Smart Planning Can Make Mergers Pay for Shareholders
Mergers can add value to shareholders and result in sustainable competitive advantages, but only if correctly priced and well implemented.
Recent analysis by my firm indicates that mergers can generate significant scale benefits.
In larger in-market mergers, for example, the cost savings alone can generate incremental shareholder value equal to 1.3 times the book value of the acquiree. This assumes a typical regional bank business mix and average going-in expense control.
For contiguous-market acquisitions, the savings can be even greater.
Further, the new Chemical Banking Corp. has demonstrated that additional earnings can be generated through improved debt ratings. This impact is seen in lower funding costs and increased acceptability as a counterparty in derivative-products businesses.
Finally, mergers can provide the scale to afford investments in new products that will be necessary given the lack of growth in many traditional businesses. This is now a critical issue for many leading retail institutions.
Through a combination of projects and discussions with banks that have captured these benefits, we have formulated a list of critical factors for success in merger integration.
Many of these "best practices" are relatively simple to articulate but often prove difficult to put into place.
Here are the key ones:
Understand and articulate how shareholder value and competitive advantage will be created.
Successful acquirers determine how the acquisition premium will be earned back or, if there is no premium, how much value will be created - and why.
The leading acquisition-oriented banks use proper methodologies to assess what financial improvements must be accomplished in order to serve shareholders.
This includes a recognition that discounted cash-flow analyses are preferable to earnings-per-share dilution calculations, and that discounted cash flow approaches can give a materially different perspective. These banks compare what is needed against what is feasible, and only proceed when value creation is possible.
Set aggressive but feasible targets for expense savings, which provide income with infinite return on equity. Such dollars have very high value. For example, depending on growth-rate assumptions, $100 million in savings (pretax) could increase market capitalization by $700 million.
Delivering these savings quickly is also key. For example, BankAmerica's target of $1.2 million in expense savings translates to $5.2 million a day in pretax earnings. If the program is accelerated 10 days, shareholders are enriched by $52 million.
With such potential, it is critical for top management to drive expense savings targets and timetables aggressively. This requires developing an initial perspective on the potential for savings in each major line of business, and for each support function.
Further, once the institution is merged, bottom-up efforts should be initiated to validate and ensure "ownership" of the targets by down-the-line managers.
The importance of this target-setting step cannot be overemphasized. We know of no bank that has achieved its full potential without setting such targets.
Favor-efficient decision-making, Top management should define its organization structure as quickly as possible. It must also define the principles by which decisions will be made. These principles can then be applied whenever "political postuting" begins to delay the process.
It is critical for top management to focus on making the right decisions on technology and operations. Effective implementation of these decisions is critical to achieving many other savings.
It is tempting to take the time to go through comprehensive analyses, to optimize and incorporate everyone's viewpoint. But management must bear in mind the time value of faster savings.
Exercise caution with "business as usual" revenues and risks. One should attempt to inaculate customer contact and day-to-day risk management personnel from being overly involved in extra integration-related work.
Although expedient implementation is preferred, customer-related conversions require extra care to minimize disruptions.
Unexpected credit losses or revenue attribution can offset the economic benefits of consolidation.
Simplify the cultural issues. Cultural integration is challenging, particularly in deals with two large players or "mergers of equals." There can be a desire to blend the best aspects of each institution's culture.
The longer there is uncertainty related to the culture and management process that the merged bank will adopt, the longer it will take for employees to focus on customers.
This is because uncertainty slows the decision-making process and turns off the best people who want to get on with their jobs. Thus, strong leadership is a necessity; an up-front articulation of the desired culture for the new institution can greatly facilitate integration.
Delegate, but ensure accountability. Integration progress should be monitored in a disciplined manner. Items to be tracked should include activities, major milestones, expense savings targets, and performance relative to these targets.
Accurate measurement requires defining a baseline for financial performance and developing methodologies to adjust for changes in both business mix and volume.
Such tracking systems need not be overly bureaucratic. First Manhattan Consulting Group has found that when straightforward accountability tracking is in place, the odds of achieving the desired results are increased. Good tracking builds credibility in the markets: witness Society Corp. and Chemical.
A final benefit: The bank ends up with a fact base that is invaluable on future deals.
Sustain momentum. Early "wins" need to be communicated so that employees continue to feel empowered, and to ensure that the financial community adequately recognizes the ongoing potential of the new institution.
It is important to stick with it. Most larger deals will take 18 months or more to resume steady-state operation.
Allocate funds to invest in new sources of growth. The lack of real growth in attractive banking revenues has placed a premium on new growth opportunities.
The leading consolidators will be uniquely able to find new growth opportunities because of their scale advantages.
Many of these institutions are working now to identify new growth opportunities for the future.
As the consolidation game unfolds, we believe that success in merger integration will become a key to survival in the '90s and beyond.