The Anglo File: Royal Bank's Bid for NatWest Could Leave Bank of Scotland Vulnerable

By locking horns with Royal Bank over NatWest, Bank of Scotland has effectively left itself vulnerable to becoming a takeover target.
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LONDON -- To lose one partner might be regarded as misfortune. To lose two looks like carelessness.

This is how

Bank of Scotland

shareholders may well feel. Earlier this year the bank was forced to abandon its proposed online banking venture in the U.S. with

Pat Robertson

after the TV evangelist made some controversial comments about homosexuals in Scotland. And now it seems the bank is on the verge of losing out again, this time to the

Royal Bank of Scotland

in a battle for the U.K.'s

National Westminster Bank

(NW)

.

Even though NatWest rejected Royal Bank's initial bid, forcing Royal Bank to launch a hostile bid on Monday, most analysts believe the conciliatory tone of NatWest's response to the bid, together with a small sweetener, should see the English bank recommending the offer to its shareholders.

On almost all fronts, Royal Bank's bid looks more attractive than Bank of Scotland's. Royal Bank is offering 0.968 of its own shares plus 305 pence ($4.87) in notes for each share of NatWest. This is the equivalent of 15.90 pounds for each share and is higher than the Bank of Scotland's offer of 14.57 pounds per share, if the plan for a special dividend of up to 2 billion pounds is excluded.

On Tuesday, Royal Bank's shares closed down 2.5% at 12.10 pounds and Bank of Scotland was up 2.2% at 744.5 pence. NatWest ended up 0.3% at 14.40 pounds.

As well as the bigger cash component of the offer, Royal Bank's cost-cutting program of 1.2 billion pounds is larger and more credible than Bank of Scotland's, and its management is generally regarded as having greater experience integrating acquired companies. On Tuesday, Royal Bank also received backing from a number of key institutions. The Spanish bank

Banco Santander Central Hispano

, Royal Bank's largest shareholder, gave a thumbs-up to the bid, as did the U.K. insurer

CGU

, another large shareholder.

The only thing Bank of Scotland really has going for it is that the U.K.'s

Department of Trade and Industry

cleared its bid for NatWest on Thursday, while the authorities have yet to do so for Royal Bank's. But even though Royal Bank does have a larger branch network in England than Bank of Scotland and, as such, there are greater competition concerns, the government and the

Office of Fair Trading

are unlikely to see this as enough to prevent the merger from going ahead.

To the victor go the spoils ... what, then, is the fate of the vanquished?

"In general, the failure of such a bid shows to all a certain vulnerability," says Jonathan Iseson, general partner of

Blue Water Partners

, which doesn't hold shares of any of the banks involved.

By embarking on a hostile battle for NatWest, Bank of Scotland has effectively left itself vulnerable to becoming a takeover target. Recent hostile bids for NatWest now make such moves a more realistic approach in the U.K.

However, Simon Samuels, analyst at

Salomon Smith Barney

, which has no investment banking relationship with Bank of Scotland, points out that Bank of Scotland's move for NatWest was clearly opportunistic -- a point that NatWest repeatedly made in its final defense document -- and as such "should not be seen as raising fundamental issues about Bank of Scotland itself." Samuels has an outperform rating on Bank of Scotland.

Rather, the most important fundamental shift in the U.K. banking sector resulting from this fracas over NatWest is the clearer regulatory attitude of the government and the Office of Fair Trading to banking mergers. The authorities' approval of the Bank of Scotland/NatWest bid and, as is likely, the Royal Bank of Scotland/NatWest bid, will undoubtedly embolden other banks to consolidate.

And more than most, Bank of Scotland is sure to come under pressure from its shareholders to team up with someone else, such as

Barclays Bank

(BCS) - Get Report

or

HSBC

. "This has opened its board up to the fact it has to do some form of transaction just to do something," says Blue Water's Iseson.