Investorstend to reward buyers in bank deals with lower price-to-tangible book valuemultiples, but advisers believe they should pay more attention to strategicbenefits and earnings power at the combined company.
Ananalysis by S&P Global Market Intelligence found that higher projectedearnings accretion did not necessarily mean a bigger boost in share price. Forexample, buyers in bank deals announced since 2010 that were projected to be atleast 20% accretive to earnings in the first year saw their stock price notablyunderperform acquirers in deals where the earnings accretion was projected tobe 10% to 20%, by a median of about 6 percentage points one year afterannouncement. The same was true for acquirers projecting those levels ofearnings accretion in the second year after a deal was announced.
Likewise,the analysis found that investors did not consistently reward buyers in dealswith lower price-to-earnings multiples.
Onearea where investor reaction was uniform was price-to-tangible book value;buyers in deals with a P/TBV of 200% or greater saw their stock rise a median6.20% one year after announcement. Buyers who inked deals priced at less than100% of TBV saw theirstock price rise a median of nearly 19%.
Investmentbankers acknowledge the emphasis investors put on P/TBV in deals, but somebelieve there are other more relevant factors to consider.
"Tangiblebook value to me is synonymous to the liquidation value of the company, whichis not how banks should be valued," said William Hickey, principal andco-head of investment banking at Sandler O'Neill & Partners.
Insome recent deals, investors have discounted the projected earnings accretionand pricing multiples and instead zeroed in on the arising from the deal. Suchwas the case in the KeyCorp/First Niagara Financial Group Inc. and / , at least initially. Bothdeals were valued around 170% of tangible book value, and stocks suffered onthe day of their announcements.
Analysts KeyCorp'sinclusion of revenue synergies in its six-year earnback calculation, which theybelieve would be even longer than the company projected; shares fell more than10% following the announcement but have since caught up with the KBW NasdaqBank Index.
At Huntington, analysts questioned the 5.5-year TBV dilution earnback,which management defended, citing increased earnings.
"Weare comfortable with the dilution and earnback in this instance because of theclear path to increased earnings and increased capital return that thistransaction provides without negatively altering our risk profile," saidHuntington CFO Mac McCullough during the Jan. 26 deal call.
Bylate afternoon on the day of the announcement,shares had slid 8.51% to $8.05, but they have slightly outperformed the KBWNasdaq Bank index since then.
Hickeycautioned investors against getting caught up in a deal's price or its dilutionat the risk of missing the point of the transaction: the earnings stream thebuyer is acquiring and what the combined earnings power of the pro-formacompany looks like. He encouraged investors to also consider the strength of abuyer's currency, the expected cost saves in the transaction and the portion ofcash used in the deal. "Certainly Sandler is not breaking deals down to'this is good or bad because of book value dilution,'" he said.
WhileTBV dilution can overshadow earnings accretion in the minds of investors anddeals with lower P/TBV often receive positive reactions from the Street, thereare some exceptions to the rule. Jeff Adams, managing director at Banks StreetPartners, pointed out that there is not necessarily a correlation between P/TBVand P/E. A deal that carries a lower price-to-tangible book value can stillhave a higher price-to-earnings multiple, which could necessitate a higherinternal rate of return on the transaction. Westfield Financial Inc.'s $110 million of , on April 4, is valuedat 119.7% of tangible book but 34.2x earnings.
Otheradvisers believe bank management teams should not be solely focused on investorreactions to transactions because this might prevent them from landingopportunistic acquisitions. Bankers are "scared to death" ofinvestors' reactions, said Dory Wiley, president and CEO at Commerce StreetCapital. He believes confidence in a deal's attractiveness or shareholder valuecomes down to bank leadership.
"I'veeven seen bankers turn down a deal because they had the same P/E, all elsebeing equal, and it looked great," he said. "Does the deal work ornot? Does it work within the time frame? To me, that's a function of leadershipand I have seen the world turn a little bit more toward deference to theinvestors."
Someacquisitive banks have management teams that have earned credibility with investorsand have been rewarded with premium valuations, including names likeCharleston, W.Va.-based UnitedBankshares Inc., Bankof the Ozarks Inc. and Prosperity Bancshares Inc.
ButWiley said executives who want to do deals need to focus on the long-termoutlook and their track record of performance, and ignore the short-termfluctuations in stock price. He held up the first quarter's volatility asevidence that stock price fluctuations will happen regardless of managementdoing or passing on deals.
Forbanks that were working on transactions before the recent volatility hit, hisadvice was clear: "Pull your pants up, buckle up, and do the deal."
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