higher growth levels and better profitability ratios. The consequences of the coronavirus pandemic undoubtedly affect most of the economies around the global having significant impact on companies’ financial results. However, looking from a long-term perspective, the Polish banking sector has a lot of growth potential since at the end of 2018, its overall size, relative to GDP, was rather low, accounting for 89.6%, while the overall size of banking industry, relative to GDP accounted for 232% in the euro area (EBF, 2019b; Eurostat
2020a). Solid financial results of mBank indicate its ability to grow even when economic indicators are in a downward trend. Consequently, mBank should be considered an appropriate investment opportunity by PZU Group as the successful acquisition of mBank could improve the overall financial performance of PZU Group.
Theoretical Justification and Research Methodology
This section of the paper provides the framework for the valuation of mBank as the acquisition target by PZU Group. More precisely, the concepts of value of a company and valuation are presented in the section below. The analysis of the four most commonly used valuation models, including discounted cash flow models, relative valuation, contingent claim models, and asset-based valuation, as well as their advantages and disadvantages, are also provided in this part of the paper. Since banks are operating in the financial service industry, the main challenges, which analysts face when valuing financial companies are stressed out in this section. Moreover, based on the strengths and limitations of the analyzed valuation approaches, the choice of the most suitable valuation method for mBank is made. Lastly, the key inputs of the chosen valuation model are identified, and the application of the respective method is presented in detail. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 35
Value definition, valuation approach and purpose of valuation. According to Dayag et al.,
“banks promote economic wealth, and signify strength of a country’s financial system, apart from its responsibility of keeping public trust and confidence” (2019, p. 44). Consequently, a great variety of different stakeholders are interested in the value of financial service firms including shareholders, potential investors, supervisors, government institutions and society in general as the valuations may provide some practical implications about the “safety and profitability of funds invested as well as stable and safe growth of the economy” (Strumickas M. et al., 2006, p. 22).
Moreover, the value of a bank or other firm might vary, depending on the intentions of the stakeholder to buy or to sell the asset. While the selling part wants to receive the highest possible price for the assets, the potential investors try to avoid overpaying for the assets that could be overvalued. Assets could be overvalued due to several reasons, including deterioration in the firms’ financial strength, which has not been observed by the market yet, or emotional trading, which artificially increases the price of assets. In case of mergers and acquisitions, one of the basic rationales for it is synergies that have to be assessed additionally. Synergies created through the merger usually leads to cost reduction or higher revenues. Costs could be reduced through realized economies of scale in procurement, administration, marketing, as well as research and development (CFA Institute, 2013). On the other hand, revenue could be enhanced mostly through the cross-selling of services and products and the increase in the market share
(ibid.). All in all, the chosen valuation method typically depends on the type of stakeholder, and the motives behind.
As stated by Deev, the value of a firm is “a relatively informal term” that, in most cases, is used as a determinant of the financial health of a company in the long-term horizon (2011, p. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 36
33). Therefore, it is necessary to define the value term in the context of the valuation of the firm.
The concept of economic value is closely associated with the shareholder value creation as it relates to the ability of an asset or a claim to generate cash flows to the holder in the foreseeable future (Helfert, 2000). According to this concept, the valuation of a financial service firm is the determination of its market value, considering elements of aggregate risk, time and cash flow prospects. What is more, Deev argues that the basic principles of valuation typically used for non-financial firms are applied as much to banks, however, there are “few aspects relating to banks that could affect how they are valued” (2011, p. 33). These aspects are analyzed in detail in the section of Challenges in bank valuation below.
Challenges in bank valuation. Most of the literature on the valuation of financial institutions, including banks, insurance companies, and other financial service firms, addresses particular challenges, which are faced by the analysts who attempt to value these firms. That provides an implication that the value of the financial service firm is one of the most difficult and complex subjects to determine. As stated by Bolibok, due to the “idiosyncratic character and complexity of banks’ activities”, which differ from the activities performed by non-financial entities in various aspects, banks are placed “amongst the most difficult businesses to value, especially from outside” and might lead to differences in the estimation of the intrinsic value (2017, p. 24).
Furthermore, two main challenges regarding the valuation of banks identified by Damodaran
(2009) are the determination of both debt and reinvestments as well as the heavily regulated environment in which financial service firms operate. Koller et al. share similar opinion as
Damodaran stating that “banks are highly levered, making bank valuations even more contingent on changing economic circumstances than valuations in other sectors” (2015, p. 757). In addition, Koller et al. (2015) argue that banks are engaged in a wide range of activities, covering VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 37 retail and wholesale banking, investment banking, and asset management. Consequently, being a multi-business company requires a separate analysis and valuation of the main segments of the business (ibid.).
First of all, measuring the level of debt is usually the core issue while valuing the company, which also makes it difficult to estimate the value of the firm or define the cost of debt. However, in case of financial service firm valuation, particular challenges are faced. The initial inputs for the forecast of the free cash flows and valuation of the financial service firms are presented in their financial statements and annual reports. Nevertheless, the overview of a bank performance is “dependent on discretionary management decisions (e.g. recognition of asset impairment)”, making the valuation process even more difficult for external analysts
(Bolibok, 2017, p. 24). According to the research performed by Deev, banks usually have a significant amount of debt since their “liabilities consist of customer deposits and borrowings on funds market, which apparently perform the same function, but with a different margin” (2011, p. 34). It is worth noting that the debt for financial service firms seems to have a different connotation as they “seem to view it as a raw material”, unlike the non-financial firms, which treat debt as a source of capital (Damodaran, 2009, p. 5). As a result, the term capital of financial institutions is limited to equity capital and reinforced by regulatory authorities who evaluate equity capital ratios of the banks (ibid.) As mentioned before, the term debt is also hard to determine in the context of the banking sector firms due to the deposits made by the clients, especially if the deposits are interest-bearing (Damodaran, 2009). In case deposits of the customers are categorized as debt, the operating income for a bank should be calculated before the interest payments to depositors are made (ibid.). However, this could lead to distorted figures as interest expenses usually account for the largest share of costs for a bank. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 38
The second main issue of the valuation of banks is that they are operating in a strictly regulated environment, which might have a material impact on their profitability level. The regulatory authorities determine specific criteria for banks regarding the level of capital they should have to maintain required capital ratios and where they are allowed to invest their funds to ensure that their claim holders or depositors are not put at risk. From valuation perspective, assumptions regarding growth rate are closely related to assumptions about reinvestments
(Damodaran, 2009). In the context of financial service companies, the assumptions made should consider the regulatory environment and the changes that are expected to be done in the future to ensure that regulatory constraints would not be violated (ibid.). Consequently, while determining the value of banks, it is necessary to be aware of regulations that are set in place as they put limitations on the growth rate and might lead to uncertainty when forecasting net capital expenditures and working capital.
Overview of valuation methods. In literature, there is a great number of valuation methods used to estimate the value of the company depending on various specifications including business profile, environment in which the company operates and other circumstances. According to
Damodaran (2012), generally, there are four different approaches to valuation:
• Discounted cashflow valuation;
• Asset-based valuation;
• Relative valuation;
• Contingent claim valuation.
Since, in some cases, more than one method might be used to estimate the value of the analyzed company, all the features of the valuation models should be assessed properly to choose the most VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 39 suitable valuation method or a combination of a few methods. The detailed overview of each valuation approach, as well as their strengths and limitations, are discussed below.
Discounted cashflow valuation approach. The discounted cash flow (DCF) approach determines the intrinsic value of the asset as the present value of its expected future economic benefits. It should be noted that present value is determined by discounting expected future cash flows “at a rate that reflects the riskiness of these cash flows” (Damodaran, 2010, p. 22).
According to Deev (2011), DCF approach is the most popular valuation method in academic literature and has the best academic support around academia. The generalized formula of the
DCF valuation approach is the following:
푡=푛 퐶퐹 푉푎푙푢푒 = ∑ 푡 (1 + 푟)푡 푡=1
푤ℎ푒푟푒 푛 = 푙𝑖푓푒 표푓 푡ℎ푒 푎푠푠푒푡
퐶퐹푡 = 푐푎푠ℎ 푓푙표푤 𝑖푛 푝푒푟𝑖표푑 푡
푟 = 푑𝑖푠푐표푢푛푡 푟푎푡푒 푟푒푓푙푒푐푡𝑖푛푔 푡ℎ푒 푟𝑖푠푘푛푒푠푠 표푓 푡ℎ푒 푒푠푡𝑖푚푎푡푒푑 퐶퐹
Furthermore, the discounted dividend model (DDM) is an extension of the DCF valuation approach, which is strongly recommended for publicly traded companies, including banks, because most of credit institutions are listed on the stock exchange. Based on the DDM, the value of equity is equal to the present value of the expected payments of dividends in the future.
The general formula of the DDM is the following:
푡=∞
퐷푃푆푡 푉푎푙푢푒 표푓 푒푞푢𝑖푡푦 = ∑ 푡 (1 + 푘푒) 푡=1
푤ℎ푒푟푒 퐷푃푆 = 푒푥푝푒푐푡푒푑 푑𝑖푣𝑖푑푒푛푑 푝푒푟 푠ℎ푎푟푒 𝑖푛 푝푒푟𝑖표푑 푡
푘푒 = 푐표푠푡 표푓 푒푞푢𝑖푡푦 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 40
What is more, the DCF method can be approached in two ways, i.e., the first way is to determine the value of the entire business, including all the assets the company has (firm valuation), and the second way is to value only the equity side of the firm (equity valuation).
Using the firm (free cash flow to the firm – FCFF) valuation method, the value of the company is determined by discounting the expected cash flow to the company at the weighted average cost of capital (WACC), which is the cost of different sources of financing used by the entity. It should be noted that FCFF shows the remaining amount of cash flows after deducting all operating expenses, tax obligations, as well as capital expenditure needs (Damodaran, 2012).
The general form of the FCFF model is presented by the formula:
푡=푛 퐶퐹 푡표 푓𝑖푟푚 푉푎푙푢푒 표푓 푓𝑖푟푚 = ∑ 푡 (1 + 푊퐴퐶퐶)푡 푡=1
푤ℎ푒푟푒 푛 = 푙𝑖푓푒 표푓 푡ℎ푒 푎푠푠푒푡
퐶퐹 푡표 푓𝑖푟푚푡 = 푒푥푝푒푐푡푒푑 푐푎푠ℎ 푓푙표푤 푡표 푓𝑖푟푚 𝑖푛 푝푒푟𝑖표푑 푡
푊퐴퐶퐶 = 푤푒𝑖푔ℎ푡푒푑 푎푣푒푟푎푔푒 푐표푠푡 표푓 푐푎푝𝑖푡푎푙
Under the equity (free cash flow to the equity - FCFE) valuation method, the value of the equity is obtained by discounting the expected cash flow to the equity at the cost of equity, i.e. the required rate of return by the shareholders. What is more, FCFE refers to the cash flows available after deducting all operating expenses, taxes, capital expenditure needs, as well as interest payments (Damodaran, 2012). The formula of the FCFE valuation method is the following:
푡=푛
퐶퐹 푡표 푒푞푢𝑖푡푦푡 푉푎푙푢푒 표푓 푒푞푢𝑖푡푦 = ∑ 푡 (1 + 푘푒) 푡=1
푤ℎ푒푟푒 푛 = 푙𝑖푓푒 표푓 푡ℎ푒 푎푠푠푒푡 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 41
퐶퐹 푡표 푒푞푢𝑖푡푦푡 = 푒푥푝푒푐푡푒푑 푐푎푠ℎ 푓푙표푤 푡표 푒푞푢𝑖푡푦 𝑖푛 푝푒푟𝑖표푑 푡
푘푒 = 푐표푠푡 표푓 푒푞푢𝑖푡푦
There are two main differences between the FCFF method and the FCFE method. Firstly, the FCFF method uses the WACC as a discount rate, whereas the cost of equity is utilized in the
FCFE method. Secondly, the debt is treated differently as under the FCFF method debt is subtracted at the very end to obtain the intrinsic value whereas interest payments and net additions to debt are integrated under the FCFE method to derive at the FCFE. Therefore, the
FCFE method is considered to be more appropriate valuation method for the valuation of financial services firms. What is more, according to Deev, the common equity valuation approach, i.e. free cash flow to the equity (FCFE) method, “is highly valid for bank valuation, also because it reflects the fact that banks can create value from the liability side of the balance sheet” (2011, p. 37).
Furthermore, the main strengths of the DCF approach are that this valuation method is extremely detailed because it based on the key assumptions about the business and includes all the estimated future economic benefits of the business. What is more, the DCF valuation model is widely used in the context of mergers and acquisitions because it shows “the actual cash that would be available to the company’s investors after making all investments needed to maintain the company as an ongoing enterprise” (CFA Institute, 2013, p. 245).
However, the advantages of DCF valuation approach may be its limitations as well.
Firstly, since DCF model is based on a large number of assumptions, it may lead to the controversial and subjective results. Secondly, the DCF approach requires to estimate an appropriate discount rate, which might also be a subject to controversy. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 42
Asset-based valuation approach. Asset-based valuation methods focus on existing assets while valuing the business. After determining the values of each asset separately, they are added together to derive the value of the firm.
Book value based valuation and liquidation value are the most commonly used asset- based valuation approaches. Under book value model it is assumed that the value of the company is equal to the book value of the assets and equity on a balance sheet representing “a more reliable estimate of value than valuation models based on shaky assumptions about the future”
(Damodaran, 2005, p. 54). Liquation value method determines the value of the firm’s assets based on assumption that they have to be sold as soon as possible. Theoretically, selling the asset without delay may lead to a discount on the value, which depends on various aspects, including the number of potential buyers, current macroeconomic environment, state of the market, and characteristics of the asset itself (Damodaran, 2005).
Using an asset-based valuation approach for the valuation of the bank would require to estimate the value of the loan portfolio of the bank as it comprises the bank’s assets and to subtract the outstanding amount of debt to determine the equity value (Damodaran, 2005).
Moreover, the main advantage of asset-based valuation is the simplicity of the method since it does not require guesswork and an extensive list of various assumptions. On the other hand, according to Deev (2011), the asset-based valuation approach is rather difficult to use in practice when the bank is engaged in a wide range of activities, covering retail and wholesale banking, investment banking, and asset management or operates in several countries.
Furthermore, the simplicity of the approach could also be considered its weakness since asset- based valuation does not consider growth opportunities leading to far too conservative estimates of the value for healthy firms. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 43
Relative valuation approach. Relative (market multiples based) valuation model aims to determine the value of the asset based “on how similar assets are currently priced by the market”
(Damodaran, 2010, p. 90). As a result, relative valuation is widely used while determining the value of banks as it is rather simple to apply this method in practice. A wide variety of multiples including earnings, book value and revenue multiples could be used for the companies operating in any, however, there are some industry-specific multiples.
Even though enterprise value multiples might be applied for bank valuation, earnings multiples are more reasonable to use due to the aforementioned difficulties encountered while determining the debt for financial service companies. According to Deev (2011), the most commonly used and sufficient market multiples for the valuation banking sector companies are the price-earnings ratio (P/E) and the price-to-book value ratio (P/BV).
Furthermore, the strengths of relative valuation are evident. The use of this method is widespread mainly because of its simplicity, because it does not require an extensive list of assumptions to be made, unlike the DCF method, meaning that this valuation approach is an appropriate alternative for analysts who face time constraints and have limited access to information. However, the advantages of multiple valuation are also its drawbacks. Firstly, using relative valuation approach while pricing a firm may lead to “inconsistent estimates of value, where key variables such as risk, growth, or cash flow potential are ignored” (Damodaran, 2010, p. 91). Secondly, considering the fact that multiple valuation reflects the current situation in the market, the determined value may be too high if the comparable firms are overvalued in the market, or it might be too low in case the market is undervaluing these companies (Damodaran,
2010). Thirdly, since the multiples that would be applied for the valuation as well as the list of VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 44 comparable companies mostly depends on the analyst, the valuation may be biased and result in unjustified value (ibid.).
Contingent claim valuation approach. Contingent claim valuation model uses option pricing techniques, such as binominal option pricing model, Black-Scholes model, etc., to determine the value of assets that have similar characteristics. It is worth noting that initially these option pricing models have been used to estimate the value of traded options, however, according to Damodaran, “there has been an attempt in recent years to extend the reach of these models into more traditional valuation” (2012, p. 29). This is mainly due to the fact that DCF approach might underestimate the value of the assets which provide financial benefits that are contingent depending on whether a particular event occurs or does not occur (Damodaran, 2012).
Contingent claim valuation model might seem like an appropriate way to determine the value of banking sector companies, because using this approach most biases related to the valuation of the firm could be eliminated by taking into account various future scenarios.
However, contingent claim valuation model has some drawbacks especially in the context of valuation of banks, as it does not include the impact of regulatory factors on the company’s performance. As stated by Deev (2011), there are two key drawbacks of contingent claim valuation approach while valuing banks. Firstly, the model does not consider the impact of taxes, reserve requirements, minimum capital requirements, as well as other regulations (ibid.).
Secondly, depreciation, amortization, and other non-cash items are not included in the model.
Consequently, using this valuation approach may lead to inaccurate and biased results.
Valuation approach for mBank. As it has been mentioned in the introduction of this paper before, the objective of the valuation of mBank is to estimate the theoretical value of mBank as an acquisition target of PZU Group. The most common and highly valid approach to value the VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 45 firm in the context of mergers and acquisitions is DCF analysis as it considers the future potential of the business and discounts the expected future economic benefits of the firm to the present value to determine the estimated value of the firm. Due to the treatment of debt and the challenges described in the section of Challenges in bank valuation, such as determination of debt and reinvestments as well as the regulatory constraints, the FCFF approach is not analyzed further, as it is not considered to be the most appropriate method for the valuation of banks. Even though the academic literature supports the application of the DDM for the valuation of financial service firms, in the case of mBank valuation, DDM could not be applied because mBank has paid dividends only three times from 2010 to 2019 (in 2012, 2013, and 2017). As a result, the
FCFE valuation method is used to determine the estimated acquisition value of mBank.
Besides, as mentioned before, the asset-based valuation approach is rather difficult to apply in practice while valuing banks that are engaged in multiple businesses or operate in several countries. What is more, the asset-based valuation approach does not reflect the future potential of the firm. Since mBank provides a wide range of services in different service lines, including retail and wholesale banking, investment banking, and asset management, it would require to evaluate assets used in each service line separately by using different income streams and discount rates, thus, the asset-based valuation approach is not used for mBank valuation.
Moreover, the relative valuation approach determines the value of the asset based on the market prices of similar assets. As noted before, this method is highly valid for the valuation of banking sector firms. To achieve higher reliability of the valuation, the FCFE valuation is combined with peer multiples analysis.
Lastly, the application of the contingent claim valuation approach is rather complicated and time-consuming and is likely to provide less accurate results than classical valuation VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 46 approaches. Also, contingent claim valuation does not reflect the effect of tax obligations and regulatory constraints as well as does not consider depreciation, amortization, and other non-cash items. As a result, the contingent claim valuation is not used to estimate the value of mBank.
All in all, to achieve higher valuation reliability, the FCFE valuation (75%) is mixed with the relative valuation (25%). Since the FCFE includes difficulties in estimating projections for future growth rates, multiples comparison to the valuation model is integrated. The usage of relative valuation is appropriate to model due to the following reasons. First, it is crucial to measure how mBank is valued to that of its competitors as most of the banks offering similar products do not differ in terms of balance sheet composition and, therefore, provides an accurate benchmark for the price. Second, since mBank is engaged in the financial services industry, equity side valuation multiples such as P/E and P/BV serve as good indicators to understand current market interpretation. However, due to the stock markets’ reaction to the coronavirus pandemic and the uncertainty regarding the pandemic in the market, a lower weight of 25% has been opted on the multiples analysis valuation.
Inputs of discounted cash flow valuation approach. As has been noted before, the FCFE discount model is used for the valuation of mBank. Therefore, the inputs of the model are analyzed in the following sections.
Discount rate. The discount rate is a critical input in the DCF valuation model, thus, it should be assessed very carefully, as incorrect estimation of the discount rate might significantly affect valuation results. Since the FCFE valuation method is used to estimate the equity value of mBank, the expected cash flow to equity is discounted using cost of equity.
Cost of equity. The cost of equity is defined as the rate of return required by the shareholders to invest in a specific asset. There is a wide range of models used to determine the VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 47 cost of equity, including the capital asset pricing model (CAPM), which is considered as the default model, and the alternative models such as arbitrage pricing model, multifactor models, power, asymmetric, and jump distribution models, as well as proxy models. According to
Damodaran, despite the number of alternatives for the cost of equity estimation, the CAPM remains the most widely used method due “to both its intuitive appeal and the failure of more complex models to deliver significant improvement in terms of estimating expected returns”
(2012, p. 70). Consequently, the cost of equity is determined using the CAPM. The general formula of the CAPM is the following:
퐸(푅푖) = 푅푓 + 훽 × [퐸(푅푚 − 푅푓]
푤ℎ푒푟푒 퐸(푅푖) = 푒푥푝푒푐푡푒푑 푟푒푡푢푟푛 표푛 푎푠푠푒푡 𝑖
푅푓 = 푟𝑖푠푘 − 푓푟푒푒 푟푎푡푒
훽 = 푏푒푡푎 표푓 푎푠푠푒푡 𝑖
E(푅푚 ) = 푒푥푝푒푐푡푒푑 푟푒푡푢푟푛 표푛 푚푎푟푘푒푡 푝표푟푡푓표푙𝑖표
Risk-free rate. The risk-free rate is considered to be the rate of return that investors expect to receive from the riskless investment (Damodaran, 2016). What is more, the investment which has no default risk and no reinvestment risk is considered a risk-free investment (ibid.).
According to Damodaran (2016), long-term government bonds should be used to estimate the risk-free rate. What is more, the risk-free rate has to match the currency in which the valued company generates its cash flows. Therefore, if the currencies do not match, the default spread of the country (CDS) in which the company operates should be subtracted from the yield of the long-term government bond used for the valuation (ibid.).
Beta. The beta is the measure of the risk of a particular investment in terms of the total market portfolio. What is more, the betas are estimated by regressing the stock returns against VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 48 the market returns. There are three common approaches used to determine betas. The first method is to use historical market price information for individual investments (Damodaran,
2012). The second approach estimates “the betas from the fundamental characteristics of the investment”, while the third method “is to use accounting data” Damodaran, 2012, p. 148).
Estimating beta using historical data is the most commonly used approach in practice, as it does not require to have additional information about the company that might be obtained only from the inside of the respective firm. As a result, the historical approach is used for beta estimation valuing mBank.
What is more, according to Damodaran (2016), in the CAPM the beta could be determined using the following formula:
푆푡푎푛푑푎푟푑 푑푒푣𝑖푎푡𝑖표푛 표푓 푆푡표푐푘 × 퐶표푟푟푒푙푎푡𝑖표푛 표푓 푆푡표푐푘 푤𝑖푡ℎ 푡ℎ푒 푚푎푟푘푒푡 퐵푒푡푎 = 푆푡푎푛푑푎푟푑 푑푒푣𝑖푎푡𝑖표푛 표푓 푡ℎ푒 푚푎푟푘푒푡
Consequently, the formula presented above is used for the estimation of beta valuing mBank.
Equity risk premium. The equity risk premium refers to the premium that investors, on average, expect to receive over the risk-free rate investing in equities with average risk
(Damodaran, 2012). The most widely used approach for estimation of the equity risk premium is the historical approach, which is based on the stock market history for a long period (ibid).
However, to obtain a reliable estimate of the equity risk premium for a specific market requires to have “a large and diversified stock market and a long history of returns on both stocks and government securities” (Damodaran, 2012, p. 132). Even though markets in Western and Central
Europe might be considered as mature, “their equity markets do not share the same characteristics” as a few decades ago they were dominated by a small number of large companies those stocks were traded (ibid.). Therefore, according to Damodaran (2012), risk premiums for markets outside the United States should be calculated by taking historical premium for the VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 49 mature equity market, i.e. United States, and adding the risk premium of the country in the analysis.
Free cash flow. While estimating the value of the company using the FCFE discount model, the cash flows attributable to the firm’s shareholders should be determined. The general formula for the calculation of the FCFE is as follows:
퐹퐶퐹퐸 = 푁푒푡 𝑖푛푐표푚푒 + 퐷푒푝푟푒푐𝑖푎푡𝑖표푛 & 퐴푚표푟푡𝑖푧푎푡𝑖표푛 − 퐶푎푝𝑖푡푎푙 퐸푥푝푒푛푑𝑖푡푢푟푒푠
− 퐶ℎ푎푛푔푒 𝑖푛 푤표푟푘𝑖푛푔 푐푎푝𝑖푡푎푙 + 푁푒푡 푏표푟푟표푤𝑖푛푔
According to Damodaran (n.d.), in case of valuation of firms operating in banking industry, the
FCFE for banks should be determined as follows:
퐹퐶퐹퐸푏푎푛푘 = 푁푒푡 𝑖푛푐표푚푒 − 퐼푛푐푟푒푎푠푒 𝑖푛 푟푒푔푢푙푎푡표푟푦 푐푎푝𝑖푡푎푙
Growth rate. The growth rate is one of the keys inputs that might significantly affect the final results of the valuation. Thus, the growth rate must be precisely determined. As stated by
Damodaran (2012), there are three approaches to the growth rate on which model should be built:
1. The constant growth FCFE model should be used to determine the value of the
companies growing at a stable rate that is close to the growth rate of the overall economy.
2. The two-stage FCFE model should be used to determine the value of the companies,
which are assumed to grow at the higher rate than the stable company in the beginning
and at the stable rate later.
3. The E model (a three-stage FCFE model) should be used to value the firms, which are
expected to grow at the high rate in the initial period, at the lower growth rate in the
transitional period, and at the stable rate in the steady-state period. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 50
Terminal value. When the firm grows, it gets more difficult to maintain a high growth rate, and eventually, it is assumed that the company will grow at a rate less or equal to the growth of the economy. Since it is difficult to determine the cash flows for an indefinite period, Damodaran suggests to stop estimating cash flows at some point in the future and “then computing a terminal value that reflects the value of the firm at that point” (2012, p. 235). The formula for the terminal value in year n is the following:
푇푒푟푚𝑖푛푎푙 푣푎푙푢푒푛 = 퐶퐹푛 (1 + 푔) / (r − 푔)
푤ℎ푒푟푒 퐶퐹푛 = 푓푟푒푒 푐푎푠ℎ 푓푙표푤 푓표푟 푡ℎ푒 푙푎푠푡 푓표푟푒푐푎푠푡 푝푒푟𝑖표푑
g = 푡푒푟푚𝑖푛푎푙 푔푟표푤푡ℎ 푟푎푡푒
푟 = 푑𝑖푠푐표푢푛푡 푟푎푡푒
Sensitivity analysis. Sensitivity analysis is used to determine the variation in the output depending on the information fed into the model. As stated by Saltelli, sensitivity analysis “is hence considered by some as a prerequisite for model building in any setting, be it diagnostic or prognostic, and in any field where models are used” (2002, p. 579). Sensitivity analysis is used to evaluate how the final results of the valuation can be influenced by the changes in any inputs that have a significant level of uncertainty. In the context of the FCFE valuation method, the risk-free rate, beta, and growth rate selected might have a material impact on the final results of the valuation. As a result, sensitivity analysis is conducted by using different inputs for the risk-free rate, beta, and growth rate. Finally, the results of the analysis are used to evaluate the effect of the changes in inputs on the final value, and conclusive recommendations are made.
Valuation of mBank
In this section of the paper, the value of mBank is estimated following the chosen methods that are described in detail in the Theoretical Justification and Research Methodology VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 51 section. As noted in the previous section, to ensure higher valuation reliability, the DCF method using FCFE (75%) is combined with the relative valuation (25%). For the relative valuation, P/E and P/BV multiples are used. What is more, sensitivity analysis is performed for the FCFE valuation method. Consequently, the value of mBank as the potential acquisition target of PZU
Group is determined, i.e. the value of Commerzbank’s share in mBank is estimated. Moreover, the key synergies between mBank and PZU Group are considered. Finally, conclusions are stated based on the obtained results.
DCF valuation method application. First of all, the DCF valuation method using FCFE is used to estimate the value of mBank. The general formula that is utilized for the value estimation is as follows:
퐹퐶퐹퐸1 퐹퐶퐹퐸2 퐹퐶퐹퐸3 퐹퐶퐹퐸푛 퐹퐶퐹퐸푛+1 + 푇푉푛+1 푁푃푉 = + 2 + 3 + … + 푛 + 푛+1 1 + 푘푒 (1 + 푘푒) (1 + 푘푒) (1 + 푘푒) (1 + 푘푒)
푤ℎ푒푟푒 푁푃푉 = 푛푒푡 푝푟푒푠푒푛푡 푣푎푙푢푒
n = 푝푒푟𝑖표푑 푛푢푚푏푒푟
퐹퐶퐶퐹푛 = 푒푥푝푒푐푡푒푑 푓푟푒푒 푐푎푠ℎ 푓푙표푤 푡표 푒푞푢𝑖푡푦 𝑖푛 푝푒푟𝑖표푑 푛
푘푒 = 푐표푠푡 표푓 푒푞푢𝑖푡푦
푇푉푛+1 = 푡푒푟푚𝑖푛푎푙 푣푎푙푢푒 𝑖푛 푝푒푟𝑖표푑 푛 + 1
Cost of equity. Cost of equity calculation is done by using the CAPM, which is described in detail in the Theoretical Justification and Research Methodology section. The following parts of the paper are followed by the determination of inputs for the CAPM.
Risk-free rate. mBank is mostly operating in Poland, thus, the yield of the long-term bond issued by the Polish government, which is denominated in the country’s currency, i.e. PLN, is used as the risk-free rate. Based on the information obtained from the Bloomberg database, the
Poland 10-Year Government Bond with a yield of 1.25% is taken as the risk-free rate for mBank VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 52 valuation. While mBank has a slight risk exposure to the Czech Republic and Slovakia economies, in this analysis no adjustments are made, since the net interest income, which is the main source of the Group’s revenue, in the non-Polish markets constituted only 5.38% and
6.40% of total net interest income earned by the company in 2018 and 2019, respectively. What is more, the gross profit earned in the non-Polish markets constituted only 2.16% and 6.59% of total gross profit earned by the firm in 2018 and 2019, respectively.
Beta. As noted in the Theoretical Justification and Research Methodology section, the historical approach is used for beta estimation valuing mBank. In order to capture the actual risk of mBank, the beta computation is based on regressing the five-year daily changes in the share price of mBank against the daily changes in the underlying stock market index WIG20. What is more, the WIG20 index was chosen as it includes the 20 largest and most liquid companies which are listed on the Warsaw Stock Exchange. It should be noted that no more than 5 firms from the same exchange sector may be included in the WIG20 index. It is worth noting that companies operating in the commercial banks, oil & gas exploration and production, and video games sectors account for almost 47.1% of the total share in the WIG20 index. Moreover, commercial banks sector accounts for 21.6% of the total share in the WIG20 index. The second largest sector in the WIG20 index is oil & gas exploration and production accounting for 13.6% of the total share.
The beta is estimated using information for the period from November 2, 2015, to
October 30, 2020. The chosen sample consists of 1248 observations providing a sufficient amount of information to observe the fluctuations in the market and stock price. The graphical representation of the sample used for the beta calculation is presented in Figure 3. The linear VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 53 regression shows the relationship between the daily changes in returns of mBank share and
WIG20 index during the analyzed five-year period.
Figure 3
Daily changes in mBank share and WIG20 index prices, November 2, 2015 - October 30, 2020, %
10.00%
5.00%
0.00%
-20.00% -15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 15.00% 20.00% MBK -5.00%
-10.00%
-15.00% WIG20 Index Source: prepared by author, data retrieved from Investing.com
The beta for mBank valuation is estimated based on the formula, which has been presented in this paper before and is as follows:
푆푡푎푛푑푎푟푑 푑푒푣𝑖푎푡𝑖표푛 표푓 푆푡표푐푘 × 퐶표푟푟푒푙푎푡𝑖표푛 표푓 푆푡표푐푘 푤𝑖푡ℎ 푡ℎ푒 푚푎푟푘푒푡 퐵푒푡푎 = 푆푡푎푛푑푎푟푑 푑푒푣𝑖푎푡𝑖표푛 표푓 푡ℎ푒 푚푎푟푘푒푡
Based on the five-year daily data, the correlation between the returns of mBank share and the returns of the WIG20 index is 0.6554. What is more, the returns of mBank share have a standard deviation of 2.399%, whereas the standard deviation of returns of the WIG20 index is 1.315%.
The calculated beta is equal to 1.195, indicating that theoretically the price of mBank share is approximately 19.5% more volatile than the WIG20 index.
Equity risk premium. As described in the Theoretical Justification and Research
Methodology section, the equity risk premium for the Polish market is calculated by adding the VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 54 country risk premium of Poland to the equity risk premium of the mature market, i.e. the United
States. Based on the information provided by Damodaran (2020) on country default spreads and risk premiums, the estimated risk premium for the mature market accounts for 5.23%. The risk premium for the mature market was obtained based on the implied premium for the S&P 500 as of July 1, 2020. Based on the data provided by Damodaran (ibid), the country risk premium for
Poland that was estimated using Moody’s rating methodology is 1.25% as of July 1, 2020.
Consequently, the adjusted risk premium is determined to be 6.48% (based on Damodaran), which resulted in a cost of equity of 9.00%.
FCFE and growth rate. As noted before, the equity value of mBank is determined by discounting the estimated FCFE. Therefore, the FCFE should be properly determined to obtain the equity value of mBank, which would be as accurate as possible. As described in the
Theoretical Justification and Research Methodology section, the FCFE for companies operating in the banking sector is determined as the difference between the net profit and the increase in regulatory capital. The net profit of mBank for 2020 is estimated using the financial information of the first three quarters of 2020. The financial results of 2020 are estimated based on the main tendencies throughout the years that have been observed using the historical data for the last quarter of 2015-2019. It can be seen that the total interest income and net trading income of the three-quarters during 2015-2019 account for 73.30-74.99% of the annual interest income and net trading income. However, the interest income and net trading income during the first three- quarters of 2017 account only for 65.73% of the annual amount. Therefore, for the estimation of the financial results of mBank for 2020, median values (instead of mean) are used to eliminate any possible outliers. Following the same pattern, total fee and commission income and expenses, total interest expenses, impairment or reversal of impairment on financial assets not VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 55 measured at fair value through profit or loss, and other costs were determined for 2020. The estimated financial results are provided in Appendix D and Appendix E.
Starting from 2021, the interest income from corporate and retail clients is determined as follows. Firstly, margin on WIBOR 6M (6 months) of the historical retails loans and corporate loans is calculated. The determined margin is used to estimate the yields of retail and corporate loans. Finally, the estimated yield is multiplied by the average loan receivables from the retail clients and corporate clients, respectively. What is more, since the historical growth of the total loan receivables was rather close to the growth of GDP, it is assumed that the loan receivables from customers including retail, corporate, and public sector clients, will increase at the growth rate of Poland real GDP. The application of FCFE valuation model involves using a constant
FCFE growth model incorporating the GDP growth rate forecasted by the NBP for the period of
2020-2022, which is provided in the Situation Analysis section, and using a fixed long-term growth rate of 2.00% for years 2023-2025. GDP projections are put into the context of on-going patterns of Poland’s political-economic development and the crisis caused by the COVID-19 pandemic combined with ambiguity revolving around expansionary fiscal policy implementation plans in the upcoming years. Likewise, banking market has a potential for growth as the overall size of the Polish banking industry, relative to GDP, was rather low, accounting for 89.6%, while the overall size of banking sector, relative to GDP accounted for 232% in the EU Member States in 2018. In addition, the industry analysis shows no signals of major disruptions happening in the
5 year horizon.
To estimate the total interest expenses, the percentage of the total interest expenses as a share of the total interest and net trading income is calculated based on the historical financial results for 2015-2019. As mentioned before, the total interest expenses for 2020 are estimated VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 56 based on the main tendencies throughout the years that have been observed using the historical data for the last quarter of each year in the period of 2015-2019. The historical median percentage value of expenses as a share of total interest and net trading income for 2015-2019 is used for the forecast of total interest expenses during 2021-2025. Furthermore, the total fee and commission income is expected to grow in line with the total loan receivables. What is more, the total fee and commission expenses fluctuate from year to year, therefore, to eliminate any possible outliers the historical median growth (instead of the mean) of the total fee and commission expenses for 2015-2019 is used for the forecast during 2021-2025. The table below summarizes the main inputs used for the forecast. The historical data as well as the forecasts are provided in detail in Appendix D and Appendix E.
Table 10
Main inputs of the FCFE valuation method, 2020-2025
2020E 2021F 2022F 2023F 2024F 2025F Growth GDP growth, % - 5.40% 4.90% 3.70% 2.00% 2.00% 2.00% Profitability WIBOR (6M) 1.79% 1.79% 1.79% 1.79% 1.79% Corporate loans yield, % 3.50% 3.50% 3.50% 3.50% 3.50% Retail loans yield, % 3.70% 3.70% 3.70% 3.70% 3.70% Due from financial institutions 12.66% 14.60% 13.63% 14.12% 13.87% yield, % Effective tax rate, % 27.09% 27.09% 27.09% 27.09% 27.09% 27.09% Results Net profit, M PLN 917 952 1 164 1 178 1 215 1 223 Source: prepared by author
Furthermore, the regulatory capital is forecasted to grow in line with the total loans receivables based on the trend observed during 2015-2019. The historical data and forecast of
Tier 1 capital and Tier 2 capital as well as total loan receivables are provided in Table 11 and
Table 12, respectively. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 57
Table 11
Historical data of own funds and total loan receivables, 2014-2019, in million PLN
2014 2015 2016 2017 2018 2019 Tier 1 capital 8 142 9 915 11 303 12 454 13 317 13 883 Tier 2 capital 1 608 2 056 1 941 1 826 2 454 2 480 Own funds (Tier 1 + Tier 2) 9 751 11 971 13 244 14 280 15 771 16 363 Total loan receivables 77 637 80 331 84 846 86 184 94 564 107 545 Increase in regulatory capital 2 220 1 274 1 036 1 491 592 Source: prepared by author
Table 12
Forecast of own funds and total loan receivables, 2020-2025, in million PLN
2020E 2021F 2022F 2023F 2024F 2025F Tier 1capital 14 417 14 801 15 025 15 182 15 454 15 565 Tier 2 capital 2 537 2 703 2 816 2 778 2 893 2 942 Own funds (Tier 1 + Tier 2) 16 954 17 504 17 840 17 959 18 348 18 507 Total loan receivables 107 786 113 049 117 217 119 554 121 937 124 368 Increase in regulatory 591 550 336 119 388 159 capital Source: prepared by author
FCFE valuation method results. To obtain the equity value of mBank using FCFE valuation method, the net present value of future cash flows and terminal value should be determined based on the formula provided in the beginning of this section. The estimated cost of equity used for discount factor calculation is 9.00%. The FCFE is determined as the difference of the estimated net income and increase in regulatory capital. The steady growth rate form 2025 to infinity is equal to the long- term growth of the Polish economy, which according to OECD
(2020c) is equal to 2%. As a result, the estimated terminal value is equal to PLN 15,518.71 million. After the terminal value is estimated, the present value calculations are performed. As a result, the net present value of mBank equity is PLN 12,452.78 million. What is more, the net present value of mBank equity attributable to Commerzbank is equal to PLN 8,630.98 million. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 58
Accordingly, the estimated share price of mBank is PLN 294.04. The results of FCFE valuation method are provided in table below.
Table 13
FCFE valuation method results
2020E 2021F 2022F 2023F 2024F 2025F Discount factor 0.92 0.84 0.77 0.71 0.65 0.60 FCFE, M PLN 326 402 827 1059 827 1,064 Terminal Value, M PLN 15 518.71 Present Value, M PLN 298.72 338.31 639.02 750.14 537.46 9 889.13 Value, M PLN 12 452.78 Value attributable to 8 630.98 Commerzbank, M PLN Total shares outstanding, M 42.350 Shares owned by Commerzbank, M 29.353 Share price, PLN 294.04 Source: prepared by author
Sensitivity analysis. Since every valuation has a certain level of bias, sensitivity analysis is used to determine the variation in the output depending on the inputs of the model. What is more, it is reasonable to analyze the impact of changes in risk-free rate, beta and steady growth rate since it is difficult to determine these inputs accurately for the long period in the future. What is more, the risk-free rate and beta coefficient in cost of equity estimation are the inputs that might change rather often due to changes in the market. Therefore, the sensitivity analysis should be performed to check how the equity value of mBank would change if different risk-free rate and beta would be applied for the cost of equity estimation, and different steady growth rate would be used.
Sensitivity analysis of risk-free rate. Sensitivity analysis of risk-free rate suggests how the estimated equity value of mBank could change if the different risk-free rate would be used.
Since the risk-free rate directly affects the cost of equity, which is utilized as the discount rate in the model, it is crucial to check the sensitivity of the model in relation to the change in the risk- VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 59 free rate. The summary of the results of the risk-free rate sensitivity analysis is provided in Table
14. As seen from the information provided in the table below, if the risk-free rate would increase by 15% to 1.438%, the estimated equity value of mBank would decrease by 2.85%. On the other hand, if the risk-free rate would decrease by 15%, the estimated equity value of mBank would increase by 3.01%. The sensitivity analysis of the risk-free rate indicates that the model is not very sensitive to the changes in the risk-free rate as the changes are rather insignificant. Thus, the risk-free rate used in the model could be considered an appropriate measure since it provides us with rather conservative results.
Table 14
Sensitivity analysis of risk-free rate
Change of Changed risk- Cost of equity using Value of the Change in risk-free rate free rate value changed risk-free rate equity, M PLN value +15% 1.438% 9.18% 12 097.51 -2.85% +10% 1.375% 9.12% 12 213.83 -1.92% +5% 1.313% 9.06% 12 332.23 -0.97% 0% 1.250% 9.00% 12 452.78 0.00% -5% 1.188% 8.93% 12 575.52 0.99% -10% 1.125% 8.87% 12 700.52 1.99% -15% 1.063% 8.81% 12 827.83 3.01% Source: prepared by author
Sensitivity analysis of beta. Sensitivity analysis of beta suggests how the estimated equity value of mBank could change if the beta applied would be different. Since the beta directly affects the cost of equity, which is utilized as the discount rate in the model, it is crucial to check the sensitivity of the model in relation to the change in beta. It should be noted that the estimation of the beta is rather subjective procedure as the beta could be determined using information for the periods of the different duration. Table 15 summarizes the results of the beta sensitivity analysis. As seen from the information provided in the table below, if the beta would increase by 15% to 1.3746, the estimated equity value of mBank would decrease by 15.54%. On VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 60 the other hand, if the beta would decrease by 15%, the estimated equity value of mBank would increase by 21.81%. The sensitivity analysis of beta indicates that the model is very sensitive to the changes in beta, however, the beta utilized in the model is assumed to be appropriate as it leads to rather conservative results.
Table 15
Sensitivity analysis of beta
Change of Changed beta Cost of equity using Value of the Change in beta value changed beta equity, M PLN value +15% 1.3746 10.16% 10 517.10 -15.54% +10% 1.3149 9.77% 11 097.23 -10.89% +5% 1.2551 9.38% 11 739.03 -5.73% 0% 1.1953 9.00% 12 452.78 0.00% -5% 1.1356 8.61% 13 251.13 6.41% -10% 1.0758 8.22% 14 149.90 13.63% -15% 1.0160 7.83% 15 169.12 21.81% Source: prepared by author
Sensitivity analysis of steady growth rate. Sensitivity analysis of steady growth rate suggests how the estimated equity value of mBank could change if the rate applied would be different. Since the steady growth rate considers the long-term growth of the economy, there is some uncertainty related to this as it is difficult to determine the economic conditions that will be prevailing in the future. The summary of the results of the steady growth rate sensitivity analysis is provided in Table 16. As seen from the information provided in the table below, if the steady growth rate would increase by 15%, the equity value of mBank would grow by 2.95%. What is more, if the steady growth rate would decrease by 15% to 1.7%, the value of the equity would drop down by 2.93%. The sensitivity analysis of the steady grow rate implies that the model is not very sensitive to the changes in the steady grow rate as the changes are rather insignificant.
Therefore, the steady growth rate used in the model could be considered an appropriate measure since it provides us with more conservative results. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 61
Table 16
Sensitivity analysis of steady growth rate
Change of steady Changed steady Value of the Change in growth rate growth rate equity, M PLN value +15% 2.30% 12 819.74 2.95% +10% 2.20% 12 697.22 1.96% +5% 2.10% 12 574.90 0.98% 0% 2.00% 12 452.78 0.00% -5% 1.90% 12 330.85 -0.98% -10% 1.80% 12 209.13 -1.96% -15% 1.70% 12 087.60 -2.93% Source: prepared by author
Multiples analysis. Since the FCFE valuation method includes difficulties in estimating projections for future growth rates, it has been chosen to integrate multiples comparison to the valuation model. It is believed that in the context of this analysis, the usage of relative valuation is appropriate to the model due to the following reasons. First, it is crucial to measure how mBank is valued in relation to that of its competitors as most of the banking sector companies offering similar products do not differ in terms of balance sheet composition and, therefore, provides an accurate benchmark for the price. Second, since mBank Group is engaged in the financial services industry, equity side valuation multiples such as P/E and P/BV serve as good indicators to understand current market interpretation. As mBank is considered to be the Polish bank and a significant share of mBank revenue is generated in the Polish market, mBank is compared to its rivals within Poland. However, due to a high level of uncertainty in the market and the impact of the COVID-19 pandemic on the financial markets, a lower weight (25%) on the multiples valuation is chosen.
In relation to the information provided in this section before, relative valuation relies on the comparison of P/E and P/BV multiples. As cost of funding and realized yields are similar for most of the industry peers, P/BV is a suitable proxy to analyze the efficiency of the utilized funds VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 62 and assets for mBank. What is more, the selected peers include eight banks operating in Poland.
The selected peers were considered to be comparable on the basis of the value of their total assets and country of operations. The list of the industry peers and the respective multiples are presented in Table 17.
Table 17
Multiples for relative valuation
P/E P/BV Peers 2019 2019 PKO Banki Polski S.A. 10.7x 1.0x Bank Pekao S.A. 12.2x 1.1x Santander Bank Polska S.A. 14.7x 1.2x BNP Paribas Bank Polska S.A. 16.3x 0.9x ING Bank Slaski S.A. 15.9x 1.7x Alior Bank S.A. 14.8x 0.6x Bank Millennium S.A. 12.7x 0.8x Bank Handlowy W Warszawie S.A. 14.1x 1.0x Average 13.9x 1.0x Median 14.4x 1.0x Source: prepared by author, data retrieved form Bloomberg Terminal
It should be noted, that for valuation purposes, calculations were performed using median values to eliminate any possible outliers. Using the median P/E multiple and the net profit for
2019, the obtained value of mBank is PLN 14,541.06 million. What is more, utilizing the median
P/BV multiple, and the total equity for 2019, the estimated value of mBank is PLN 16,096.77.
Using the median P/E multiple, the estimated share price is PLN 343.35, whereas using the median P/BV multiple the determined share price is 10.7% higher accounting for PLN 380.09.
The chosen multiples reflect the market situation when the coronavirus crisis just was about to start, therefore, the values obtained should not be affected by the uncertainty created by the
COVID-19 pandemic in the market. Consequently, relative valuation results accounts for a lower weight of 25% in the final estimated value of mBank. What is more, the average share price VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 63 provided in Table 18 is used for the final value estimation of mBank. The results of relative valuation are provided in table below.
Table 18
Relative valuation results
P/E P/BV Net Profit Equity Average Company metric (Net 1 010 16 153 n/a profit/Equity), M PLN Total mBank value, M 14 541.06 16 096.77 15 318.92 PLN Value attributable to 10 078.36 11 156.62 10 617.49 Commerzbank, M PLN Total shares outstanding, M 42.350 Shares owned by
Commerzbank, M 29.353 Share price, PLN 343.35 380.09 361.72 Source: prepared by author
Value of mBank. As noted before, to obtain higher valuation reliability, the final estimated share price of mBank is determined by using the composition of the FCFE valuation (75%) and relative valuation (25%). The determined final share price of mBank is used for the estimation of final value of mBank. Table 19 summarizes the final results of the valuation.
Table 19
Final mBank value estimation
Share price of mBank obtained 294.04 using FCFE valuation method Share price of mBank obtained 361.72 using relative valuation Final share price of mBank 310.96 Total shares outstanding, M 42.350 Final value of mBank, M PLN 13 169.31 Shares owned by Commerzbank, M 29.353 Final value of mBank attributable 9 127.61 to Commerzbank, M PLN Source: prepared by author VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 64
As seen from the information provided in the table above, the value of mBank estimated using the relative valuation approach is approximately 23% higher compared to the value obtained using the FCFE valuation method. Since the assumptions for the FCFE valuation method hold the uncertainty related to economic circumstances that are currently prevailing, the higher weight of 75% is applied. The final estimated value of mBank is PLN 13,169.31 million.
Accordingly, the estimated mBank value attributable to Commerzbank is equal to PLN 9.127.61 million.
Consideration of synergies. Almost the most common motivations for mergers and acquisitions is the creation of synergies. In relation to that, a successful acquisition of mBank presents a direct impact on operational strategy of the PZU Group as additional physical units of mBank covering the network of 353 various retail outlets and 46 points of corporate service offices in Poland will lead to increased distribution of insurance products by cross-sale through mBank’s network of approximately 5.67 million existing clients. Accordingly, this should lead to increased sales of insurance products and revenue growth. In addition, the innovative mobile banking platform offering a wide range of products is expected to contribute to increased efficiency by slowly integrating into already owned systems operated by Alior Bank, which is a part of PZU Group. Increased efficiency of Alior Bank may result in lower operating expenses and higher net profit. Nonetheless, the mBank’s Swiss Franc (CHF) denominated mortgage portfolio of CHF 3.5bn (i.e. PLN 13.6 billion) could pose legal problems resulting in questionable acquisition value. However, the total value of claims related to the loans denominated in CHF amounts to 430.1 million. What is more, the final rulings as of December
31, 2019, in the loans denominated in CHF clauses proceedings are favorable to mBank in the majority of the cases. Additionally, the loans denominated in CHF that are fully repaid amounted VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 65 to PLN 6.3 billion as of December 31, 2019. Considering the information provided above, the mortgage portfolio should not have a significant impact on the acquisition value of mBank.
Conclusions
1. Polish banking industry strongly reflects the general trends observed in European banking
sector and looking from a long-term perspective, the Polish banking sector has a lot of growth
potential since at the end of 2018, its overall size, relative to GDP, was rather low, accounting
for 89.6%, while the overall size of banking industry, relative to GDP accounted for 232% in
the EU Member States.
2. mBank Group has a strong position in the Polish banking sector being the fourth largest
financial institution in Poland as measured by total assets. mBank services 5.6 million
customers in the retail segment and 26,500 corporate clients offering a well-diversified
portfolio of comprehensive products and services within the scope of retail, business,
corporate and private banking through the mobile and online banking systems. As a result,
successful diversification of business activities helps to ensure constant growth and reduce
financial risks.
3. Solid financial figures of mBank indicate its ability to grow even when economic indicators
are in a downward trend. Even though the profitability measures of mBank are a bit lower
compared to its peers, the growing net interest margin ratio and decreasing cost/income ratio
indicate that the bank has the potential to increase its net income in the foreseeable future.
Moreover, favorable loan-to-deposit ratio and the decreasing NPL ratio imply that mBank is
able to increase the value of loans issued to the customers of higher creditworthiness.
4. Based on the research performed, a combination of the DCF method using FCFE and relative
valuation was chosen for the estimation of mBank value. To achieve higher reliability of the VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 66
results a higher weight of 75% was applied for the FCFE valuation method whereas relative
valuation accounts for 25% of the final estimated value of mBank. What is more, since
mBank is engaged in the financial services industry, equity side valuation multiples such as
P/E and P/BV were chosen for the relative valuation as they serve as good indicators to
understand current market interpretation.
5. The total value of equity of mBank calculated using the FCFE valuation method and applying
the cost of equity of 9.00% is equal to PLN 12452.78 million. Based on the FCFE valuation
results solely, the mBank value attributable to Commerzbank is PLN 8630.98 million. The
estimated share price of mBank is PLN 294.04.
6. Based on the relative valuation results, the total value of mBank utilizing the median P/E
multiple accounts for PLN 14,541.06 million. What is more, utilizing the median P/BV
multiple, the estimated value of mBank is PLN 16,096.77. Using the median P/E multiple, the
estimated share price is PLN 343.35, whereas using the median P/BV multiple the determined
share price is 10.7% higher accounting for PLN 380.09. The average share price of relative
valuation used for the final mBank value estimation equals to PLN 361.72.
7. The determined final share price of mBank obtained utilizing the set weights for each of
the selected methods is equal to PLN 310.96. Consequently, the final estimated value of
mBank is PLN 13,169.31 million. Accordingly, the value attributable to Commerzbank
accounts for PLN 9,127.61 million, which could be paid by PZU Group when acquiring
mBank.
8. The estimated value of mBank attributable to Commerzbank is higher than the current market
value of their share in mBank, as the uncertainty created the coronavirus pandemic had
significantly affected the situation in the market. On the other hand, the successful acquisition VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 67
of mBank presents a direct impact on operational strategy of the PZU Group as additional
physical units of mBank covering the network of 353 various retail outlets and 46 points of
corporate service offices in Poland will lead to increased distribution of insurance products by
cross-sale through mBank’s network of approximately 5.67 million existing clients.
Considering that the most common motivations for mergers and acquisitions is the creation of
synergies, PZU Group should consider acquiring mBank for the estimated value of PLN
9,127.61 million. VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 68
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VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 74
Appendices
Appendix A. Formulas of financial ratios
Profitability ratios:
퐼푛푡푒푟푒푠푡 𝑖푛푐표푚푒 − 퐼푛푡푒푟푒푠푡 푒푥푝푒푛푠푒푠 Net interest margin = 푇표푡푎푙 푎푠푠푒푡푠
푂푝푒푟푎푡𝑖푛푔 푒푥푝푒푛푠푒푠 Cost/income ratio = 푂푝푒푟푎푡𝑖푛푔 𝑖푛푐표푚푒
푁푒푡 𝑖푛푐표푚푒 Return on equity (ROE) = 푇표푡푎푙 푒푞푢𝑖푡푦
푁푒푡 𝑖푛푐표푚푒 Return on assets (ROA) = 퐴푣푒푟푎푔푒 푡표푡푎푙 푎푠푠푒푡푠
Asset management ratio:
퐸푥푝푒푛푠푒푠 (푛표푡 𝑖푛푐푙푢푑𝑖푛푔 𝑖푛푡푒푟푒푠푡 푒푥푝푒푛푠푒푠) Efficiency ratio = 푇표푡푎푙 𝑖푛푐표푚푒
Debt ratios:
푇𝑖푒푟 1 퐶푎푝𝑖푡푎푙 Tier 1 ratio = 푅𝑖푠푘 − 푤푒𝑖푔ℎ푡푒푑 푎푠푠푒푡푠
푇𝑖푒푟 1 퐶푎푝𝑖푡푎푙 + 푇𝑖푒푟 2 퐶푎푝𝑖푡푎푙 Total capital ratio = 푅𝑖푠푘 − 푤푒𝑖푔ℎ푡푒푑 푎푠푠푒푡푠
Liquidity ratios:
푇표푡푎푙 푙표푎푛푠 Loan − to − deposit ratio = 푇표푡푎푙 푑푒푝표푠𝑖푡푠
푁표푛 − 푝푒푟푓표푟푚𝑖푛푔 푙표푎푛푠 Non − performing loans (NPL) ratio = 푇표푡푎푙 푙표푎푛푠
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 75
Appendix B. mBank S.A. Group consolidated income statements
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VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 77 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 78
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 79
Appendix C. mBank S.A. Group consolidated balance sheets
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 80 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 81 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 82 VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 83
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 84
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Appendix D. Forecast of mBank S.A. Group consolidated income statement
Interest income from other 2020E 2021F 2022F 2023F 2024F 2025F customers, including: - Corporate clients 1 494 1 610 1 679 1 727 1 761 1 796 - Retail clients 2 027 2 288 2 386 2 454 2 503 2 553 - Public sector 783 695 695 695 695 695 Interest income from other 4 305 4 593 4 760 4 875 4 959 5 044 customers Interest income from banking sector 433 633 848 825 879 881 Net trading income (FX result, other 188 233 288 356 441 546 net trading income) Total interest and net trading 5 097 5 459 5 896 6 057 6 279 6 471 income
Total fee and commission income 2 227 2 335 2 421 2 470 2 519 2 569
Total interest expenses (789) (1 151) (1 243) (1 277) (1 324) (1 364)
Total fee and commission expenses (738) (800) (866) (939) (1 017) (1 101)
Gains or losses on non-trading financial assets measured at fair 104 104 104 104 104 104 value or not measured at fair value through other comprehensive income Impairment or reversal of impairment on financial assets not (1 265) (1 511) (1 437) (1 366) (1 299) (1 236) measured at fair value through profit or loss Other operating income (and share in profits under equity method and 247 247 247 247 247 247 dividend income) Result on provisions for legal risk (389) (389) (389) (389) (389) (389) related to foreign currency loans Overheads (2 041) (2 110) (2 181) (2 255) (2 332) (2 411) Other costs (depreciation, other operating expenses, tax on the (1 197) (1 269) (1 345) (1 426) (1 511) (1 602) Bank's balance sheet items)
Profit before tax 1 257 1 306 1 596 1 615 1 667 1 678 Net Profit 917 952 1164 1178 1215 1223
Profit attributable to equity holders 917 952 1164 1178 1215 1223 of Parent company Profit attributable to holders of non- (0.09) (0.11) (0.12) (0.11) (0.11) (0.11) controlling interest Dividends - - - 582 - - Retained Earnings 917 952 1164 596 1215 1223
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 86
Appendix E. Forecast of mBank S.A. Group consolidated balance sheet
2020E 2021F 2022F 2023F 2024F 2025F ASSETS Total cash and cash equivalents 7 861 8 245 8 549 8 720 8 894 9 071
Intangible assets 1 094 1 094 1 094 1 094 1 094 1 094 Tangible assets (PPE and other fixed 1 118 1 118 1 118 1 118 1 118 1 118 assets) Other assets (receivables, investments in associates, non- 1 053 1 158 1 274 1 401 1 541 1 695 current assets held for sale) Derivative financial instruments and 2 853 2 992 3 103 3 165 3 228 3 292 trading securities Deferred and current income tax 503 522 638 646 666 671 assets Non-current assets and disposal groups classified as held for sale (with fair value changes of hedged 17 17 17 17 17 17 items in portfolio hedge of interest rate risk) Non-trading financial assets mandatorily at fair value through profit or loss, including equity 1 919 1 919 1 919 1 919 1 919 1 919 instruments, debt securities, and loans and advances to customers
Investment securities 48 175 49 127 50 291 50 887 52 102 53 326
Loans and advances to credit 5 668 5 946 6 166 6 289 6 415 6 543 institutions Loan receivables from corporate 44 950 47 153 48 898 49 876 50 873 51 891 segment Loan receivables from retail segment 60 345 63 302 65 644 66 957 68 296 69 662 Loan receivables from public sector 385 385 385 385 385 385 Provisions/Impairments for loans (3 562) (3 736) (3 874) (3 952) (4 031) (4 112) and advances Total loan receivables 107 786 113 049 117 217 119 554 121 937 124 368
Total Assets 170 443 179 241 185 220 188 520 192 516 196 571 LIABILITIES AND SHAREHOLDER'S EQUITY Provisions 739 739 739 739 739 739 Deferred and current income tax 162 162 162 162 162 162 liability Other liabilities (including liabilities held for sale and fair value changes 2 951 3 095 3 209 3 273 3 338 3 405 of the hedged items)
VALUATION OF MBANK AS AN ACQUISITION TARGET OF PZU GROUP 87
Current deposits (*including loans and advances received and repo 88 323 92 635 96 051 97 966 99 919 101 911 transactions) Term deposits 26 143 27 419 28 430 28 997 29 575 30 165 Other financial liabilities due to 1 385 1 453 1 506 1 536 1 567 1 598 customers Financial liabilities to financial 10 938 11 844 12 446 12 134 12 975 12 590 institutions Total liabilities due to clients 127 073 133 649 138 742 140 948 144 357 146 592
Financial liabilities held for trading 966 984 1 002 1 021 1 040 1 059 and hedging derivatives Financial liabilities on the debt 18 575 19 534 20 186 20 545 20 981 21 423 securities issued Subordinated liabilities 2 893 3 042 3 144 3 200 3 267 3 336
Total liabilities 153 359 161 205 167 184 169 888 173 884 176 715
Retained earnings 13 311 14 263 14 263 14 859 14 859 16 083 Share capital and other components 3 773 3 773 3 773 3 773 3 773 3 773 of equity Non-controlling interest (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) Total equity 17 084 18 036 18 036 18 632 18 632 19 856
Total equity and liabilities 170 443 179 241 185 220 188 520 192 516 196 571