Valuing Bids Trickier in Stock Deals

Security Bancorp, Southgate, Mich., announced on Sept. 12 its sale to First of America Bank Corp., Kalamazoo, for $550 million - a very high valuation of 2.78 times book value and 17.8 times latest 12 months' net income.

The initial market perception seemed to be that First of America had stretched to win a competitive bidding process, as its stock price dropped from $31.50 to $28.50.

At Banc One Corp., one of the four losing bidders, the reaction to the news was disappointment, according to executive vice president William P. Boardman, the head of the acquisition team.

Banc One is eager to expand its foothold in Michigan (24 offices, $600 million in assets, and 0.6% market share of deposits) and made, according to Mr. Boardman, a "very fair" offer for Security - $39 a share, compared with the $40.50 offered by First of America.

What About the Shareholders?

Mr. Boardman makes the point that a seller is often in a better long-term position if it takes a nondilutive offer that it initially somewhat lower, rather than accepting a higher offer that caused significant dilution for the buyer.

Of course, reasonable people can disagree. Security's president and chief executive, Andrew R. Brodhum, said the determination of the winning bidder was "an extremely thoughtful process."

And necessarily so. Several factors make this deal even more complex than the average merger.

The first complicating factor is the currency of the transactions. First of America's stock has been trading for about 120% of book value and 9.6 times earnings, much lower figures than for other active acquirers in stock deals.

Last year, First of America traded at 88% of book, and in 1989 it traded at 105%. During the past year Banc One stock has traded at an average of 240% of book and 15.7 times earnings.

A Distinct Disadvantage

Therefore First of America is and has been at a serious competitive disadvantage, compared with other acquirers in any stock transaction.

The agreement between First of America and Security attempts to protect the value offered to Security's shareholders through an "exchange ratio collar" designed to compensate for any adverse movement in First of America's stock relative to an index of other bank stocks in the period before closing.

A second complicating factor is that the market may not appreciate First of America's success as an acquirer.

Despite the disadvantageous price/book value ratio, First of America has a demonstrated record of success with 52 acquisitions in the past 20 years.

Over the past 10 years, First of America's market appreciation and dividend yield have outperformed all regional competitors except NBD Bancorp., and earnings per share have risen steadily.

First of America has also consistently strengthened the performance of acquired banks. The average return on assets for the 52 acquired institutions has risen, since affiliation, to 1.31% from 0.36%.

In the past four years, however, First of America's gains have been less impressive. Earnings per share have risen 5.7% annually on a restated basis, but using originally reported financials, the growth drops to a less impressive 3.1%. In contrast, Banc One's originally reported earnings per share have grown by 13.8% during the past four years.

Earnings Growth

The median of earnings estimates published by Wall Street analysts shows long-term earnings growth of 11% for First of America and 12% for Banc One.

The First of America/Security combination offers the opportunity for cost savings estimated at $33 million annually by 1994, which must be balanced against the initial dilution of First of America stock.

Security shareholders will also receive a $1.65-a-share dividend when the deal closes, compared with $1 a share offered by Banc One.

Ultimately, Banc One may be proved right, as it has been before in similar circumstances. In July 1987, Marine Corp. declined an offer of $65.94 from Marshall & Illsley to take an offer of $60.66 a share from Banc One.

Stockholders who did not convert to cash now hold Banc One shares worth in excess of $120 for each share of Marine stock sold. Had the M&I offer been accepted, their shares would now be worth about $80.

This deal is over, of course, and any debate should look to the future. The economics of bank consolidation are still not well understood. Diametrically opposed views on such fundamentals as the achievability of cost savings can be argued persuasively.

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