Nikko Cordial hard to swallow for SMFG

May 5, 2009

alex-smith— Alexander Smith is a Reuters columnist. The opinions expressed are his own —

The deal may have lifted the bank’s shares, but Sumitomo Mitsui Financial Group is biting off more than it can chew in buying retail brokerage Nikko Cordial and parts of Citigroup’s Japanese investment bank.

True, the deal doesn’t look too expensive at first glance. The $5.9 billion Japan’s third-largest bank is paying for Nikko Cordial is almost two-thirds lower than the $16.1 billion that Citi spent to secure the business last year. But at 1.5 times Nikko’s book value, it is still a substantial premium to market leader Nomura’s 0.81 times or number two Daiwa’s 1.02 times.

Moreover, the business isn’t profitable — Nikko Cordial lost $36.6 million last year, while the proportion of Nikko Citi’s losses which sit with the parts SMFG is buying (largely domestic equities and bonds) have not been revealed.

SMFG isn’t in great shape itself. It expects to have lost $3.9 billion last year, due to a sharp rise in bad loans and writedowns on its equity portfolio.

This is substantially more than the $2.7 billion which Japan’s largest bank Mitsubishi UFJ expects to lose. The Nikko deal won’t do anything to help the bank restore its core business to health.

Indeed, the challenge of integrating Nikko Cordial (Japan’s fifth largest brokerage by operating revenue) could actually prove a huge management distraction. It doesn’t give a huge amount of confidence that SMFG has not said whether it expects Nikko Cordial to enhance the group’s earnings this year.

Moreover, it won’t obviously help SMFG reach its stated strategic goal of extending the international reach of its investment banking activities. Nikko Cordial will bring it closer to Mitsubishi UFG, Mizuho Financial Group and Japan’s top brokerage Nomura domestically with more than 100 branches and a familiar brand.

But that’s pretty much it. Overseas, there’s little more than a loosely defined relationship with Citigroup, and expanding SMFG’s global footprint is hardly going to be top of its “to do” list.

There is also another complicating factor — the not insignificant task of working out what it does with its 40 percent owned investment banking joint venture with Daiwa Securities.

One option being touted about is for SMFG to merge the Nikko Citi stock and bond underwriting operations it is buying with this JV, called Daiwa SMBC Securities.

That of course, relies on Daiwa being in a mood to assist SMFG and see its shareholding diluted — by no means a given as the big Japanese players vie for strategic advantage.

The worry for SMFG’s shareholders must be that the bank is using the deal to put some growth spin on the $8 billion share sale it has just announced. This might otherwise be seen as a hole-plugging exercise. If that is what it is, the Nikko deal is an extremely expensive piece of window dressing and the share price bounce will be short-lived.

— At the time of publication Alexander Smith did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.
(Editing by David Evans)

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