THE signing of a preliminary agreement for a merger between Thai Danu Bank and Finance One Plc only marks the start of a gruelling consolidation in the Thai financial industry.

Yet nobody can guarantee that this unprecedented deal will succeed since it will be subject to complicated valuations and, more crucially, to approval from shareholders.

The finance and banking authorities have made it clear that this Thai Danu/Fin-One deal must not fail because they would like it to serve as a model for other mergers and acquisitions in the finance sector. This was evidenced by the presence of Amnuay Viravan, the finance minister, and Rerngchai Marakanond, the Bank of Thailand governor, who presided over the signing of the memorandum of understanding on the merger of the two institutions at the central bank's Bangkhunphrom headquarters.

The general impression was that the authorities almost literally forced Pornsanong Tuchinda, the president of Thai Danu, and Pin Chakkaphak, the president of Fin-One, into inking the MOU. ''This deal just cannot fail," Siri Garnjaroendee, assistant BOT governor, was quoted as saying last week.

As guardian of the Thai financial system, Amnuay intends to shake up the finance sector to prevent a recurrence of the financial crisis. Earlier, he indicated that the symptoms of some finance companies are so severe that leaving them untouched over the next three to six months will certainly create a financial crisis beyond repair. The only way to cure the malaise of the debt-ridden finance companies is through recapitalisation and system-wide mergers and acquisitions between the 91 finance companies.

Phatra Thanakit Plc clinched this deal as a financial adviser. Both Thai Danu and Fin-One have also appointed Baker & McKenzie to conduct due diligence. The exchange or swap ratio of shares between the two institutions, which will merge to become a brand new entity and retain the name of Thai Danu Bank Plc, will be determined in 30 days, according to the memorandum of understanding. Both sides will have to further consult each other on assets, liabilities, contractual agreements and organisational structures.

By law, the new Thai Danu Bank Plc must be capitalised at Bt6.64 billion, derived from adding Thai Danu's share capital of Bt2.50 billion (250 million shares) with Fin-One's share capital of Bt4.14 billion (414 million shares).

Equalising the prices of both stocks to get a fair value of the new stock is not going to be easy. Since Thai Danu's current price is Bt43 a share, its market capitalisation value is Bt10.75 billion. At Bt23.75 a share, Fin-One's market capitalisation value is Bt98.32 billion. Adding together the market capitalisations of both companies and dividing the figure by their combined outstanding shares produces an average share price of Bt30.99 for the new Thai Danu.

Certainly, Thai Danu shareholders will not accept a share price of Bt30.99 because their shares are now worth Bt43. To equalise the share price, it is necessary to split Thai Danu's shares so their price comes close to Fin-One's. This can be done by raising the capital of Thai Danu, probably through a one-for-two rights issue at par value.

In addition, Thai Danu shareholders won't accept the present market value of Fin-One at Bt23.75 a share because the finance company has not yet stripped off its bad assets or liabilities to reflect the actual book value of its stocks. Only after Fin-One's book value is calculated can it be placed in the equation for the share swap.

The MOU states that the allocation, valuation and total number of shares of the new Thai Danu will be determined by market value and/or the true asset value. This means that Thai Danu will not take advantage of Fin-One by demanding a further discounting of its stocks.

Nobody presently knows the level of Fin-One's debt. So in theory, Fin-One's stocks, after the asset stripping, may be worth Bt15, Bt10 or Bt1.

The issue of real estate and hire-purchase loans will also have to be settled before the merger is to take place. Fin-One's hire-purchase loans amount to Bt15-Bt16 billion, while its real estate loan portfolio reaches about Bt25 billion. Fin-One has already sold off its hire-purchase loan portfolio at a discount and intends to further downsize its real estate portfolio before bringing it into the government-sponsored Property Loan Management Programme.

Since Pornsanong has indicated that Thai Danu prefers to retain Securities One Plc, Thana One Finance & Securities Plc and One Investment Management Co Ltd, Fin-One will have to liquidate all of the assets of its subsidiaries, which were behind the collapse of Fin-One. During this economic slump, it may be rather difficult to find buyers for Fin-One's assets.

Governor Rerngchai said the BOT, through the Fund for Rehabilitation and Development of the Financial Institutes, will provide liquidity backing for Fin-One and the new organisation before and after the merger is completed. Furthermore, the authorities will coordinate closely by seeking a tax waiver from the Finance Ministry to ensure completion of the transaction.