“Price is what you pay; value is what you get.” – Warren Buffett
Mergers and acquisitions in the bank space are on a blistering pace, following a listless year of deal activity due to the coronavirus pandemic and associated uncertainties.
Anecdotal evidence now strongly suggests that the consolidation wave will swell, provided there isn’t a new surge in Covid-19 cases. PNC FIG Advisory expects many more merger announcements that feature rational pricing metrics underpinning the strategic rationale for combining. A key driver – and permanent effect of the pandemic – is banks’ desire to increase scale in order to better satisfy new customers’ habits and their growing acceptance of financial technology.
Last year’s pause created pent-up demand among potential buyers and sellers; if history is any indication, the industry can bet on a post-crisis resumption of merger activity. Deal volume slowed measurably at the start of the Great Recession, dropping from 285 deals in 2007 to 174 in 2008, according to S&P Global Market Intelligence. It normalized once potential buyers gained more clarity regarding their own balance sheets, as well as those of potential sellers. We expect that cycle to repeat itself following 2020’s pause in M&A volume.
Perceptive bankers and investors recognize that the best deals typically occur when bank valuations are reasonable, offering greater strategic flexibility and facilitating share price appreciation for the combined institution.
Does the market fairly value mergers?
Over the long term, the evidence to this question appears mixed and is specific to the individual transactions themselves. However, trading immediately following a deal announcement usually favors the sellers. There have been 51 deals announced as of April 2021; the median price change three days after a merger announcement was -0.6% for the buyers’ stock, while the sellers’ stock price increased 21.6%. For these deals, the median price to tangible book value was 153% and price to trailing 12-month earnings multiple was 17.1 times.
Compare that to the approximately 2,600 bank mergers that took place between 2011 and 2020. The median price change for those deals three days after announcement was 0.3% for the buyers’ stock; the sellers’ stock price increased 21.1%. This consistency over the past decade is somewhat surprising; empirical evidence that investors increasingly emphasized short earn-back periods fueled the perception that buyers had become more price disciplined. Excluding 2021 deals, the median price to tangible book value over those 10 years was 139%; the price to trailing 12-month earnings multiples was 20.3 times. These median ratios are skewed by relatively low deal multiples between 2011-12, where 516 transactions had a median P/E multiple of 20.3 times and median P/TBV multiple of 113%.
The share prices of the buyers fared better over the longer term, which probably indicates that acquirers should not place too much stock (pun intended) in traders’ initial reactions. The one-year price increase of buyers for deals announced between 2011 and 2020 was 8.3%. The axiom that it is better to “buy low” proved correct: The median one-year price increase was 14.4% for acquirers who bought in 2010-11, when valuations were relatively inexpensive.
There have been 51 bank and thrift deals announced as of April 2021, according to S&P Global Market Intelligence. There were 117 deals announced in 2020, 262 in 2019 and 254 in 2018. Key takeaways are:
It is a reasonable conclusion that the need for better economies of scale will spur more banks to seek a merger partner, including fintech and other nonbank financial companies. These deals may be smaller in size, given that most banks have less than $2 billion in assets. These institutions have a greater need for scale compared to their bigger peers, although recent deals among larger banks suggest all companies seek greater efficiencies.
Banks are sold, not bought. Mergers and acquisitions are largely determined by potential sellers’ willingness to accept the acquisition premiums relative to trading values.
PNC FIG Advisory believes the best deals typically occur when valuations are reasonable and there is “upside” potential for both sides. This includes strategic mergers of equals.
Our analysis suggests that investors are usually better off owning the target, rather than the buyer.
The views expressed in this article are the views of PNC FIG Advisory, PNC Capital Markets LLC’s investment banking practice for community and regional banks.