Publications & Resources
May/June 2008
Focus: Mergers & Acquisitions
The Difficult M&A Environment and What Potential Sellers Should Focus On
By Jeffrey J. Wishner
As of February 2008, Western independent bank merger and acquisition activity has been nearly nonexistent. Since September 30, 2007, only two Western community bank transactions have been announced, Stockmans Financial Group’s sale to PremierWest Bancorp and United Bancorp of Wyoming’s sale to Wells Fargo. That compares to 26 transactions in the first six months of 2007, when it wasn’t uncommon for banks to sell for over 3x book. As an M&A investment banker, the past six months have been frustrating as market volatility has “killed” several deals that had gotten past due diligence and close to signing a fully negotiated definitive agreement.
The lull in M&A activity has been caused by (i) high seller expectations, (ii) weak buyer currency, (iii) credit concerns on both sides of potential transactions, and (iv) market volatility. Like real estate markets, bank seller expectations are set by what their neighbors were able to sell for. Every bank director believes that their bank is worth more than the bank down the street. Sellers focus on price to book and many of the better performers were selling for more than 3x book a year ago. For the first six months of 2007, the average price to tangible book value of a bank that sold in the West was 2.60x. Since June 30, 2007 (through February 20, 2008), buyer bank stock prices, as measured by the Western Keefe Bank Index, have declined on average by 28% and trade at a price to last twelve months earnings of 12x. Buyers focus on earnings accretion and an ability to pay higher prices is dependent upon a high price to earnings ratio. There is obviously a disconnect between current publicly traded bank valuation levels and seller expectations.
Another detriment to M&A activity is credit concerns. Due diligence has become important again and it’s not unusual for buyers to review a greater proportion of the loan portfolio and take a week to do it, as opposed to a cursory review in less than a day’s time. Also, sellers who are taking stock in the transaction need to do cross due diligence. Potential buyers have become resistant to taking on someone else’s potential loan problems, especially when they are concerned about their own. Likewise, potential sellers feel comfortable with what they’ve originated even if their loans are in workout mode compared to the unknown in a potential buyer’s loan portfolio.
Last, declining stock prices have really put a damper on M&A activity. Firsthand experience has provided a good example of what sellers should be focused on in this challenging M&A environment. A deal and its key terms had been agreed to in late 2007 between a buyer and a potential seller. A month later, the deal had fallen apart just days before its scheduled announcement. The buyer had offered the potential seller a mix of its stock on a fixed exchange basis and a fixed amount of cash. Customary collars were agreed to, which was supposed to protect the transaction if the buyer’s stock price fell. No one could have anticipated that we would be at the bottom of our collar within a month, after due diligence had been satisfactorily completed, a definitive agreement had been completely negotiated, a draft investor presentation had been completed and a draft press release was ready to go. The potential seller was a private company and wasn’t subject (as in no quoted stock price) to the downdraft in the market that had affected most publicly held bank stocks. Although none of the terms of the deal had changed, the Board of the potential seller wasn’t willing to take a lower price. The only thing that had changed was the buyer’s stock price.
The potential seller should have been focused on the relative value their shareholders were receiving in the form of the pro forma ownership and the structure of the transaction. Both were favorable to the seller. Since the stock portion was based on a fixed exchange ratio, the potential seller’s shareholders would still own the same amount of the pro forma company despite the lower valuation of the buyer’s stock. The downward movement in the buyer’s stock price was in line with the rest of their peers. We had negotiated two walk-away triggers in the collar. The first was a 15% double trigger, whereby the seller could walk if the buyer’s stock had declined by 15% and underperformed its peers by a 10% margin. The buyer’s stock price had declined 20%, but that was in line with what their peers had experienced. The second trigger was an absolute decline of 25%. The buyer’s stock price hadn’t blown through that trigger, but they were dangerously close and the seller didn’t want to announce a transaction that was that close to the bottom of the collar.
Moreover, because 40% of the total consideration was in cash, the potential seller was insulated from downward movement in the buyer’s stock price. Thus since the buyer’s stock price was down 20%, the total value to the potential seller was only down 12%.
In today’s environment, sellers may take solace in the certainty of cash, but I would opt for stock in the right buyer’s currency because a potential seller will share in the upside of recovering stock prices. Sell for cash when stock prices are high. When a board has reached the conclusion that it might be time to sell, directors should be making an investment decision and that is why it is not necessarily the highest price that should win the day, but which currency has the highest net present value of its future potential cash flows.
Jeffrey
J. Wishner is a Managing Director in the San Francisco office of Keefe, Bruyette
& Woods (www.kbw.com). He has advised banks and thrifts for over 15 years in
capital raising efforts and M&A transactions and can be reached at
415-591-5035 or through email at
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