Merger and acquisitions have become a strategic maneuver to enhance profitability and competitiveness in the evolving financial landscape. These can create significant value through synergies, which arise when the combined entity is worth more than the sum of its individual parts. The banking industry is constantly evolving, with banks seeking new avenues for growth and profitability. Acquisitions, particularly of leasing companies, have become a strategic approach for banks to expand their product offerings and customer base.

Inorganic growth strategies are all about achieving growth through external means, rather than relying solely on internal development. Whilst organic strategies focus on internal development and leveraging your existing resources to increase capital. They are generally slower but offer more control. 

The Indonesian Financial Services Authority (OJK) implemented regulations No. 12/POJK.03/2020 expected to further stimulate corporate actions within the banking and financial sectors. These rules include:

• Higher capital requirements: By December 2022 and 2024, commercial and regional development banks (BPR/BPD) respectively must meet a minimum core capital of IDR 3 trillion.

• Limited fintech lending licenses: A moratorium on new fintech lending licenses restricts new players from entering the market.

These factors could incentivize mergers and acquisitions (M&A) as smaller institutions seek to pool resources, by merging with another bank can help meet the increased capital requirement. Acquiring a competitor could also be a way to expand their reach in a limited licensing environment and gaining market share. 

The Bank has disclosed its plan to use the proceed from the Rights Issue fund to expand and invest through the acquisition of financing business companies namely PT Oto Multiartha and PT Summit Oto Finance. As of March 28 2024, based on Keterbukaan Informasi Kepada Pemegang Saham BTPN, referring POJK 17/POJK.04/2020 Transaksi Material dan Perubahan Kegiatan Usaha and POJK 42/POJK.04/2020 tentang Transaksi Afiliasi dan Transaksi Benturan Kepentingan, the bank disclosed the transaction value of the acquisition of IDR 6.550.743.411.334, resulting ownership of 51% both in OTO & SOF.

The collaboration between Bank BTPN and OTO Group will cover a variety of issues, including joint financing, expanding the ecosystem for the two entities through the integration of their respective branch networks in Indonesia. Based in the above explanation, the author choose to observe the synergy valuation after the acquisition is conducted. What is the impact of the acquisition, rationales and expected outcome on this acquisition and the value of this synergy. 

Research Questions and Objectives

1. Research Questions

2. What are the expected results and rationales for this acquisition?

3. How much the value of synergy of this acquisition?

4. Research Objectives 

5. Analyzing the strategic policy behind the acquisition and the expected outcomes

6. Calculating how much potential value of synergy of the acquisition

7. Providing information and recommendation on future prospect of Bank BTPN 

8. Research Limitation

    

The data used is taken from Bank BTPN official website, annual reports, audited financial statement FY 2023 and published disclosure on material transaction. Therefore, the assumptions are made based on data given. This research will be based on secondary data and information and by review of relevant literature, thus may be bias to some extent

Valuation

Difficulties in valuing financial service firms originate from three important aspects.

The first is that a financial services firm's cash flows are difficult to estimate since factors such as reinvestment (capital expenditures and working capital) and debt are not clearly defined. Determining a bank's reinvestment needs (capital expenditures and working capital) can also be difficult. Banks don't have the same kind of tangible assets as traditional companies (i.e PPE, fixed asset). This makes it challenging to calculate a bank's future cash flows, which are crucial for valuation models like discounted cash flow (DCF). Unlike traditional companies that use debt financing, banks rely heavily on debt to fund their lending activities. Third party fund (TPF) are a major source of funds for banks, and the interest they pay on TPF is a cost. But this cost is directly linked to the interest rate charged on loans.

Second, banks are heavily regulated, and such alteration in regulation may have a substantial change in firms value. Banks must maintain Capital Adequacy Ratio (CAR), which are calculated based on total capital (Tier 1 & Tier 2) divided to its Risk Weighted Asset (RWA), to guarantee that they do not overextend themselves and putting their claimants or depositors at risk. 

And third, the accounting standards used are different from non-financial service firm. Assets are marked to market (MTM) more frequently & the loan loss provision requirement. With assets marked to market more frequently and a conservative bank would set aside more for loan losses per loan portfolio than a more aggressive bank, resulting in higher profits during good times (Damodaran, 2009). Therefore, Damodaran suggest to better use equity valuation model rather than enterprise valuation model, such as Free Cash Flow to Equity.

Free Cash Flow to Equity

In the majority of cases, financial service firms do not reinvest in plant, equipment, or other fixed assets. Instead, the investment goes into regulatory capital (capital specified by regulatory bodies), which dictates future growth limitations.  So the formula is updated into:

Ultimately, the calculated free cash flow to equity (FCFE) needs to be discounted back to present value using the cost of equity capital. Thus, the following formula:

Inputs to Model

Discount Rate

For capital structure, the FCFE (Free Cash Flow to Equity) method solely considers the cost of assets as the discount rate. Conversely, the Capital Asset Pricing Model (CAPM) focuses on calculating the cost of equity capital.

Terminal Value

Damodaran (2010) argues terminal value is key in DCF as it reflects most of a firm's worth. Due to limited cash flow forecasting, DCF valuation uses a terminal value to estimate the firm's future value at a set point. 

Motives Behind Acquisition

According to Damodaran (2009), the motive of mergers and acquisition can be categorized as follows:

1. Operating Synergies: Enhancing operational efficiency by leveraging economies of scale, increasing pricing power, combining strengths, or entering new markets.

2. Financial Synergies: Enhancing the value of the company by reducing the cost of capital, increasing cash flow, or a combination of the two. This encompasses factors such as diversification, increased debt capacity, tax benefits, and cash flow optimization (although the effectiveness of these factors is contested).

Acquisition Value Analysis

Ernst and Young LLP (2014) demonstrate the acquisition framework as follows:

Figure 1 - Acquisition Analysis Framework

The synergy is calculated by adding the NPV target, acquisition premium, and various costs together. The chart serves as a visual representation of the discounted cash flow analysis, rather than being a substitute for it.When we look at the numbers on the chart, it seems that in order for a deal to be justified, the gross synergy targets (without considering the three cost categories) typically need to be between 30% and 80% of the purchase price. After accounting for expenses, the potential synergy range would be between 25% and 65% of the purchase price.

Conceptual Framework

Figure 2 - Conceptual Framework

Research Design

This research will use a combined approach, drawing on both qualitative and quantitative research methods. As Creswell and Creswell (2018) explain, a research design acts as a roadmap, outlining the study's goals, questions, methods for collecting information, and how that information will be analyzed.

Data Collection Method

The data collected from secondary data of historical financial statements and annual report 5 years backdated, the acquirer disclosure on material transaction and the consolidated financial statement after M&A, which was in the first quarter of 2024. Other supporting data from JKSE, website of the Indonesia Stock Exchange (IDX), the company’s own website and several equity research database. 

Data Analysis Method

Externally, the author will use the PESTLE Framework to gain a better understanding of the company's overall condition.  This examines the industry's competitive landscape, and consider broader external factors that may have an impact on the company, such as political changes, economic trends, social shifts, technical breakthroughs, environmental regulations, and legal difficulties.

Internally, the author will assess company’s valuation using DCF FCFE method, derived from published historical financial statements. The author will also evaluate the company’s performance prior and post-acquisition according to PBI 13/1/PBI.2011 and POJK No. 35/POJK.05/2018 in terms of Risk, Earnings and Equity. 

PESTLE

Political

POJK 12/2020, announced by Indonesia's financial services authority (OJK), raises the core capital requirement for commercial banks to IDR 3 trillion till 2022 and for regional development banks (BPD) to 2024. As a result, regional development banks in Indonesia would likely merge or acquire one another in order to meet this need, opening the door to potential inorganic expansion.

Additionally, the government has attempted to make the investment climate better for M&A in the financial services industry. The Omnibus Law on the Financial Industry (Law No. 4 of 2023) brought about several important changes in different sectors of the financial industry. These changes include allowing commercial banks to operate as digital banks (which was already regulated by OJK. This reform will continue to drive growth in M&A deals.

Economic

The monetary sector in 2023 was remarkably stable, despite the fact that Bank Indonesia (BI) increased its benchmark interest rate, the BI 7-Day Reverse Repo Rate (7DRRR), from 5.75% to 6.00% in October 2023. Lending and deposit rates had also increased to 6.75% and 5.25%, respectively. 

Bank BTPN anticipates increasing competition in its collection of Third Party Funds (TPF), leading to gradual alterations in interest rates for loan and time deposit. This might have a direct impact to higher cost of fund (increase in time deposit rate) and to offset the increase of cost of fund, bank might need to adjust rate for loan as well to still have a desirable net interest margin (NIM).

Social

Bank Indonesia reports that in Q1 2023 digital transaction services grew by 9.9% year over year. Partnering with digital lending platforms allows digital banks to acquire a share of the underbanked through alternative credit products. In addition, Indonesia has a 31% penetration of young digital natives aged 15-35 and an 81% unbanked or underbanked population, which act as a “catalyst” that accelerates digital banking, fintech, and lending in Indonesia. 

With a large unbanked population and rising internet penetration as well as most of the workforce depending on the informal MSME sector, borrowing from a bank is a bit challenging in Indonesia; hence, the popularity of peer-to-peer (P2P) lending companies which provides access to small loans. 

Technological

Banking and multi-finance sectors have been significantly affected by the significant transformation of the technological landscape. The importance of cybersecurity, digital banking, and fintech innovations has increased. In 2023, Bank BTPN stabilize IT System by consolidation core banking system, enabling bank to offer digital solution, particularly for corporate segment and improve operations becoming more efficient.

As for OTO Group, the company is working with multiple parties to make installment payments convenient for debtors through retail locations, ATMs, internet banking, and mobile banking apps.

Environmental

Environmental considerations refer to ecological and climate-related challenges that can have a substantial impact on the financial service industry. As part of this, the bank participate in syndication funding of green financing that relates to ESG.

As for OTO Group, to date has been offering funding for electric cars (EVs) as part of its efforts to promote sustainable finance. The company is currently researching several ESG-based financial products that are needed in the market.

Risk, Earning, Capital

Referring to PBI 13/1/PBI/2011, which measures bank health, we use risk, earning and capital to ensure BTPN overall soundness and financial health. Risk measurement is derived from non-performing loan (NPL) and Loan to Deposit Ratio (LDR), Net Interest Margin (NIM) and Return on Asset (ROA) for Earnings, and Capital Adequacy Ratio of total capital divided to its Risk Weighted Asset (RWA).

As for OTO Group, we also refer to 35/POJK0.5/2018 to measure the key elements of soundness, which also cover risk that is obtained from non-performing financing (NPF) and debt to asset ratio, ROA for earnings, and Gearing Ratio analysis.

Risk

There are two types of NPL ratio, i.e Gross NPL and Net NPL. As for net NPL, the NPL is deducted by loan loss provision before compared to total loan disbursed/portfolio.

Table 1 - BTPN NPL Compared to Industries

From 2019 to 2023, BTPN's NPL performance consistently below the industry average. BTPN has had an excellent track record in managing non-performing loans over the last five years when compared to the industry benchmark. 

As for OTO Group, The NPF of both the OTO and SOF sectors has experienced a substantial increase from 2019 to 2021, followed by a better performance in 2022 and 2023 after Covid 19. Nevertheless, the NPF levels for SOF remain significantly higher compared to OTO.

Earnings

The return on assets (ROA) is a metric that defines the efficiency of a bank's management in managing its assets to generate income. The stronger the bank's position in asset utilization, the more efficient the bank's management is in utilizing its economic resources, and the higher the return. BTPN Return on Assets (ROA) has consistently been lower than the industry average during the same period.

Table 2 - BTPN ROA Compared to Industry

One of the main factor is a more conservative approach in loan loss provisioning. In 2023, Bank BTPN increased its loan provisioning in 2023. Bank BTPN's net profit after tax was impacted by the increase in credit costs to Rp1.20 trillion as a result of this additional provision.

Capital

Capital adequacy ratios are a metric that calculates the proportion of the bank's capital that is expressed as a percentage of its risk-weighted credit exposures. Tier 1 Capital is regarded as the highest quality and typically consists of common equity, retained earnings, and non-cumulative perpetual preferred stock. Supplementary Capital (Tier 2) is achieved through the utilization of subordinated loans to strengthen the Bank's capital structure.

According to POJK's "Capital Adequacy Ratio Requirement for Commercial Banks," all banks in Indonesia are required to maintain a minimum capital adequacy ratio of 8%, alongside to maintaining several capital buffers.

Table 3 - BTPN CAR compared to industry

From 2019 to 2023, BTPN has consistently increased its aggregate capital. This positive trend is demonstrated by the consistent increase from Rp34,803,067 million in 2019 to Rp41,157,380 million in 2023. One of the contributor to this was a merger with SMBCI in 2019.

As for OTO Group, according to POJK 35/2018 The Company is obligated to, but not limited to, the following: 

• Maintain a gearing ratio that does not exceed the maximum limit of 10 times 

• Have an equity of at least Rp100 billion 

• Have an equity to paid-up capital ratio of at least 50%

   

A low gearing ratio indicates a more conservative approach, but it may also restrict the company's growth potential. Both OTO Group has complied to maintain gearing ratio by not exceeding POJK limit. The consistently high gearing ratio of SOF suggests a more aggressive financial strategy. Although this may result in increased growth, it also puts the company at a higher financial risk.

Operational and Financial Synergy

Operational Synergy

Economies of Scale – Shared Ecosystem, Cost Efficient & Profitability

Economies of scale in the context of Bank BTPN acquiring OTO & SOF are predominantly derived from the potential to enhance efficiency and reduce costs through the combined operations. Because BTPN and OTO Group are operating in relatively the same industry (financing business), both companies can shared ecosystem and create a more integrated shared database. Services and products can be delivered more efficiently to a wider customer base through a consolidated distribution network. SOF had already 253 operational areas, operating all throughout Indonesia and OTO with 166 office network. Together both company can reach untapped financing market in Indonesia with shared infrastructure.

Higher growth of loan disbursement/financing

Based on annual reports above, it shows that one of the consideration of OTO Group acquisition is due to higher loan disbursement in joint financing sectors that rose up to 1,138,955 in 2023 compared to 2022 which only 145,699.

BTPN The Net Interest Margin (NIM) increased from 6.36% in the previous year to 6.45%. The growth of 7.6% in corporate segment loans, 17.7% in SME financing, and 131.1% in Jenius lending, as well as Joint Finance financing of 681.7%, were the primary factors contributing to the increase in net interest income.

Financial Synergy

Financial synergy payout might take the form of increased cash flows or a lower cost of capital (discount rate). When a firm with extra cash/"cash slack" (and limited investment possibilities) combines with another company with profitable projects (but limited cash), the extra cash can be used to fund those projects, unlocking the value creation. A larger, more diverse financial companies frequently has lower borrowing costs. 

By integrating the activities of BTPN and OTO Group, the business can benefit from economies of scale in financing, lowering the cost of capital and cost of fund. OTO Group can receive funding for working capital from BTPN as a controlling shareholder, and the integration and expansion of both ecosystem and also digital services, will further enhance BTPN to diversified into new product and service offerings. OTO Group has a history of constant dividend payment in the last 5 years. As the majority shareholder, BTPN will receive a substantial portion of OTO Group's dividend payments. This persistent dividend payment can boost BTPN's earnings per share (EPS) and overall profitability.

Diversification 

The acquisition of OTO Group is part of BTPN diversification to expand their business to financing activities through joint finance. BTPN had already financing business segment, but this segment is not the biggest portfolio growth. The acquisition is also a part of risk management strategy to have a well-balanced asset portfolio and part of optimization and diversification of lending taken by BTPN. 

Synergy Valuation

Stand Alone Valuation

Cost of Equity

Cost of equity is calculated using CAPM and consist of the following factors:

1. Risk- Free Rate

The author uses Indonesia Government Bonds Yield (5 years period) from Indonesia Rating Agency. 5 years tenor is chosen due to BTPN latest shelf-registered bonds that wil mature in 2024. According to Penilai Harga Efek Indonesia (PHEI), as per Jun 24, 5 year government bonds yield is at 6.98%.

1. Beta

Beta measures the relationship between the returns of Bank BTPN's stock and the overall market returns. The author obtained the latest BETA beta from Pemeringkat Efek Indonesia (Pefindo) which was 0.575.

1. Market (Equity) Risk Premium

Damodaran Country Default Spreads and Risk Premium to derive the risk premium figure. Based on the table provided below, the author points out an equity risk premium of 7.38% that is specific to the Indonesian market.

After considering the factors mentioned above, we can calculate the cost of equity (ke) for BTPN using the CAPM formula:

k_e = Risk Free Rate + Beta * Equity Risk Premium

k_e = 6.98% + 0.575*7.38%

k_e = 11.2%

Free Cash Flow to Equity Model

According to Damodaran's theory (2014), in order to estimate the value of BTPN using FCFE, several fundamental assumptions need to be made. These assumptions are outlined below:

• The growth in a bank's asset will have an impact on the total risk weighted assets (RWA) and consequently influence the bank's Capital Adequacy Ratio (CAR). Thus, the calculation for estimating regulatory capital growth will rely on the historical growth of RWA for BTPN as shown on table below. By excluding RWA after BTPN merger with SMBCI in 2019, projections, the RWA is expected to experience a steady annual growth rate of -0.6% over the next 4 years,

Table 4 - BTPN Average RWA Growth

1. The CAR target in the next five years will also have an impact on the growth of regulatory capital and RWA growth. The author believes that the CAR in 2024 will be 25.6%, which is a satisfactory amount for BTPN. This is because BTPN has maintained an average CAR of 25.6% over the past 5 years. It is assumed that the decline of CAR will be accordant  each year. Based on the current CAR of 29.29% and a target CAR of 25.6%, it is expected that the CAR will gradually decrease by 0.7% per year or 3.69% over a span of 5 years, from 2024 until 2028.

Table 5 - BTPN Average CAR

Furthermore, given that determining regulatory capital from Tier 1, it is assumed that the Tier 1 to Total Capital ratio remains constant at 88.7%. This ratio is calculated using the actual Tier 1 to Total Capital ratio as of December 31st, 2023.

• When figuring out the FCFE amount, Return of Equity is the most important thing to look at. In this case, it means comparing net income after taxes to regulatory core (Tier 1) capital. Based on historical average growth rates, the author thought that ROE growth from 2024 to 2028 would be in the form of a compounded growth rate of 9.5% using average historical ROE. Since BTPN is already stable and working at its best, ROE growth is higher each year.

   

• Regulatory capital is determined by multiplying risk-weighted assets by the target CAR. A constant 88.7% of total capital is used to compute Capital Tier 1. The regulatory capital change refers to the annual increase in capital required to accommodate the expansion of the asset base. The desired ROE per year is multiplied by Capital Tier 1 to determine net income as the source of cashflow. Subsequently, the present value of FCFE can be determined by subtracting net income from the change in regulatory capital and discounting it using the cost of equity.

   

• Likewise, the terminal value must be determined after five years, with the assumption that FCFE will continue to increase at an even rate. Consequently, the terminal value is determined by using the risk-free rate as the stable growth rate, which is determined by the following formula:

The following is a comprehensive summary of the aforementioned assumptions, as well as a detailed computation of the PV of BTPN stand alone:

Table 6 - BTPN PV FCFE

Combined Valuation

Cost of equity

1. Risk- Free Rate

The author uses Indonesia Government Bonds Yield (5 years period) from Indonesia Rating Agency.

1. Beta

Since the target company is a private company and not publicly traded, therefore we need to calculate the unlevered beta using comparable industries of multi finance company, using Pefindo beta stock as of April 2024 as follows:

Table 7 - Comparable Industries Beta

Unlevered beta is derived from the following equation:

Beta of BTPN is 0.58, with firm value of 29.683.508 (in million IDR) and Beta of OTO Group is 0.78, with combined firm value of 4.065.860 and 2.773.344. The beta combined is 0.61, which is higher than stand alone beta of 0.58

1. Market (Equity) Risk Premium

   1. We use the average RWA growth after the acquisition. An analysis of post-merger and acquisition data revealed a 20.2% growth in the average RWA in the first quarter of 2024. Using the first quarter RWA as the base of the projection, the average growth is shown in table below:

k_e combined = Risk Free Rate + Beta * Equity Risk Premium

k_e combined = 6.98% + 0.61*7.38%

k_e combined = 11.5%

Free Cash Flow to Equity Model

To calculate the FCFE of the combined firm, the author use consolidated financial statement of BTPN and OTO Group after M&A in first quarter 2024. The assumption are outlined below:

Table 9 -  Average RWA combined

An analysis of post-merger and acquisition data revealed a 1.45% declined CAR in the first quarter of 2024. Taking the current CAR into consideration of average CAR of 5 years backdated, the projected CAR in the next 5 years is assumed at 25.98%, with the decline of each year of 0.4%.

Table 10 - Average CAR combined

• Based on historical average growth rates, the author thought that ROE growth from 2024 to 2028 would be in the form of a compounded growth rate. Since the data of  consolidated net income of the first quarter does not represent year on year growth, we used last year as the calculation basis. The initial effect on ROE at the early stages may be neutral or even negative as a result of transaction costs, restructuring expenses, or integration challenges. Hence, the author decided that the growth of ROE is assumed to be at a compounded growth rate of historical ROE of 8.9% on average.

• The target CAR is multiplied by risk-weighted assets to determine regulatory capital. Capital Tier 1 is calculated by utilizing a consistent 89.7% of the total capital. This ratio is calculated using the actual Tier 1 to Total Capital ratio as of March 31^st 2024, with total tier 1 of 41.451.022 and total regulatory capital (tier 1 & tier 2) of 46.202.843

• Similarly, the terminal value must be determined after five years, based on the assumption that FCFE will continue to increase at a consistent rate.

Table 11  - PV FCFE combined

Therefore, the calculated synergy is as follows:

Table 12 - Synergy Calculation

The ultimate objective of any merger and acquisition is to achieve a result greater than the sum of its parts, 2+2 = 5. The breakdown of the acquisition synergy, which was determined by analyzing the individual values of the OTO Group and BTPN firms separately, as well as their combined value. The synergy achieved from this purchase has resulted in a 33% increase in value. Based on E.Y Capital Agenda Insight (2014), in order for the deal to be considered successful, the NPV of synergies target should be 15%-30% higher than the purchase price. Thus, it appears that the acquisition of OTO Group by BTPN is considered beneficial.

Conclusion

The timeframe for achieving synergies following an acquisition can vary significantly. Economic conditions, industry dynamics, and the complexity of the integration process are all vital factors. Typically, the first year or two may yield some initial synergies, such as cost reductions through operational efficiencies. Nevertheless, the complete potential of synergies, which includes revenue growth and an improved market position, frequently requires a longer period of time to be realized.

Synergy from the combined firm including operational and financial synergy. The combined operations will create a shared and integrated ecosystem, enabling efficient delivery of services and products to a wider customer base and cross selling opportunity. With a large unbanked population and rising internet penetration, the combined companies can reach untapped financing markets in Indonesia.

BTPN and OTO Group's integration can reduce cost of capital and cost of costs, benefiting both business. OTO Group has maintained a consistent dividend payment pattern over the past five years. 

BTPN will receive a significant portion of OTO Group's dividend distributions as the majority shareholder. This consistent dividend payment has the potential to increase the overall profitability and earnings per share (EPS) of BTPN. Furthermore, diversification of income streams of joint financing, BTPN can reduce reliance on traditional banking products which will later on stabilize earnings. 

The value of synergy is Rp 2.1 billion and exceed the OTO firm’s value by 33%. Therefore, the acquisition of OTO Group  by BTPN is categorized as successful. The value come from the calculation of free cash flow of equity to the firm using discounted cash flow valuation method. The net present value of synergies derived from subtracting the firm value of OTO Group and BTPN as standing alone firm. The assumptions set for the calculation referred to historical data of BTPN and consolidated financial statements after the acquisition. 

Recommendation for BTPN

Given that BTPN has recently acquired a multi-finance company in the first quarter of 2024, it is essential to concentrate on customer focus by utilizing the combined capabilities of both organizations to identify opportunities to improve the customer experience. Furthermore, to formulate cross-selling strategies to optimize revenue potential. Also, to enhance the capabilities of Jenius as a platform and wealth management, can optimize distribution channels, collaboration across business lines, and establish strategic partnerships with the joined ecosystem. Lastly, to optimizing the cooperation between subsidiaries and SMBC Group by joint partnership and capital participation

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