Virgin Money and CYBG agree merger to 'disrupt status quo'

Virgin Money has accepted a £1.7bn takeover offer from CYBG, the owner of Clydesdale Bank and Yorkshire Bank, to create a banking group large enough to "disrupt the status quo" in UK banking.

CYBG will pay 1.2125 of its own new shares for each Virgin Money share, valuing them at 371p apiece, based on CYBG's closing price at the end of last week of 306p. The combined £4.4bn group, which will have around £70bn of assets, will be around 62% owned by current CYBG shareholders and 38% by those of Virgin Money.

A key condition to the deal has been agreed with Richard Branson's Virgin Group for the Virgin Money brand on an exclusive perpetual licence, where a fixed yearly minimum royalty will be payable by CYBG of up to £3m during the period from completion of the deal to the first quarter date, then £12m in the first year up to £15m in the fourth year. From the fifth year the payment will comprise a minimum £15m plus an additional yearly royalty of 1% of CYBG turnover above a certain level.

CYBG's current chairman, chief executive and chief financial officer, Jim Pettigrew, David Duffy and Ian Smith, will retain their current roles, with Virgin Money CEO Jayne-Anne Gadhia agreeing to work in a "consultancy role" as a senior adviser to the Duffy for a period of time beyond completion of the takeover. The combined group will be headquartered in Glasgow.

The deal is expected to complete during the fourth quarter of 2018, subject to a shareholder vote on both sides. Both boards have recommended their shareholders vote in favour of the deal, which has been irrevocably backed by Branson's Virgin Group, which has a 35% stake.

"It is clear to us that the combined group can transform the UK banking landscape and offer real benefits to customers and communities throughout the UK," said Pettigrew, adding that the merger of the two business can "create a powerful force in UK banking".

With the combination expected to generate £120m of annual pre-tax cost synergies out of a combined group cost base of around £1bn by the end of the September 2021, Duffy added: "The combination of CYBG and Virgin Money will create the first true national competitor to the status quo in UK banking, offering a genuine alternative for consumers and small businesses.

"By combining two of the UK's leading challenger banks, we will create a national, full-service bank with the capabilities needed to compete effectively with the large incumbent banks. We are bringing together CYBG's 175-year heritage in serving retail and SME customers and advanced digital technology, with the iconic Virgin Money brand and consumer champion credentials."

"Together we will serve around six million customers, with the scale, capabilities and financial muscle to disrupt the status quo - and with a clear ambition to provide our customers with the best service in the UK."

Shares in the pair were little moved on Monday, both marginally in positive territory, with Virgin Money almost flat at 355.1p and CYBG up 0.2% at 306.8p.

While some have suggested that the terms of the deal aren’t exactly generous, Michael Hewson, chief market analyst at CMC Markets, felt the deal is less about the terms than whether it's a good fit for the two banks. "On their own both banks are likely to struggle for market share while together they are a decent fit, and will probably be more durable in terms of competing on the same playing field."

He pointed to Virgin's strong digital presence and decent presence in mortgages and credit cards, via its purchase of Northern Rock, while CYBG is strong in current accounts and personal banking.

"While it will certainly help competition in the UK banking market which has suffered to some extent from a lack of competition, it’s unlikely they will make much of a dent in terms of eroding the market share of the big four. Another problem the two businesses will face as TSB will testify will be integrating two different IT systems without too many hiccups, which will probably mean that consumers won’t see too much in the way of benefits for quite some time."

Analysts at broker Shore Capital said the combination has "much strategic logic", with their differing areas of strength and the potential additional economies of scale from overlapping strengths in savings and mortgages.

"From a financial standpoint, the transaction is expected to be materially earnings accretive for CYBG," ShoreCap added, suggesting that perhaps of more importance is return on investment, which based on its current full year adjusted earnings per share forecast for Virgin Money of 40p, equates to roughly 11%, or a price ratio of just over 9 times earnings, before synergies.