RENEWED HOPE FOR TAIWAN BANK CONSOLIDATION

C O N F I D E N T I A L SECTION 01 OF 02 TAIPEI 003287 SIPDIS DEPT PASS TO AIT/W AND USTR DEPT FOR EAP/TC, EAP/EP AND EB/IFD/OIA TREASURY FOR OASIA ZELIKOW,WISNER AND OCC AMCMAHON TREASURY ALSO PASS TO FEDERAL RESERVE BOARD OF GOVERNORS, SAN FRANCISO FRB AND NEW YORK FRB E.O. 12958: DECL: 07/08/2020 TAGS: ECON EFIN PINR PREL TW SUBJECT: RENEWED HOPE FOR TAIWAN BANK CONSOLIDATION REF: A. TAIPEI 2984 ¶B. 04 TAIPEI 04050 Classified By: AIT DIRECTOR DOUGLAS PAAL, REASON 1.5 B/D ¶1. (C) Summary: On July 22 Taishin Financial Holding Company (Taishin) won a 22.5% of equity in the state-owned Changhwa Commercial Bank (CCB) with a bid price 46% higher than the floor price set by CCB and twice the value foreign investors had assigned to CCB shares in May of this year (ref A). The high acquisition cost prompted investors to dump 88 million Taishin shares and drove down Taishin share price by 4% on the first trading day after the July 22 bidding. Top Taishin executives have since argued the logic of their acquisition to the public and separately to AIT, but outside analysts still describe the bid as "very rich." Although Taishin shares remain slightly down, the deal has spurred interest in other bank acquisitions. End summary. High Bid Surprised Even Bid Organizers -------------- ¶2. (C) On July 22, 2005, Taishin surprised its rivals, local market observers, and government officials by winning a bid for 22.5% equity in new stocks issued by CCB, one of the large state-owned banks in Taiwan. Taishin offered NT$26.12 per share, 46% higher than the floor price of NT$17.98 set by CCB. The price of NT$26.12 was NT$2-3 above an offer by Temasek Holdings (a Singapore Government-controlled investment company) that Taiwan's Ministry of Finance (MOF) considered most likely to win. The bid price of NT$26.12 per share far exceeded the NT$10-14 offered by foreign portfolio investors in an aborted plan to issue global depository receipts in May 2005. On August 1, the Taishin-CCB deal was finalized in a formal signing ceremony. Taishin Has Its Reasons -------------- ¶3. (C) Taishin Holdings Taiwan Securities Company President Lin Keh-Hsiao explained the reasoning behind the surprise acquisition to AIT on August 3. According to Lin, after the failed sale of CCB in June, MOF was under pressure to find a way to fulfill the goals announced by President Chen of selling one of Taiwan's state-owned banks to a foreign investor and reducing the number of state-owned banks by half by the end of 2005. ¶4. (C) Lin told AIT that MOF held discussions with Temasek prior to the July bidding in order to ensure the sale went smoothly, and MOF even modified the bidding rules to allow Temasek, an investment company rather than a financial holding company (FHC),to participate. Temasek, which has been aggressively expanding its operations in East Asia over the past year, persuaded MOF to sweeten the deal by adding guarantees to the dividend payments and control over the CCB board of directors. ¶5. (C) Lin said that like most other financial experts he had dismissed the second attempt to sell CCB as little better than the first. The due diligence conducted during the failed June sale had revealed non-performing loans (NPL) that made the book value of CCB shares only NT$6-8 per share, while lowest acceptable bid price was NT17.98 per share. However, Lin said that Taishin Holdings Chairman Thomas Wu (Tung-liang) took a boldly different way of interpreting what was being offered. ¶6. (C) Lin explained that the deal gave Taishan &special8 preferred stocks. Normally, preferred stocks give three privileges: 1) priority in dividends (the CCB preferred stocks carry a guaranteed dividend of 1.8% of the par value); 2) convertibility to common stocks (the CCB preferred shares will automatically convert to common stocks after three years); 3) protection of retained earnings, dividends to preferred stockholders foregone in one year should be paid in subsequent years. ¶7. (C) Moreover, at Temasek,s urging, the MOF had agreed to grant the bid winner the following three additional advantages: 1) the right to vote and be voted as board directors (MOF also promised to vote its 17.5 % equity shares with the winner, effectively giving the winner control of the CCB board of directors); 2) the preferred stock will have the par value of the winning bid (NT26.12 per share) instead of a par value based on the book or market value of the shares; 3) The bid winner has priority over common stock holders to receive liquidated assets. ¶8. (C) Lin told AIT that Taishin Chairman Wu believed that with these guarantees, in a worst case scenario where the merger failed and CCB continued to lose money, the total acquisition price of NT35.6 billion could be viewed as a capital injection into CCB that paid 1.8% interest. The guarantees meant that the capital injection would be treated as a debt in case of CCB liquidation, and almost certainly would be paid back. Taishin Chairman believed this third "special" preference was the most important, and made the high bid a low-risk move. ¶9. (C) In addition, according to Lin, Chairman Wu reasoned that the worst case was very unlikely to happen. The winning bidder would have control over the board of directors and could certainly arrange for a merger on acceptable terms. President Lin told AIT that Taishin is confident that it can increase efficiency and profitability at CCB, which in turn will push up the stock price from the current level of NT$14 per share to over NT$26 before the end of three years (when the preferential stock converts to common stock). MOF has agreed to sell its shares to Taishin, and should Taiwan's legislature object, the MOF has agreed it would not allow the shares to go to any other single investor, or be sold in a block, thus providing reasonable assurance that Taishin will keep control of the CCB board of directors. ¶10. (U) When Taishin International Bank, a subsidiary of Taishin FHC, and CCB merge together, the new bank will be the second largest with a combined asset of NT$2.1 trillion. The new bank will account for a market share nearly 9% in terms of assets and operate the largest banking network, with 270 branches on the island. Book Value of CCB Not Worth Bid Price -------------- ¶11. (C) BNP Paribas Taiwan Corporate Finance Head Peter Kurz told AIT that the value of CCB did not justify the Taishin bid price. He estimated that the bid was about 2.5 times CCB's "clear book value" (i.e., net worth). Kurz said Taishin was paying a greater premium than was paid in other recent bank acquisitions (which he thought were also valuated too high). He noted, however, that the bid price might be justified on a strategic basis when the fit between Taishin's strengths in consumer products and CCB's branch locations was taken into account. Taishin Securities Lin revealed to AIT that Taishin Chairman Wu had expected Fubon Holdings to also notice the sweeteners added to the deal and so Taishin bid high in order to shut out Fubon. However, it turned out that Fubon did not submit a bid. ¶12. (C) Comment: Prior to the actual July 22 bidding, Temasek was the favored bidder because Taiwan authorities wanted to sell CCB to a foreign investor. MOF accepted Temasek,s requests for special privileges to make sure the deal was a success. Taishin was apparently the only bidder that recognized the implications of these privileges. However, the success of the deal, and the high bid price, has had a dam-breaking effect on Taiwan bank consolidation. Several FHCs did not want to be the first to buy a state-owned bank, but also do not want to be left out as Taiwan authorities push further consolidation. AIT has learned that several other bank merger talks have taken on new impetus, and may be finalized in coming weeks. State-owned banks will be major targets because they are large enough to quickly expand the operational scale as well as the market share of a bid winner. End Comment. PAAL