A question we are often asked is “What’s the outlook for mergers and acquisitions in the banking sector and do large acquisitions build or destroy shareholder value?” Now, these are actually two questions and there are no clear, definitive answers to either one. The safe answer to the first question is “Who Knows” and to the second “It Depends”. Well, we at the RJ Report don’t take the easy way out and are fully willing and able (?) to make assumptions and provide opinions. After all, we subscribe to the motto of “Often wrong, but never in doubt!”
The Outlook for M&A
Over the past couple of years, the number of deals between banks has decreased, but the size of those deals has increased as super regional and regional banks have been eating each other. The driving forces behind these deals have been both strategic and financial. In some cases, the acquisition provided entry into new business lines or attractive geographic markets. Others were driven by the need to to produce cost efficiencies, increase scale economies, and/or obtain lower cost funding sources. As pressures on expense management and funding intensify, we expect the urge to grow through large-scale acquisitions to increase over the next two years, The problem of course is the value of potential acquirer's currency. As stock prices and market multiples rebound, we expect M&A activity to accelerate.
The question, of course, is whether or not these large acquisition enhance or destroy shareholder value. Clearly, shareholders of acquired companies benefit through receiving a premium for their shares. The impact on the shareholders of the acquiring company is less clear. Some of these acquisitions have worked out from a shareholders’ perspective and others not so much. In our view, some of the major drivers of success are:
Opportunities to buy/enter new attractive markets or business lines without having to build them;
Proven management ability to identify and realize available expense synergies;
A track record of managing systems and organizational integrations without destroying the acquired customer franchise; and,
Pricing structures that provide near-term value without relying on heroic or unlikely expense savings.
Who Wore it Best?
When major deals are announced involving banks we follow we analyze them from a strategic perspective and provide our members with an assessment of what is good and what is bad about the deal. For example, when Huntington (HBAN) announced their acquisition of TCF we took a very negative stance and downgraded our overall assessment of Huntington accordingly. We felt that TCF’s business model provided no benefits, the price was too high, and, although it increased Huntington’s geographic scope, the new markets were not terribly attractive and did not provide significant synergy with Huntington’s legacy franchise. Alternatively, we were very bullish on M&T’s (MTB) acquisition of Peoples in Connecticut for all the opposite reasons. While Huntington has somewhat outperformed our expectations, we believe our positive assessment of the M&T deal was correct as their stock continues to outperform the banking sector, overall. As (if?) the market rebounds, we expect M&T to outperform its peers. The jury is still out on Citizen’s (CFG) acquisition of Investors and PNC’s (PNC) purchase of BBVA’s U.S. franchise. Although Citizens has outperformed the banking index on a YTD basis, neither looks like a homerun from a shareholder perspective just yet..
We Expect M&T to Outperform Other Acquirers
Our latest assessment looks at the recently completed acquisition of MUFG’s U.S. retail business by US Bank (USB). Our preliminary analysis amounts to “Meh”, because we don’t see how this acquisition addresses some of USB’s core strategic and performance challenges. The fact is that USB has been an average performer, significantly underperforming the banking index during the latter part of 2022. However, this has changed significantly during the first part of 2023.. We will watch this carefully to see if this trend continues. However, it appears that Warren Buffett doesn't think so because he dumped a bunch of their stock last year. But what does he know.
Who’s on the Menu?
We expect these larger acquisitions to continue as organic growth becomes more difficult to achieve and escalating expenses put added pressure on profit margins. As mentioned, the major headwind is not the availability (and affordability) of some high potential targets, but the value of the acquirer's currency. If valuations rebound, we would expect M&A activity to accelerate. While it’s always interesting and instructive to look at what happened in the past, the real fun is playing the parlor game of “Who Gets Eaten Next?” At the end of 2021 we identified First Horizon (FHN) as our top acquisition target. We liked their markets and their efficiency ratio was too high, meaning that an acquirer could come in and buy them with their own money. Okay so we got lucky when TD Bank bought them for a 40% premium, but trying to predict the next acquisition is a little like playing pin the tail on the donkey. We know there’s a donkey and we know there’s a tail, but often the two won’t connect. Nevertheless, we like playing the game. We identify a number of these targets in our latest newsletter. However, we have identified four particularly tasty morsels here -- Atlantic Union, Cadence, PacWest, and Associated. In general, all four are in attractive markets and/or have attractive and stable customer bases, have relatively high expense ratios (CADE and ASB), or are trading at significantly discounted market multiples (PACW). Our estimate of target acquisition prices is based on a number of factors, including market comps, our assessment of the attractiveness of the franchise, and shareholder expectations. As always, our assessments are based solely on publicly available information and we certainly do not guarantee that any of these banks will be acquired or, if they are, at these price levels.
*Prices and multiples as of 1/20/22
Over the past six months, all of these banks have outperformed the Regional banking index. However, the two smallest banks on this list, AUB and ASB, have both outperformed the banking index significantly despite delivering somewhat average financial performance. Does this indicate that an acquisition is already built in to their stock price? Maybe. However, in our view the most interesting bank on this list is PacWest which was hammered throughout 2022. It is highly possible that shareholders might start to get restless and put pressure on the Board to explore other options.
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Opinions expressed in this article are solely those of the RJ Report and do not represent those of any other company or entity (that we know of).
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