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Morningstar | Deutsche Bank and Commerzbank Announce Start of Merger Talks

Deutsche Bank and Commerzbank formally announced the initiation of discussions aimed at a potential tie-up of the two German banks, which would form the second or third largest European bank with about EUR 1.9 trillion of assets. The announcement comes after speculations of a merger had intensified amid the lacklustre progress both banks have made over the last years in their respective restructuring efforts and anticipations of a lower-for-longer interest rate environment diminishes hopes of a macro-driven relief in operating results. We do not model for a potential tie-up, however, as we believe the likelihood of a deal to be slim at this point in time due to the many hurdles needed to be overcome as well as the early stage of the exploratory talks. Also, we question the strategic rationale for the deal with respect to the position both banks are in currently, their weak performance on restructuring efforts and M&A deals historically, as well as the soundness of the potentially resulting bank. Fair value estimates of EUR 9.2 and EUR 10 per share for DBK and CBK, respectively, and no-moat ratings are unchanged.

The notion of bigger is better that underlies the thinking of pro-deal advocates is flawed in our opinion. The German financial system is highly fragmented and competitive, filled with state owned cooperative and savings banks keeping profitability low relative to other European jurisdictions. As such a post-deal bank would not be likely to carve out a moat due to the unattractive nature of Germany’s banking system and competition from banks without a profit motive.

The wish of politicians to create a German champion bank to support Germany’s large SME market globally and prevent both banks from becoming takeover targets themselves is understandable; however, the risk of creating an even larger troubled bank is high in our opinion.

A deal would ultimately be born out of weakness with the aim to lift both banks out of their respective ailments. A clear underlying assumption for this doubling down to work however is that the problems both banks face currently disappear in the process. We think this is unlikely. Deutsche Bank’s bedridden investment banking arm that relies on investment in staff and signals of confidence will not be rescued from its downward spiral by bolting on Commerzbank’s retail and wholesale business. Commerzbank exited the investment banking space due to its low profitability, hence we think it is unlikely that there are significant cross-selling opportunities when combining Deutsche’s investment bank with Commerzbank’s portfolio of SME clients.

As alluded to already, the resulting stronger deposit taking business would be focused on the highly competitive German market and therefore not value accretive in the long run, in our opinion. As such, we believe the post-deal bank would face the same issues in investment banking and its spread business as DBK and CBK currently do. On top of this, the deal would create significant execution risks. A good example is the still ongoing integration of Postbank, which Deutsche acquired in 2010.

Other potential hurdles include pressure from labour unions as a deal could eliminate 20,000 or more jobs. We also foresee headwinds coming to an agreement on the respective valuations in a potential deal as both banks’ investors had to swallow multiple dilutive rights issues since the financial crisis in 2008 and won’t be keen on being watered down further. Finally, outside a merger of equals, depressed multiples increase the cost of capital making it an expensive time to do a deal.