Fifth Third Bancorp drew investors' skepticism in announcing that it would pay up for a premium Chicago franchise, adding another data point that tests investors' reaction to large-bank M&A.
Superregional banks across the country have announced deals in recent years that seem to inspire price drops that can last several quarters. Executives, including at Fifth Third, have pitched that these deals are strategically important and will pay off in the long run. Investors, however, still seem to focus on factors like tangible book value dilution and other pricing assumptions or variables, and their reactions could be increasingly important if large institutions continue to use their currency to do deals.
Fifth Third announced May 21 that it would pay a reported $4.7 billion to acquire MB Financial Inc. in a bid to build dominance in the competitive Chicago marketplace. By all metrics, the deal was expensive. The transaction valued MB Financial at 272.7% of tangible book value, compared to Fifth Third's valuation of 186% of tangible book the Friday before the deal. It carried a price-to-tangible book value dilution of 7.7% with an earnback period of 6.8 years using the crossover method, according to the company presentation.
The price tag was the fourth-highest since 2011, and it had a higher valuation than the three deals that cost more, according to an S&P Global Market Intelligence analysis.

Investor feedback was immediate. Two analysts downgraded the bank following the deal and shares dropped nearly 8% on the day of the announcement, gaining back just 3.20% a day later. The selloff showed that investors remain sensitive to tangible book value dilution and earnings accretion, and they felt that this deal had too much of the former and not enough of the latter, said FIG Partners research director Christopher Marinac. He said the Ohio bank "tested" the market with its strategic-but-expensive transaction and received "a big smack across the hands."
But he pointed out that investors' reaction to this deal continues a trend he first noticed in 2011, when Comerica Inc. purchased Sterling Bancshares Inc. He said investors sold off Comerica that day and its valuation lagged peers for the next 24 months.
"We felt then, as well as now, that Comerica was put in the penalty box and its relative valuation suffered for several quarters after they announced that deal," he said. "It was simply the marketplace giving the thumbs down on the company for quite a while and I think that's something that Fifth Third risks."
Following Comerica was KeyCorp's acquisition of First Niagara Financial Group Inc. in 2015 and Huntington Bancshares Inc.'s deal for FirstMerit Corp. in 2016. Both buyers faced selloffs as investors questioned revenue assumptions and tangible book value dilution earnback periods, but have since recovered as the acquisitions proved to be more attractive than initially modeled. Some cautioned that Fifth Third's price decrease could be similarly short-lived and that the deal's longer-term impact on the bank's share price is unknown.
"Clearly the market didn't like it, and that's probably a warning signal to others, but you have to take a few days to settle that out and make sure the story is properly told as to why they did and what the value is going to be," said Richard Durkes, vice chairman of investment banking for Raymond James. "I think the market is being cautious because they haven't heard the story and they don't necessarily know the benefit to Fifth Third."
Eugene Katz, managing director with D.A. Davidson & Co.'s investment banking team, said the decline may have been "a little bit of a knee-jerk." However, he said the pricing was "very strong" and that it could take some time before investors appreciate the merger's strategic nature and the bigger footprint in Chicago.
These conflicts could increasingly surface if organic loan growth fails to meet expectations. Keefe Bruyette & Woods managing director Brian Klock said banks with excess capital and single-digit loan growth year over year might increasingly turn to M&A to hasten or further their growth strategies, but they risk courting disapproval with investors in the short term.
However, Klock said he has been on the other side of these decisions in his former job in the corporate finance division of a bank. His group modeled how much the bank should pay for a potential target, which ultimately sold to another institution at a higher price. Later, the CEO came back to the group and asked how long it would take the bank to build a franchise comparable to what it could have acquired.
"Investors will look at the same thing we were looking at in the corporate finance group: 'What's the right price and multiple?'" he said. "But ... if you miss the opportunity and your competitor takes it, how long is it going to take you to try and build that?"
