Pros And Cons Of A Commerzbank-Deutsche Bank Merger: Valuation and Synergies

A merger between Deutsche Bank (NYSE:DB) and Commerzbank could potentially create the sixth largest banking group in the world, and the second largest European bank after HSBC (NYSE:HSBC), as we pointed out in a previous article. At the same time, such a combination would allow Deutsche Bank to consolidate its position in the German retail banking industry, as it opens up the alternative of integrating Postbank with Commerzbank’s widespread retail banking network. The resulting larger retail and SME banking presence should help balance Deutsche Bank’s largely investment banking-focused business model.

The single biggest benefit from the merger for Deutsche Bank would be the sizable improvement in profit margins from realized cost synergies. In this article, we estimate the value of these synergies.

See our full analysis for Deutsche Bank

Step 1: Estimating Income Statement & Valuation Metrics

The table below provides our estimates for full-year pre-tax profits (EBT) for both Deutsche Bank and Commerzbank. Using this and the consensus price target for each of these banks, we arrive at the respective value-to-EBT ratio figure for both banks. We have used consensus price targets instead of the current share price, as European bank stocks have been oversold over recent months in view of the Brexit and its impact on the region’s economy. The consensus figure should help reduce the negative bias on these stocks to a large extent.

Notably, Deutsche Bank’s implied P/EBT multiple of 3.3x is less than half the 7.5x multiple investors attribute to Commerzbank – something that is likely because of the challenges Deutsche Bank faces in streamlining its business model and strengthening its capital ratios, even as legacy legal issues threaten to cost billions more in the near future. The impact of restructuring and legal costs on Deutsche Bank’s results over recent years is evident from the fact that the bank’s key investment banking operations reported an EBT margin of -14% in 2015 due to these one-time costs.

Step 2: Valuing Combined Entity

The table below presents the valuation of the combined entity formed by the merger of Deutsche Bank and Commerzbank under the following assumptions:

• Deutsche Bank will reverse its decision to spin-off Postbank – instead integrating Commerzbank’s retail operations with Postbank
• Commerzbank’s small but sizable investment banking operations will be integrated into Deutsche Bank’s existing division
• The merger will provide €1 billion in annual costs savings while not having any negative impact on revenues
• Restructuring costs are ignored and all cost synergies are assumed to be realized immediately on acquisition, i.e. the cost savings will be reflected in full-year 2016 results itself. This is unlikely to actually occur, of course, but the assumption is made for the sake of simplicity.
• The Value/EBT Multiple for the combined entity is 4.5x – a figure above Deutsche Bank’s implied 3.3x multiple thanks to Commerzbank’s higher multiple of 7.5x as well as due to merger benefits

We estimate that a combined Deutsche Bank-Commerzbank will be worth around €38 billion. That’s about 26% ahead of the total market value of €30 billion obtained by adding their individual consensus market value. This points to synergy-related gains of up to €8 billion from the combination. This in turn implies that Deutsche Bank can gain from a merger even if it acquires all of Commerzbank’s outstanding shares at up to €14.00 a share – a premium of ~120% to the latter’s current market price.

In our subsequent articles, we will detail the key benefits of a merger for Deutsche Bank, and also the factors that work against such a deal.

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