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Would SDBs image from being labelled as worst bank in China can be transformed to a

shining star by the magic touch of Newbridges secrect formula? Can SDB can be
converted into a healthy lending institution from its current state? These among other
questions were being raised in the mayhem of making this deal finalized.

Valuation of SDB

(Equity 2002 A) 521 x 17.89% x 1.6 = $149.131 MM


Divided by total number of shares = (($149.131 x 8.28) / 1,945,822,159) / 17.89% = RMB
3.547 /share

Valuation range can only be determined during book building process, whereby investors
will indicate their interest and demand for the shares of the listed company, and the
optimum valuation is the compromise between promotors ideal valuation and a realistic
price expectation by investor in todays uncertain market, amid an improving outlook.

SDB needs to decide the selling of its legal person shares to Newbridge that can help SDB
turnaround.
The process of valuation of SDB was not simple, various problems emerged including
appropriate valuation and related risk analysis.

Dual Track system in China is big attractant for foreign institutional investors leads to
heavy reliance on bank loans as the capital resources leading to both popularity and
profitability of the banking system

SDB is already a publicly listed company which has been able to attract lot of public funds

1) Promising future in banking industry 5th largest commercial bank and has
nationwide banking license. Right to scale up. Poor governance and capital
structure exist.
2) SDB involved in traditional commercial and retail banking in more developed
coastal region and leading role in pearl river delta. Fast loan growth due to regions
economic growth. Public offerings give opportunities and capital turnover.
3) Dispersed ownership can lead to control of the company easily. Low acquiring
cost, geographic advantage and huge potential is biggest up-side for this deal

Risks
1) Poor credit risk management lack of systematic credit policy and well authorized
approval mechanism coupled with poor organizational design. Poor asset structure
and risk control. Non-performing loans are the largest proportion of total loans. The
default loan results in great loss of SDB and such a risky assets seems to be
continuous.
2) Relationship with government Control with Shenzhen government so often
provide loan for municipal projects Major shareholders also the borrowers.
3) Conflicts worsen SDB situation lack of independent management and asset
quality problems.
4) Compensation plan not tied to performance & most board members are not
obliged to perform fiduciary duties to push forward changes in the interest of
dispersed shareholders.
5) Distrust from foreign investor. Such a control transfer may lead to loose of
business clients.

How to maintain current investors and exploit market is the biggest issues.

What can be done


1) Credit risk management a sound monitoring system and strict approval system
should be implemented, this would lead to decrease in NPLs
2) Build good relationship with Shenzhen govt. big change in board memebers

Advt.
1) Timing Shenzhen Bank govt. controlled bank with same legacy issues as state-
owned bank leading to undercapitalized balance sheet and low profitability
2) Rich experience Newbridge prior investment in Chinese companies. Aware of local
context. Successful turnaround of KFB
3) Shan extensive business relationship and proven track record international
reputation
4) No threat
5) Local advt. Hong Kong office
6) Competitive pricing 1.6 is actually good

Value Added

1) Operational efficiency Debt management Newbridge wont agree who are not
qualified but have petticoat influence.
2) Efficient management suffered from governance problems. Compensation not
attached to performance. New appointees are very experienced with Asian banking
system.
3) Good Market response the shares jumped after the announcement that foreign
investor buying huge stake in SDB. Newbridge could enjoy rising equity value
4) Agent cost savings Disperse equity structure. Management and ownership was
separated. The manager of SDB may sacrifice shareholder wealth for personal
benefits. If newbridge can also be the largest equity holder, this help in aligning
shareholder interest first.
Things to consider before valuation for SDB -
1) Price of SDBs tradable share in Chinese stock market
Immature emerging market Stock valuations in china on a growth adjusted
method were generally significantly higher than mature market (coz of limited
investors who were eagerly interested to switch their bank savings to stock markets
for higher returns.
2) SDB stake from 4 sellers were under non-tradable legal person share the govt.
planned to permit the conversion of legal person shares but did not launch the
conversion timetable
3) 5 year lock up period
4) Newbridge would be effective control of the company can appoint 8 board
members
5) Decreasing CAR just above the 8% level required for China Banking Regulatory
policy, it was probable that SDB would have to raise large amount of capital. This
would lead to dilution of Newbridge shares due to large capital infusion and
ultimately losing its status of being largest stake holder.

Reason for failure


1) Potential competitors The competitors strike a break up deal to be considered by
SDB, as SDB may get better benefit from elsewhere. By announcing the potential
deal, the shares surged up, and this attracted more passive competitors to be
looking forward to snatch this deal from newbridge. While foreign private equity
firms like The Carlyle Group and Morgan Stanley were unwilling to take on the
challenge, Chinatrust Commercial Bank (CTBC) seemed eager about this rare
opportunity and emerged as a potential investor willing to pay more than
Newbridge.
2) Management replacement There was a potential rumor that upper management,
who were key backers of the deal were replaced. The replacement have created a
hostile outlook for this deal to happen because of personal losses or just new govt.
officials want to exploit their power for purely personal gains
3) Private/personal interest conflict state-stake sell down is highly politicized step
going forward. As the borrower was the same as owner, replacing 8 board members
would jeopardize potential transactions conducted by SDB. As Shenzhen govt. was
concerned by the current situation of SDB, but current management team was
reaping off the benefit from SDB functions or deterioration. The newbridge SDB
take over can create a conflict from the current SDBs clients.
4) Immature party establishment As the new management team handling the deal
saw a surge in share price, might have realized that actually SDB worth a lot more
than few months ago. So, instead of re-negotiating deal with newbridge, then can
go and look for some other acquirer who can pay the better price.
5) Discontent of SDBs existing board members comprised of Shenzhen government
officers and senior executives from local SOEs, played a large role in the public
fallout. There was great tension between the transitional management team and
the existing board members because the Shenzhen officials on the board were
more concerned about their own job security than SDBs possible boost in
performance with Newbridges assistance
6) Undervalue for SDB Newbridge was depicted as a greedy foreign investor that
greatly undervalued the bank
7) Political shift Zhu Rongji, Chinas premier at the time, was a main supporter of the
deal with Newbridge. In March 2003, Zhu retired, the Cabinet was reshuffled, and
top officials at Chinas central bank and securities agency were also replaced. This
signified great uncertainty for Newbridge because key backers of the deal were no
longer there to solidify the agreement

Key Lessons
1) Dont take too much time to close the deal Since the announcement, it was
already 8 months. As lot of stakeholders eyeing on the deal which also included
traditional powerful politicians, this deal has to be executed quickly.
2) Newbridge could raise the bidding price The heating market reaction of the SDB
share price was potentially a prime reason that why shareholders might be
dissatisfied of what being paid off for SDB valuation.
3) Misappropriate potential offer my Chinatrust bank as the agreement had the
signature from leaders of SDB, no external party can interject the deal in that
situation. A no-talk clause can be exploit by Newbridge.
4) May have launched golden parachute The key leaders who might be replaced
from the board, can be paid a good satisfactory compensation to leave SDB

Going Forward First Request and then take legal action


Lacking only an official signature from SDB on the contract, Newbridge can urge the
Shenzhen government to honor its obligations under this binding international contract,
which in an official statement, pointing out that the Bank of China (BOC) and CSRC had
already approved this deal. Newbridge should highlight that this is more of a political
decision rather than a sound economic decision. Newbridge should decide to resolve this
problem outside court if not then they should take SDB to court (but there is potential
outcome of Newbridge ruining its brand).

Arbitration and Cross petitions -


Newbridge should file a suit against Chinatrust Commercial Bank, accusing for flagrant
unjustified interference with Newbridges contractual rights. If this doesnt work then
Newbridge should file a complain in ICC (International Chamber of Commerce) for
economic compensation of whatever have newbridge paid for its due diligence and for
negotiation time period, and possible hampering of Newbridges reputation.
Newbridge should remember that for them $150 MM is a drop in its portfolio and it should
be cognizant that SDB is under more pressure to make this deal happen, if not then SDB
would loose the opportunity to revamp its banking sector and gain public trust as a
neutral/unbiased governance. On the other hand, this case can also be forwarded to The
China Regulatory Commission for feedback as this body is looking for Chinas banking
system reform, for their potential support to Newbridge. This will create pressure on SDB
from Regulatory commission to accept the deal with no potential harm.