Staying Focused on the Fundamentals

October 17th, 2018

merger-10-17-18.pngHave you ever attended a college football game where the crowd is intense, and every minor detail is scrutinized with frequent and loud complaints? Sometimes, bank mergers feel just like a football stadium on Saturday, where the fans are unhappy with the scoreboard even though their team’s play is acceptable.

The market’s take on M&A
FIG Partners research reviewed over 325 public bank mergers from 2016 through the summer of 2018 and found a mixed reaction by investors to M&A transactions. We also found that investors’ perceptions of transactions tended to evolve with time. On the first day after a merger announcement, 53 percent of the buyers’ stocks traded higher, 39 percent traded lower and eight percent were unchanged. After seven days, the experience improved slightly, with just over 60 percent (or almost 200) of bank buyers trading higher, while 35 percent of buyers (or 114) traded lower and the remainder unchanged. It still surprises us that nearly 40 percent of bank M&A transactions were greeted by a lower stock price for the buyer.

The size of a transaction also influenced investors’ perceptions. There have been a total of 67 transactions exceeding $200 million in deal price since 2016, with only 23 deals, or 34 percent, seeing the buyer’s stock trade higher on the first day after the deal was announced. This percentage held steady through seven days. The chilly reception toward larger transactions was recently echoed in the weaker share price of Fifth Third Bancorp following the announcement of its MB Financial purchase on May 21. All told, most large deals, especially those equal to 40 percent or more of a buyer’s pre-merger market valuation, have traded lower after the deal was announced.

Buy the rumors, sell the news
An old saying is that investors buy the rumors and sell the news. This could have something to do with the chilly reception to deals over the past couple of years. Sometimes, bank mergers are anticipated and lead to higher stock prices even before the deal is publicly announced. Then, once the deal press release hits, profit-taking ensues, causing the stock price to fall. This dour reception has even tended to be true when a transaction translates into a healthy increase in earnings per share. Like a football game, the crowd finds negative angles and sounds its displeasure. It’s tough to please every fan, all the time.

Our recent experience shows that investors are increasingly skeptical about mergers. Most investors and analysts agree on the benefits of scale across all balance sheet sizes. Unfortunately, the short-term focus and inherent impatience of many investors today causes them to worry. The initial concern, in the two quarters ahead of a typical deal’s closing, is directed toward tangible book value dilution. That worry is then redirected toward slower earnings per share gains in the following six to nine months, as integration occurs. This reality requires that bank directors and company leadership develop thick skin toward how the equity marketplace is likely to react to an M&A announcement.

Deal or no deal?
Perhaps the combination that your institution is considering will be part of the 53 percent of mergers since 2016 with a positive stock reaction for the buyer both on day one and after seven days. There’s as good a chance, however, this won’t be the case. In that event, I encourage you to avoid taking offense to investors’ early reaction and instead remain focused on the intermediate-term benefits of stronger earnings per share and return on assets once the deal is fully digested. Plus, I feel the opportunities in terms of deposit growth, new loan generation and upgrades to the managerial talent bench that ensue from any good merger or acquisition will be the ultimate determinants of future stock prices in the long run.

The short-term perspective of investors and their initial reactions for and against mergers should take a back seat to the real fundamentals of building earnings per share, tangible book value and core deposits several quarters down the road. No football game ends after only one quarter. You have to play through to the end.

cmarinac

Chris Marinac is the Managing Principal and Director of Research for FIG Partners, LLC. He has been an analyst since 1992, and has covered banks, thrifts, REITs, and finance companies during his career. You can contact Chris at cmarinac@figpartners.com.