Analysis: ANZ's Asia gamble; time to splash the cash?

SYDNEY (Reuters) - HSBC banker Michael Smith's 2007 presentation on how he would grow ANZ , Australia's No.4 lender, across Asia to rival his own bank and Standard Chartered so impressed ANZ's board they appointed him CEO.

Five years on, Smith looks set to miss his initial target - to more than double Asia Pacific's share of ANZ's profits to 20 percent by this year - and will need stellar 25 percent profit growth over the next five years to hit updated goals.

The new target has been widened and lengthened - to double the profit contribution from Asia Pacific, Europe and America (APEA) to 30 percent by 2017. APEA currently brings in 15-16 percent of overall profit.

Missing those targets five years down the line would risk relegating ANZ to an also-ran in Asia, where Standard Chartered gets four-fifths of its income and more banks are looking to build a regional profile.

Analysts say ANZ needs to throw its customary caution to the wind and make some acquisitions. Its "super regional strategy" aims to capture booming Asian growth, trade, investment flows and cash deposits as Western lenders pull out and a highly concentrated Australian banking market slows.

Smith arrived at ANZ with more than a decade of Asian banking know-how and a reputation for deal-making, including HSBC's 19 percent stake in Bank of Communications and Hang Seng Bank's stake in Industrial Bank , both in China in 2004. At ANZ, he's made just one Asian acquisition, but has overseen capital invested in APEA markets rise to $9 billion, or a fifth of group capital.

"Our view is that the 2017 target is not achievable at the current run rate. ANZ will need to make some bolt-on acquisitions," said Paul Dowling, principal analyst at banking analytics firm East and Partners, adding that his analysis shows APEA will account for below 25 percent of ANZ profits by 2017.

MISSED OUT

After its most visible move into Asia, paying $550 million for Royal Bank of Scotland assets in six countries in 2009, ANZ has missed out on other buys, such as a $4 billion auction for Korea Exchange Bank in late 2010.

The current global economic turmoil should put more assets on the block in Asia as banks move to free up capital, and advisers who have worked with ANZ say it should target mid-sized, family-owned Hong Kong banks where valuations have slipped. It should also look at breaking into markets such as Thailand and Myanmar, they said.

In Thailand, ING is selling its stake in TMB , the country's seventh-largest lender, while General Electric is likely to sell its one-third stake in Bank of Ayudhya .

"ANZ has been quite cautious so far. Sometimes one needs to loosen the purse strings. ANZ can't keep waiting," said one source who has worked with ANZ, noting the bank is the best capitalized among its local rivals and can easily raise the funding for acquisitions.

ANZ has an experienced M&A team and has taken a look at a number of assets, but prides itself on its cost discipline, though Smith, who owns a collection of Jaguar and Aston Martin cars, admits his M&A team can't "twiddle their thumbs" for long.

Large shareholders, who have been burnt in the past when Australian banks forayed overseas and had to take big writedowns, are content with domestic profits and so aren't pushing Smith to chase acquisitions. Despite the hype over Asia's growth prospects, clients still hold ANZ as a domestic play rather than in their regional portfolios.

"To me, they're still an Australian bank with an Asia focus," said Simon Burge, chief investment officer at ATI Investments, which owns ANZ shares.

M&A DISCIPLINE

Smith, 55, may have to move swiftly.

Brian Hartzer, one of the ANZ insiders Smith pipped to the CEO post five years ago, is now at rival Westpac Banking Corp and is seen there as CEO-in-waiting. Smith's other rival then, Graham Hodges, is ANZ's deputy CEO. Also, other Asian banks have renewed regional aspirations, such as Singapore's DBS and Malaysia's CIMB .

"Mike Smith has been among the most accurate callers of global economic conditions in the banking industry in the past few years," said Chris Hall, senior investment officer at Argo Investments, which owns ANZ stock.

"He's been astute and cautious even when things looked to be picking up a couple of years ago. He knows assets and business lines will come up for sale from the national banks soon and he's in a good position to cherry pick," he said.

A spokesman for ANZ notes that the bank's Asia earnings are in US dollars and so have faced forex headwinds as the currency has run up nearly a quarter between 2008 and now, as well as the impact of the global financial crisis.

"We've moved from being a bank with a presence in Asia to an integrated and growing, regionally focused international bank," he said, adding ANZ would look at acquisition opportunities, though these will have to pass "consistent and disciplined M&A criteria" such as price and strategy fit.

"The main focus of our strategy is organic growth, but as some European banks retreat to their home markets, we expect there may be opportunities. However, that's not our main focus.

ANZ shares have lost a quarter of their value since Smith took over in October 2007, in line with most local rivals, but have outperformed the benchmark index <.axjo>, Standard Chartered and HSBC.

HIGH COSTS HAMPERING GROWTH

The Asia growth strategy has come at the expense of ANZ's wealth management arm. The bank's share of Australia's $1.4 trillion wealth market, at under 10 percent, is little more than half that of its peers.

But, at around 1.5 times book value and with a 12-month median price target of A$24 a share, ANZ trades in line with local peers National Australia Bank , Commonwealth Bank of Australia and Westpac, and carries almost the same upside.

In a recent presentation, ANZ said it was keen to get into Thailand and Myanmar and expand in China, Indonesia and India. Last month it invested A$300 million in its Chinese operations, taking its spending there to A$700 million.

ANZ's APEA net profit has seen compound annual growth of 31 percent since 2007, on 38 percent revenue growth, but most of that came in the first three years. Growth has slowed to around 20 percent and will slow further as the base gets bigger and competition increases, analysts said.

The bank has acquired over 1,300 Asian customers, including 250 global corporates in Asia Since 2009, and seen its trade finance and cash management businesses grow by more than 40 percent in June-December last year. Its global markets business revenue last year was $1.7 billion, well below HSBC's $11.6 billion and $4.6 billion at Standard Chartered.

And costs are a persistent nag.

Analysts estimate ANZ's APEA business return on equity (RoE) at 13 percent - versus the overall group's 19 percent. This is largely due to its Asia cost-to-income ratio of 56 percent, 11 percentage points higher than the group level and higher than the 52 percent for Asia at HSBC and Standard Chartered.

ANZ blames those high costs on its investments, and has re-focused on cost controls by using cheaper locations, improving processes and reducing a focus on costly retail banking. Getting all its systems to comply with local regulations in different countries is likely to keep the pressure on costs.

"It'd be great if ANZ says Asia technology and structure will take precedence. Tech investment is woefully slow and there are just too many role duplications," said a current ANZ staffer in Asia, who did not want to be identified.

ANZ counters that it has made "significant progress" in building the technology and risk systems that underpin its super regional strategy. "These are not things you can build overnight, and given the capacity we've created over the past four and a half years we're now in a position to further accelerate execution of our strategy," the spokesman said.

(Reporting by Narayanan Somasundaram; Editing by Ian Geoghegan)

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