Prompted by the announcement of the government acquiring Kiwibank for $2.1 billion, I wanted to know how they calculated that. The amount is large, about $400 per New Zealander. If you spend over $400 on something, I’m guessing you’d want to know why $400 and not one dollar, or perhaps $350?
In the last couple of weeks, I’ve been working on the Kiwibank value question. You might say my quest for Kiwibank’s value is irrelevant because the transfer of ownership looks like a reshuffle of deck chairs: The new and the previous owners are all government or government owned. As I will explain in a next blog post, I disagree with the narrative of the seemingly innocuous reshuffle. For now, however, I will focus on the valuation of Kiwibank, or more precisely, the entire group: Kiwi Group Holdings Limited, which includes Kiwibank, Kiwi Wealth, and NZHL. When the parties involved came up with that $2.1 billion dollar figure, how did they do it?
Show me your workings
To answer that question, I sent OIA requests to the sellers and buyers: ACC, NZ Post, NZ Super and the Treasury. I asked for information including calculations, assumptions, and workings that support the valuation of $2.1 billion. I also asked for information about parties (banks, investment banks, consultants, others) that participated in the valuation process and the fees they received for their services. In all, I submitted six questions per request.
Unfortunately, none of the receivers of my OIA requests gave me the answer I was hoping for. My OIAs were all declined, mostly because the information I requested was considered confidential. Some of the replies raised my eyebrows. For example, one former owner mentioned:
“As part of the acquisition, all stakeholders settled on a fair valuation taking into account KGHL’s growth and prospects.”
Perhaps, but International Financial Reporting Standards define a fair value as
“the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price).”
The IFRS definition of fair value relies on an orderly market. This implies at least some level of transparency. My declined OIA requests, however, indicate that the terms of the acquisition are not really transparent. (In fairness, I cannot rule out that the previous owners, having lost interest in the bank, may have tried to value Kiwibank to test the market. A market of sorts may have existed, but it was not open to everyone.)
But what about the acquirer? Treasury’s response was almost comical:
“Your request as written, appears to seek something in relation to the proposed purchase of Kiwi Group Holdings Limited that does not exist – namely a $2.1 billion valuation. The figure you refer to is the price that was agreed between the parties through a negotiation process. The Crown did have valuation work undertaken but the parties neither collectively nor (as far as we are aware) individually have a specific valuation provided at $2.1 billion. … Consequently, I am refusing your request under section 18(e) of the Official Information Act … [because] … the document alleged to contain the information requested does not exist or, despite reasonable efforts to locate it, cannot be found.”
The Treasury apparently wants us to believe that the figure of $2.1 billion was the result of, for the lack of better words, … horse-trading.
For those in doubt, this is what the government announced on 22 August:
There was a $2.1 billion valuation!
Please forgive me for thinking New Zealanders deserve a better response from the Treasury.
As a result of the disappointing answers to my OIA requests, I decided to determine Kiwibank’s valuation for myself. Knowing how to value a company from my experience in teaching firm valuation is certainly possible. However, valuing firms or banks is more of an art than a science. The valuation depends on lots of assumptions, many of them about future values. And we all know that the future is uncertain.
To value Kiwibank I decided to use an approach that relies on so-called multiples. The reason to use this approach is that, in this case, traditional valuation approaches, based on discounting cashflows, do not work well. The applicable discount factor is low, volatile, and increasing, which will result in large valuation swings. It tried it myself, and the valuations ranged from $100 million to over $6 billion. That is useless.
The multiples-based approach depends less on future information. It instead relies on a group of comparable firms. These firms are very similar to the firm one wants to value. The difference is that the comparable firms are all listed. They all have a market value that we can use as a benchmark for the valuation of the unlisted firm we want to value, in this case Kiwibank.
For the group of comparable firms, it is then straightforward to find a representative Price to Earnings ratio or Price to Book ratio, which can be multiplied by the earnings and book value of the firm you are interested in.
To illustrate: suppose the average Price to Earnings ratio of the group of comparable firms is 15 and your (unlisted) firm reports a profit of $1 million. In this case, investors in the group of comparable firms are willing to pay $15 for a dollar of profit. With a 1 million dollar profit, the value of your firm is $15 million dollars. Likewise, using the Market to Book ratio: if the average M/B ratio is 1.25, and the value of book equity of your unlisted firm is $800 million, its market value is $1 billion.
The approach appears simple, but it has been proven to be effective in numerous studies. See, for example, this 2002 study by Jing Liu, Doron Nissim, and Jacob Thomas: Equity Valuation Using Multiples, published in a top-ranking academic journal.
Finding banks that are like Kiwibank
The challenging part of this approach is finding the right group of comparable banks. For Kiwibank, I chose banks from OECD countries plus banks from European countries that are not OECD members. I excluded banks from the US and Japan (because the accounting is different in the US, and because there are too many Japanese banks ending up in my sample). I also selected banks that are about the same size as Kiwibank and I filtered out banks with extreme values of critical variables, such as profitability and capitalization.
Using financial data from a commercial data provider (Datastream) I cast the net wide, and started with a sample of 255 banks. However, many of these banks are not really like Kiwibank. Many of them are too big, some of them are loss-making, others have super-high capital ratios.
After eliminating banks that are not really like Kiwibank, I ended up with a sample of 71 comparable banks. In a next step I used these banks to determine the value of Kiwibank using the P/E ratio, the Price to Book-equity ratio, and the Market to Book-equity ratio. The last two ratios are basically the same: the former relies on per-share data, the latter on the market capitalization of the bank and the book value of equity from the annual report.
Note that you can see my workings and code on this GitHub site.
The result: a 1.8 billion dollar bank
The results of my DYI valuation are as follows:
- The earnings multiple, i.e. the representative P/E ratio for the comparable banks, is 9.24.
- The Price to Book multiple for the group of comparable banks is 0.778 (on a per-share basis).
- The Market to Book value multiple for the group of comparable banks is 0.783.
These numbers are common in the banking industry, especially the below 1 Market to Book multiples.
Multiplying these numbers by Kiwibank’s earnings and book values from the RBNZ Financial Strength Dashboard, I get these values for Kiwibank
- $1.272 billion using the P/E ratio,
- $1.797 using the Price to Book multiple, and
- $1.810 billion using the Market to Book value multiple.
The valuation based on the P/E ratio is low, $1.272 billion, which may reflect a still weak profitability of Kiwibank.
I prefer to use book value valuations when it comes to banks, since these reflect profits accumulated over years and are less sensitive to current performance.
On that note, I am comfortable with the $1.8 billion valuation for Kiwibank.
The 300 million dollar gap
Now, I hear you say, the government valued the bank at $2.1 billion, what then explains the difference between that figure and my valuation, i.e. the $300 million gap?
One explanation for that gap is that my valuation is about the bank, while the government acquired the entire group, including Kiwi Wealth, which, subject to Overseas Investment Office approval, will be sold to Fisher Funds for $310 million dollars, which is very close.
Coda: What was all the fuss about?
It did not take me long to value Kiwibank, based on largely publicly available data. Maybe one afternoon. Granted, I have access to Datastream thanks to my employer. But, instead of paying for this costly source of financial data, you can use Yahoo Finance and get similar results. An equity valuation approach based on multiples is tried and tested, and it is straightforward to implement.
Of course, there is a bit of schadenfreude here. I am sure the parties involved in the transaction paid good money for the valuation of Kiwi Group Holdings Limited. It turns out that my approach gave me a sensible valuation without spending a lot of time. My GitHub page allows you to replicate my work and do your own valuation. Again, it would be nice to know what parties paid for the valuations.
In all, I am not sure if I am done yet with the acquisition of KGHL. The valuation looks fine, and the acquisition looks like an innocuous reshuffle of shares between government and government owned entities.
So why the lack of transparency around the valuation of Kiwi Group Holdings Limited?
Why did the Treasury gaslight me by telling me that the $2.1 billion valuation does not exist?
And why did Treasury inform me about a release of information, which … “will include around sixty reports and is scheduled to be released in early December 2022. These reports will include information which will be of general relevance to the negotiation process that led to the agreed price.”
Why early December 2022? My guess is that the Treasury will make some irreversible decision before the end of the month, something perhaps to do with the pending OIO approval?
Watch that space.