RZB value = zero? Markets think so

March 8, 2010

Emerging Europe’s No.2 lender Raiffeisen International and its unlisted parent, cooperative bank RZB, on Feb. 22 preempted a Reuters scoop and disclosed that they were considering to put their businesses together. This would add to Raiffeisen’s business, currently exclusively in the former Communist part of Europe, a franchise serving large Austrian and international companies and institutional investors. Analysts and investors have been concerned because they can’t easily put a value on RZB’s business ex-Raiffeisen, and many fear they may be put at a disadvantage in the merger. The 21 percent drop in Raiffeisen’s shares makes it possible to quantify this concern.

Raiffeisen International CEO Herbert Stepic (L) and RZB CEO Walter Rothensteiner address a news conference in Vienna February 26, 2010. Stepic and Rothensteiner reiterated they had not yet made a decision about a possible merger, but said they thought this was the right step to take. REUTERS/Heinz-Peter Bader
Raiffeisen International CEO Stepic and RZB CEO Rothensteiner address a news conference in Vienna. REUTERS/Heinz-Peter Bader

The planned deal – which Raiffeisen and RZB say is still only one of several options – would be implemented under a procedure known as statutory merger in German and Austrian share law. Here’s how it works: Auditors – one for each company and a third, appointed by a court – review the two companies business plans for the next 10 years and from that derive a valuation for each of the two companies. Based on that valuation, they calculate an exchange ratio for the swap of both companies’ current shareholdings into the shareholdings in the new, merged company.

Since RZB already owns 70 percent of Raiffeisen, the new company’s equity value will equal that of RZB (as determined by the auditors) plus that of Raiffeisen’s current free float of 30 percent. Or, to put it the other way round: The free float in the new company will be calculated as:

Value of Raiffeisen free float divided by the sum of RZB’s value and the value of Raiffeisen’s free float

Pending final valuations, RZB and Raiffeisen in a confidential memo obtained by Reuters have put a tentative price tag of 6.1 billion euros on RZB, which they said would equal 1.17 times its book value. The memo put Raiffeisen’s own equity value at 6.2 billion euros, based on a share price of 40 euros – the level it traded at before the possible deal was disclosed. This yields a new free float of:

30% of €6.2 bln divided by €6.1 bln plus 30% of €6.2 bln = €1.86 bln / €7.96 bln = 23%

Which is exactly what the confidential memo arrived at as a tentative free float for the combined group.

No, if you still believe in the efficient market hypothesis (and you may be forgiven if you don’t given the mispricings that helped bring about the financial crisis), you could use this formula and apply it to Raiffeisen’s share price reaction since Feb. 22.

If the market anticipates that it will be diluted to 23 percent of Raiffeisen plus RZB’s business from 30 percent of Raiffeisen alone in the deal, then let’s look how the value of that stake developed since:

30 percent of Raiffeisen at pre-disclosure 40 euros: 1.86 billion euros

30 percent of Raiffeisen now: 1.46 billion euros

23 percent of Raiffeisen at pre-disclosure 40 euros: 1.43 billion euros

In other words: 30 percent of Raiffeisen are now worth almost exactly what 23 percent would have been worth at the share price before the deal was announced. The free float’s value dropped precisely to the value it would have had if minorities were diluted to 23 percent from 30 percent without adding anything of value. In the deal, however, what would be added is RZB’s Austrian and institutional business. Ergo, what the market prices in is that its value is zero.

Of course there are a number of other factors that influence the share price. Rather than on a precise valuation of RZB’s standalone business, the share may have gone down simply because investors apply a discount for the uncertainty linked to the proposed deal, for which many variables are still completely unknown.

But be that as it may, the price now does imply a valuation of zero of RZB’s standalone business, and this opens opportunities for investors who think that it is worth more than zero, because it suggests that the market has overshot because of those deal concerns.

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