How Much Could Deutsche Bank Potentially Pay To Acquire Commerzbank?

With U.S. private equity group Cerberus acquiring a 3% stake in Deutsche Bank last month, rumors about a Deutsche Bank-Commerzbank merger have picked up steam once again, as Cerberus is also one of the largest shareholders in Commerzbank with a 5% stake. We believe that a merger between the two largest German banks would unlock considerable value for shareholders, and estimate that Deutsche Bank could shell out as much as $33 billion to acquire Commerzbank. This represents an upper limit to the acquisition price of $26 a share – about 75% higher than Commerzbank’s current share price of $15.

The premium can be justified by the fact that there would be an overall increase in earnings for the combined entity from revenue and cost synergies realized from a potential merger. Notably, the combined entity would be the sixth-largest bank in the world in terms of total assets after the Big 4 Chinese banks and HSBC (NYSE:HSBC), and would be bigger than the largest U.S bank, JPMorgan Chase (NYSE:JPM).

We maintain a $18 price estimate for Deutsche Bank’s stock, which is slightly below the current market price.

See our full analysis for Deutsche Bank

There Are Several Factors Supporting A Potential Merger

The following are some key reasons why a merger between the two German banking giants makes sense:

• Germany has a considerably fragmented banking system, where a large number of small players cater to local banking needs. In contrast, other key developed nations like the U.S., U.K. and France have much more concentrated banking industries.
• Stricter capital requirement norms, and somewhat low profitability, support consolidation in the German banking system
• The soft economic outlook for the Eurozone due to the uncertainty introduced by Brexit will hurt profitability further over subsequent quarters, and a combined entity could fare better in the face of economic headwinds.
• Deutsche Bank and Commerzbank have complementary business models, with the former focusing more on its investment banking operations, while the latter predominantly generates its profits through retail banking. Additionally, the combined entity is likely to have more luck integrating Postbank – something Deutsche Bank struggled with over 2012-2015 despite incurring heavy restructuring costs.

Combined Entity Would Benefit From Merger Synergies Of Up To $16 Billion

We estimate that the financial behemoth formed by a merger of Deutsche Bank and Commerzbank could be able to realize revenue synergies of about 0.5%, meaning the combined entity could potentially generate a modest 0.5% higher revenues compared to the figure obtained by adding their individual revenues. These synergies should be realized from an expanded retail footprint in Germany, which should allow the banks to attract more banking business from retail customers, while also being able to leverage its size to cross-sell more financial products to existing customers.

We estimate the revenues for Deutsche Bank and Commerzbank to be $31.4 billion and $10.0 billion in 2018, respectively – implying a figure of $41.4 billion for both banks taken together. However, revenue synergies of 0.5% could potentially boost the figure for the combined entity to $41.6 billion. While that is not a material figure relative to the bank’s overall revenues, 0.5% annual revenue synergies would add up over the coming years.

Besides this, the combined entity should also be able to realize cost synergies of about 2%, meaning total operating expenses could potentially be 2% lower than the two bank’s combined individual figures. These synergies should be easier than realize than the revenue synergies, and would primarily come from a reduction in overhead costs from an optimized branch network and also due to headcount reductions in various support functions.

We estimate operating expenses for Deutsche Bank and Commerzbank to be around $27.8 billion and $7.5 billion in 2018, respectively – implying a figure of $35.3 billion for both banks taken together. However, cost synergies of 2% could potentially reduce this figure for the combined entity to $34.6 billion. It should be noted that we do not consider merger and restructuring-related charges here, which the banks will need to incur in the process of integrating their businesses (something that could potentially run into the billions) as they would be one-time costs.

The revenue and cost synergies could help the 2018 EPS figure for a combined entity jump to $1.78 from a figure of $1.63, obtained by adding our 2018 EPS estimates for both banks. Also, the implied forward P/E ratios for Deutsche Bank and Commerzbank based on their current market prices are 21.5 and 17.5. Accordingly, the effective P/E ratio for a combined entity – obtained by weighting the individual P/E ratios by the market capitalization for each bank – is slightly over 20. Using this and the estimated EPS figure of $1.78 suggests a share price of almost $36 for the combined entity – or a market capitalization of nearly $75 billion.

As Deutsche Bank’s current market capitalization is around $40 billion while that for Commerzbank is $19 billion, the combined entity’s $75 billion market cap estimate points to synergy-related gains of over $10 billion. Taking into account one-time costs of roughly $2 billion, the maximum Deutsche Bank could pay for acquiring Commerzbank is (Commerzbank’s Market Cap + Expected Synergy Gains – Expected Acquisitions Costs) = ($19 billion + $16 billion – $2 billion) = $33 billion. This is likely on the high end in terms of what the bank would actually be willing to pay, but any potential acquisition price below that would be attractive to shareholders, in our view.

You can use your own estimates to come up with a potential acquisition price for Commerzbank by using our Deutsche Bank – Commerzbank Merger Dashboard.

Deutsche Bank – Commerzbank Merger Would Face Some Challenges

While a Deutsche Bank-Commerzbank merger can unlock billions in value for shareholders, a deal of this magnitude comes with a long list of challenges – operational as well as regulatory. The most sticking issues for a potential deal would be:

• Operational Challenges
  • Deutsche Bank may not be able to integrate the businesses properly: Given the size of Deutsche Bank’s and Commerzbank’s retail banking business, it is very possible that the integration would simply fail. It should be noted that Deutsche Bank struggled in its attempt to integrate Postbank’s operations with its retail unit, and with Commerzbank added to the fray the task would be a much more difficult one.
  • Merger-related costs could be much higher than estimated: Even if Deutsche Bank is successful in integrating the two businesses, it could incur significantly higher reorganization fees. This would eat into the overall value unlocked by the combined entity.
• Regulatory Challenges
  • The combined entity will have higher capital requirements: As size is a critical criteria used by the Basel Committee for deciding on the capital requirements of the largest banks in the world, Deutsche Bank’s capital requirements could increase by 0.5-1% if it swells in size. This would force the bank to hold a higher amount of cash – leading to a negative impact on long-term dividend payouts and share repurchases.
  • The deal could be blocked under German/EU antitrust laws: The fact that Deutsche Bank and Commerzbank are the two largest German banks would result in considerable scrutiny of a potential merger to determine the impact on the overall banking industry in Germany as well as the EU. Under the worst case scenario, regulatory authorities may block the deal altogether. It is also possible that the authorities set a requirement for Deutsche Bank or Commerzbank to spin off business units before approving a merger – something that could also reduce the potential value created by a merger.

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