Upside in Undervalued Mitsubishi UFG Financial Group

We see upside to our fair value estimate for

We see very little risk in closing the announced deal in three phases after acquiring the initial stake of 19.9%. By the third quarter in 2018, MUFG is expected to complete the 40% acquisition in cash from Danamon’s current majority shareholder, Singaporean sovereign wealth fund Temasek Holdings. Subject to regulatory approvals, MUFG is then expected to complete the remaining acquisition for a total stake in excess of 73.8% from Temasek and other minority shareholders.

Indonesia benefits from an improving banking environment as reflected by Moody’s upgrade to the country’s low triple-B credit rating outlook to Positive in February 2017. Less vulnerability to the external environment and more stringent fiscal discipline--with the deficit ceiling up to 3% of GDP--has allowed the country to build a longer track record indicating more reliable systemic supports closer in line to those in developed countries. Given the current environment diverging from its past, we think it has become meaningless for the national regulators to keep a foreign ownership cap of 40%. Furthermore, the national regulators are modestly incentivized to lower Danamon’s unacceptably high loan to deposit ratio tracking above 120% to be below the regulatory ceiling of 92%.

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