It’s Virgin Money For Bank Of Queensland

This story features WESTPAC BANKING CORPORATION. For more info SHARE ANALYSIS: WBC

-Cool reception to Virgin Money acquisition
-Gains online customers and well known brand
-Low risk but may conflict with other challenges
 

By Eva Brocklehurst

It was, on first view, underwhelming. Bank of Queensland ((BOQ)) announced the acquisition of Virgin Money Australia and received a cool reception from brokers. The underlying problem is that Virgin Money is loss-making at present and comes via previous ventures with Westpac ((WBC)) and Macquarie ((MQG)). Venturing deeper into the benefits of the acquisition provides a better view of how the bank can leverage the business.

For JP Morgan, the bank is effectively buying a brand in order to attract a different customer and increase on-line capability that it would need to build. The broker is cautious about the ability to fund incremental credit growth through Virgin Money, as it does not bring deposit gathering business. The purchase price involves a $10 million pay-out of obligations and $30m in scrip (1% of BOQ shares). Virgin Group will hold a board seat on the bank. The majority of the acquired business involves funds management base fees but credit card revenue is the key factor for the broker that could swing the business to profitability in FY15.

Deutsche Bank views Virgin Money as a reasonable fit for Bank of Queensland. It will provide the online channel that the bank lacks and long term access to a well known brand name. There is additional scale to be had in credit card lending, penetration of a younger demographic and a number of avenues for expanding wealth management. The broker believes the acquisition is reasonably low risk. It reduces the bank's core tier 1 ratio by around 12 basis points. On the downside, Deutsche Bank believes the losses could continue for another 12-18 months. The main changes made to forecasts is around the scrip issue, which reduces earnings per share forecasts by around 1%. The acquisition is expected to become earnings accretive in the second full year of ownership, FY15.

On analysis, Macquarie likes the purchase. Mainly because it fills a few capability gaps for the bank and leverages a universal brand, for which a royalty payment will be made over 40 years. The FY13 earnings impact is expected to be immaterial. As Macquarie calculates it, the Virgin Money business is currently losing around $6.3 million per annum, around 2.3% of the bank's FY14 earnings estimates, while equity dilution amounts to 1%. This leaves synergy delivery of $4-6m in FY14 and over $8m in FY15, which the broker thinks is plausible.

It's a small ticket growth option in Credit Suisse's view, at a time when the industry is emphasising non-branch distribution. The broker is disappointed that scrip was involved but thinks strategically it makes sense, noting cross-selling to an existing customer base has long been a goal of financial services providers. The key asset is the 150,000 customers that Virgin Money brings to the bank's table, along with contractual arrangements and infrastructure.

Citi finds the acquisition expensive in terms of the 150,000 customers, noting only 4% have multiple product relationships with Virgin Money and these customers are highly selective. The broker thinks the bank will need to provide very competitive alternatives in order to deepen relationships with the customer base. This could be a challenge. In terms of risk, at the company level, Citi finds the share price dependent on the bank's ability to continue funding growth of owner managed branches and any disruption to this, or decline in volumes, could be negatively perceived by the market. Add to this the relatively low credit rating and disruption currently in the wholesale funding markets and the impact on sentiment could be greater. One positive in Citi's opinion is that, given the scarcity of distribution networks in the Australian market, a bidder could emerge for the bank.

Deutsche Bank increased the price target for BOQ on the announcement, but to keep more in line with the recent market re-rating of the banking sector and changes to assumptions around discounted cash flow and capital requirements. Macquarie chose the moment to downgrade the stock to Hold, finding most of the positives factored into the price. This was CIMB's decision too, the acquisition announcement flagging the fact the stock is fully valued, hence a downgrade to Hold. Moreover, CIMB's formerly stronger view on the bank was predicated on recovery in the home market of Queensland and the downgrade partly reflects renewed economic weakness in that state.

On the FNArena database Bank of Queensland comes up with no Buy rating. There are six Hold recommendations and one Sell (JP Morgan). The consensus target price is $8.74, suggesting 8.2% downside to the last share price, and the range of targets is from $7.15 (Citi) to $9.95 (Macquarie). Both these brokers have a Hold rating. The dividend yield on FY13 earnings forecasts is 5.5% and 5.6% for FY14.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms