KFH invites AUB to study merger: After more than a year of rumours on merger talks, Kuwait Finance House (KFH) has issued a release to the Kuwait Stock Exchange today disclosing that it has sent a letter to Bahrain’s Ahli United Bank (AUB) inviting them to sign a Memorandum of Understanding and Non-Disclosure Agreement to start valuation studies for a potential merger and to assess the feasibility of establishing a new banking entity that combines the business of both banks. On a separate disclosure, AUB has issued a release confirming that they have been approached by KFH to conduct due diligence and any other necessary steps in order to combine both business through a share swap.
 
A KFH-AUB merger would create Kuwait’s largest bank by assets; AUB would give KFH larger scale in Kuwait and an entry to Egypt, where Islamic banking is underrepresented
A merger between KFH and AUB would create an entity with cUSD91bn in total assets, the largest in Kuwait, slightly ahead of NBK, which had an asset base of USD89bn as of June 2018, and the fifth largest bank in MENA. The combined market cap, based on today’s market prices for both KFH (USD12.9bn) and AUB (USD5.3bn) would be USD18.2bn (vs NBK’s USD16.8bn). AUB is headquartered in Bahrain, but its largest country exposure is Kuwait (where it has a 7.6% lending market share), which represents c50% of AUB’s loan book, followed by Bahrain, with 18% of the book and other GCC countries, which represent 15%. AUB has a subsidiary in Egypt, which accounts for around 7% of the loan book. We note that AUB’s Kuwait subsidiary is Islamic, but its business in Egypt and Bahrain are conventional. A merger would require Egypt and Bahrain to switch to Sharia compliant banks, and this would require regulatory approval. KFH’s market share in Kuwait would increase from 16% (based on our estimate, as loan book Kuwait only for KFH is not available) to 23.6% if it merges with AUB.
 
Valuation considerations and earnings impact on KFH: We think KFH-AUB would not be a merger of equals, given KFH’s larger asset base and market capitalization (although the earnings differential between both banks is not that large- AUB had an ROE of 16.2% in 2017, compared to KFH’s of 10.5%). Assuming KFH issues shares to AUB shareholders, and assuming a 20% premium to AUB’s current market cap, the exchange ratio would be 1.20. Our estimates, also included in the attached excel file, show that the merger would be both EPS and BVPS accretive to KFH and slightly dilutive initially in terms of ROE.  This is based on conservative assumptions: no revenue synergies and 25% cost synergies based on cost base of target entity - AUB. 
 
Kuwait Finance House: KWD0.63 as of 16 Jul. 2018, Rating: Buy, TP: KWD0.68/share, MCap: USD12,953mn, KFH KK/KFH.KW
Elena Sanchez-Cabezudo