FirstRand offer to Aldermore puts challengers in play

An indicative offer for Aldermore from South Africa’s FirstRand spotlights likely increased interest in Britain’s ‘challenger banks’ from overseas.

No majority, no problem

Aldermore shares held their ground on Monday having soared at the end of last week, on news of preliminary talks with $22bn FirstRand about a takeover worth £1bn. The Johannesburg group now says its offer is not conditional on a unanimous recommendation. Both parties highlight the lack of certainty of a firm offer at this stage, whilst the Takeover Panel’s ‘put up or shut up’ rule has kicked in, with a deadline of 1^st November. However, Aldermore has told its suitor it is “likely to recommend” an offer if one is forthcoming at the flagged price. The mooted sum equates to cash of 313p per ordinary share. It’s worth noting the stock did not quite reach that price even amid Friday’s 19% bound. Scepticism is the traditional interpretation when a takeover target’s shares do not match the offer price.

Challenged

In fact, it’s difficult to detect much more than prudent caution at Aldermore itself over the prospect of giving up control. Perhaps this is not so surprising given that the seven-year old institution, founded by a former Barclays executive, is better apprised of the outlook for its market than most. Having grown by acquiring a clutch of minor commercial lenders, Aldermore’s focus remains on small-to-medium-sized businesses; particularly their mortgage needs. It was a great idea post GFC. But last year’s sterling crash combined with lingering weak rates have weakened the sector’s economics. All but the very strongest of a dozen or so challengers can be expected to thrive under current conditions. And soon, higher capital requirements will pile on further pressure after the BoE recently ordered banks to raise capital held to ensure adequate liquidity, in case the consumer credit ‘boom’ goes sour.

Aldermore going for less than average

With a net interest margin of 3.2%, Aldermore makes relatively average profits from lending, even if forecast return on equity for fiscal 2017, at 17.6%, is set to top Metro, Virgin Money, OneSavings and others. Investors have still nevertheless discounted Aldermore to the low end of that peer group’s price-to-book range. A forward 9.74 times rating is also timid against the sector’s average low double-digit value. FirstRand’s indicative offer is similarly circumspect, implying a valuation below key mortgage rival Lloyds Banking Group.

FirstRand interest won’t be the last

The shortfall can be pinned on outlook uncertainties. These have not been assuaged by Aldermore’s underperformance of its own loan growth targets in H1. With shares in Virgin Money, Paragon and OneSavings also getting a tailwind in recent days, investors seem to think FirstRand may not be the last to come knocking at challengers’ doors. They will find a group that has seen free cash flow generation trend lower across the board over the last two years.

Technical terms

The most striking point in Aldermore stock’s technical price chart is that last week’s huge spike hit a ceiling at almost the exactly same price—309.70p—where it saw an aggressive rejection in late August 2015 (see red ellipses on chart below). Whenever we see a sharp sell-off—and I think the sustained one that followed the last time Aldermore reached 309p qualifies—we can conclude we are looking at action by determined large sellers, often institutions. In light of Friday’s repeated tag, for whatever reason, of 309p, it becomes quite a line in the sand. It can therefore signify sentiment on FirstRand’s deal. 309p is also close to the stock’s record highs around 318p in July 2015. In theory these pitch the bar to the market’s view on a deal even higher. Failure to breach 309p resistance in coming days need not be fatal for consummation. However we would expect the stock to weaken on such an eventuality; at least to the upper limit (c. 255p) of the stock’s channel that was in place this year before Friday. The stock is now of course deeply overbought.