CYPRUS: MERGERS AND ACQUISITIONS WAVE LOOMS OVER

UNCLAS NICOSIA 001092 SIPDIS SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN ECON CY SUBJECT: CYPRUS: MERGERS AND ACQUISITIONS WAVE LOOMS OVER CYPRIOT BANKING SECTOR - BOC BID TO ACQUIRE EMPORIKI BANK IN GREECE STIRS THE WATERS (U) This cable is sensitive but unclassified. Please protect accordingly. Not for internet distribution. ¶1. (SBU) Summary. Up until June 2006, the Cypriot financial landscape could be described as rather bland and predictable, although offering impressive gains over the past two years to the few foreign investors who dared venture in the island's shallow stock exchange. All of this changed mid-June 2006 when the Bank of Cyprus (BOC), Cyprus's largest bank, launched a bid to acquire Emporiki Bank in Greece, partly in response to efforts by the Greek Piraeus Bank to become the BOC's largest shareholder. With the stock market crash of 1999-2001 well behind it, the Cypriot financial system had been ripe for a wave of mergers and acquisitions, which has finally hit in what seems, by Cypriot standards, to be like a tsunami. Credit rating agencies are generally apprehensive about the prospects of success of the BOC's ambitious gamble. The stakes are high: the BOC bid could either make or break Cyprus' leading financial institution, with all the implications that would have on the Cypriot economy and the country at large. End Summary. Background on BOC -------------- ¶2. (U) Founded in 1899, the Bank of Cyprus (BOC) group is the leading Cypriot banking and financial services group. The group also has a strong presence in Greece, currently being sixth largest in terms of assets and growing rapidly, particularly since 1999. The BOC group currently operates 275 branches, of which 147 operate in Cyprus, 111 in Greece, six in the United Kingdom, ten in Australia and one in the Channel Islands. The Bank of Cyprus also has representation in the United States, Canada, South Africa, Russia and Romania. The Bank of Cyprus Group employs 6,065 staff worldwide. On December 31, 2005, the Group's Total Assets reached CYP 12.8 billion (USD 27.5 billion) and the Group's Shareholders' Funds were CYP 762 million (USD 1.6 billion). The Bank of Cyprus shares are listed on both the Cyprus and Athens Stock Exchanges. (Note: the average exchange rate between the Cyprus Pound (CYP) and the USD since the beginning of 2006 has been USD 2.15 to CP 1.00.) BOC Bid to Acquire Emporiki Stirs Financial Waters -------------- -------------- ¶3. (U) On June 22, 2006 the BOC group launched a CYP 3.8 billion (USD 8.2 billion) cash-and-shares public offer to acquire 100 percent of Emporiki bank - Greece's fourth largest -- but ailing -- bank. The sale of Emporiki (11 percent owned by the Greek government and 10 percent by Greek pension funds) is the highlight of the Greek government's divestment agenda this year designed to help pay down public debt. ¶4. (U) If the acquisition goes through, the combined BOC/Emporiki group would become the second-largest financial institution among Greek and Cypriot banking groups in terms of deposits and loans. It would have a total market share of 12 percent of deposits and 15 percent of loans in Greece, and 32 percent of deposits and 27 percent of loans in Cyprus. ¶5. (U) The BOC offer is conditional on acquiring a minimum of 40 percent of Emporiki's shares. The BOC bid rivals a Euro 3.1 billion (USD 3.9 bilion) all-cash bid by Credit Agricole (France's largest retail bank). Emporiki shareholders will be asked to decide between the two bids by August 7, 2006. ¶6. (U) To finance the deal, the BOC proposes to double its share capital from CP 300 million (USD 645 million) to CP 600 million (USD 1.3 billion) through the issue of 600 million new ordinary shares at a nominal value of CP 0.50 each. The proposal will be put to a vote at an emergency general meeting of BOC shareholders on July 28, 2006. Having secured the approval of the Greek Capital Markets Commission, the BOC bid is now subject to the approval of bank supervisory authorities and competition authorities in both Greece and Cyprus. Playing with the Big Boys -------------- ¶7. (SBU) The BOC announcement exploded like a bombshell among Cypriot financial circles, causing a storm of speculation as to its pros and cons, its motives, and other related issues pertaining to the bigger picture of the emerging mergers and acquisitions scene between Greek and Cypriot banks. The debate is far from academic. The success or failure of the BOC's ambitious endeavor could literally make or break the BOC - Cyprus' leading financial institution, with all the implications which that has for the Cypriot financial sector in general. ¶8. (SBU) Acquiring Emporiki will not be an easy undertaking for the BOC. The first problem is size. The market value of the BOC is USD 5.05 billion -- barely more than Emporiki's total capitalization of USD 4.55 billion. (By contrast, size is not an issue for Credit Agricole, which has a capitalization ten times that of BOC). The second major problem, and this applies to both bidders, is Emporiki's corporate mentality, which is characterized by osteoporosis and very strong labor unions. The BOC's bid is a calculated gamble by the BOC that it can tame Emporiki's unions, and infuse the ailing Greek dinosaur with a youthful enthusiasm and a reinvigorated sense of purpose. ¶9. (U) On the plus side, acquisition of Emporiki will give the BOC a leg up in expanding into the Balkans - a move deemed a long-term strategic objective and an imperative for BOC senior management. Secondly, the bid will result in economies of scale for the BOC in its Greek operations - by far its most profitable and rapidly-expanding market. Experts consider the two networks of branches of the BOC and Emporiki in Greece to be complementary of one another - a key component to the idea of achieving economies of scale. Lastly, the BOC is considered as having a competitive advantage over Credit Agricole in both understanding Greek corporate culture and dealing with unruly unions. The BOC's long experience in dealing with ETYK -- the notoriously powerful banking union in Cyprus - will certainly come in handy. ¶10. (U) Analysts note that merger waves are fairly common during the post-correction phase of a stock market boom-and- bust cycle. Cyprus is a typical example. The Cyprus Stock Exchange (CSE) experienced a painful boom-and-bust cycle from 1999 to 2001. The downward slide of the CSE finally hit rock bottom towards the end of 2004, by which time the index had lost 90 percent of its value from its hey day in November 1999. Since then, the CSE has recorded a solid recovery, with impressive gains in the last two years: 52 percent during 2005, and a further year-to-date gains of around 54 percent so far in 2006. ¶11. (U) The CSE recovery in 2005 and 2006 was driven by the return to profitability of the island's two largest banks: the BOC and Laiki (Popular) Bank, currently accounting for 50 percent and 17 percent, respectively, of the CSEs overall capitalization. Against this backdrop, it is no wonder that the two leading local banks have become very attractive acquisition targets for foreign investors, at the same time as they themselves are trying to expand further into the Greek market. "Hostile" Interest from Piraeus -------------- ¶12. (SBU) In other words, it should not have been a surprise for the BOC Board when another bank, Piraeus Bank S.A. of Greece, suddenly started quietly snapping up large numbers of BOC shares around mid-June, building up its position initially to six percent and, by the end of June, to more than eight percent. Instead, a perturbed BOC Board described Piraeus Bank's actions as "hostile" and "not in the best interest of BOC shareholders, as they lack completeness and substantiated strategic intention." The buying frenzy also prompted the Cypriot bank supervisory authority, the Central Bank of Cyprus, to issue a stern warning to Piraeus Bank, asking it to come clean with its intentions, leading some to speculate that the Central Bank was being xenophobic and was trying to protect one of Cyprus's business icons from foreign influence. ¶13. (U) Piraeus Bank, which had initially attributed its interest, innocently enough, to "investment" reasons, eventually admitted that it had a "strategic interest" in the BOC, and confirmed that it had its eyes fixed on building up its stake in the BOC to 9.9 percent. The Central Bank also reminded the Greek bank of its obligation to obtain the Central Bank's prior authorization for the acquisition (whether directly or indirectly) of any Cypriot bank - a requirement founded on EU Directive 2000/12/EC. ¶14. (SBU) Some local commentators have suggested that BOC's bid for Emporiki is a defensive measure designed to stave off Piraeus's possible interest in gaining a controlling stake in the BOC by making it too large for Pireaus Bank to swallow. Some have gone so far to suggest that the bid for Emporiki was rashly prepared as a desperate attempt by the BOC Board of Directors to ensure their well-paid jobs would not be put at risk. The BOC has denied these charges, arguing that the takeover bid fits their strategic objectives and has been planned for some time. If successful, the BOC/Emporiki merger will catapult the new group way ahead of Piraeus in terms of size and into the Greek "Premier League of banks" -- competing head on with the three leading Greek banks at present: Ethniki, Alpha, and Eurobank. ¶15. (U) Having already snatched up 8.2 percent of BOC's shares, Piraeus is currently the Cypriot bank's largest single shareholder. Other major shareholders include the Cyprus Church (8.0 percent); the BOC Provident Fund (6-7 percent); followed by various institutional investors, investment and insurance firms, and pension funds and, lastly, by thousands of smaller investors. Attention is now focused on how the bigger BOC shareholders will respond to the BOC management's proposal to acquire Emporiki. A minimum of 75 percent of those present at the BOC EGM on July 28 must approve the proposal for the Emporiki bid to go through. Marfin Shares the Spotlight -------------- ¶16. (U) With the plot thickening rather more quickly than Cypriots are used to, the Central Bank of Cyprus also fired a warning shot across the bow of Marfin Group. Marfin, which is 31.5 percent owned by Dubai Financial, currently has a 10 percent stake in Laiki and a 40.6 percent stake in Greek Egnatia. On June 27, the Central Bank informed Marfin that it was investigating "unconfirmed information" that Marfin had colluded with Tosca Fund to buy the HSBC stake in Laiki. When HSBC decided to sell its 21.6 percent stake in Laiki early this year, Marfin Fund absorbed 10 percent of the shares and Tosca Fund another 8.2 percent. ¶17. (U) Marfin does have a stated goal as well as permission by the Central Bank to build up its share capital of Laiki to 20 percent. The Central Bank, however, has also warned Marfin that it has information suggesting that Marfin has violated the law by systematically buying Laiki Bank shares within 30 days of the release of Laiki's quarterly financial results. Cypriot law prohibits company insiders to buy or sell shares within this "closed" period. Marfin denied any collusion with Tosca Fund and wondered why the Central Bank had chosen to publicize this issue. Still, Marfin decided to stop buying Laiki shares "as a sign of respect to the regulatory authorities." ¶18. (U) In a parallel development in Greece, Marfin announced on July 6 plans for a triple merger between three smaller Greek banks -- Marfin Bank, Egnatia Bank, and Laiki's operations in Greece. The plan, which is subject to approval by the shareholders of all three banks and by the Greek regulatory authorities, is scheduled to come into effect December 31, 2006. The new entity that will emerge from the merger of these three banks will have total assets of around Euro 8.2 billion and 4 percent of total deposits, 140 branches, and 6,000 employees. Foreign Rating Firms Ambivalent -------------- ¶19. (U) Saying that these are interesting times for the Cypriot banking sector is a gross understatement. Foreign rating agencies, not to mention local analysts and investors, have been ambivalent about the BOC bid on Emporiki, contributing to the maelstrom of conflicting information. ¶20. (U) Moody's was first to raise the alarm, cautioning that the BOC's D+ financial strength rating could be subject to downward pressure, resulting in possible negative implications on capitalization levels and the likely challenges from the integration of the two institutions. Moody's did not change the BOC's deposits or senior debt ratings but it did put Emporiki's corresponding ratings on review for a possible upgrade. ¶21. (U) Similarly, Fitch put BOC's A- credit rating on negative watch on account of concerns that the BOC's plans for Emporiki might undermine the BOC's financial strength. Eurobank Securities also cautioned that the BOC/Emporiki deal would tend to dilute BOC profits per share and would alter substantially the BOC's investment profile. ¶22. (U) By contrast, UBS has maintained its Buy 1 rating on the BOC stock, retaining its bullish target price range for the stock at CP 7.20 (from the current level of CP 4.14). UBS sees merits in the BOC's bid to acquire Emporiki and believes the acquisition will expedite the BOC's strategy of achieving scale in its most important market (Greece). UBS also remained very positive on other Cypriot banks. ¶23. (U) Deutsche Bank (DB) was also supportive of the BOC bid, maintaining its price target of CP 5.60 on BOC shares with a "buy" recommendation. It also described the BOC bid as more attractive than that of Credit Agricole. However DB, expressed concern that the bid would tend to reduce the BOC's Tier 1 capital. ¶24. (SBU) Comment. A cynic might describe the BOC bid on Emporiki as similar to a boa constrictor trying to swallow an antelope of roughly the same size. The potential payoffs are obvious but the inherent risks are also considerable -- worst case scenario is that the boa constrictor collapses from indigestion. Only the future will tell whether the BOC has bitten off more than it can chew. But first, the BOC bid must receive the approval of both Greek and Cypriot authorities as well as that of most BOC shareholders, before Emporiki shareholders can have their say. End Comment. SCHLICHER