Bank acquisitions in the immediate aftermath of the crisis were all about finding bargains, and there were indeed deals too good to pass up. But with the extended recovery, investors are increasingly concerned about high premiums and unsatisfactory benefit from recent deals. In some notable cases, wary shareholders are right that an acquisition just isn't worth it.
Corporate acquisitions reached record levels in 2015. Bank-level acquisitions also increased to their highest level since the financial crisis. Low growth, margin pressures, tepid returns on equity and the influence of some shareholders demanding a deal are forcing banks to consider acquisitions to achieve growth and improve efficiency. Acquisitions, however, are notoriously dangerous. Most, not all, acquisitions fail to increase the acquirer's shareholder value.
So other investors are justifiably skeptical of acquisitions, especially large ones. This is reflected in the negative share price movements when the transactions are announced. For example, KeyCorp's share price dropped by 7% when it announced its First Niagara acquisition in October, outbidding other institutions. Nonetheless, most acquirers believe they can beat the odds to create value for their shareholders.
The key to beating the odds and achieving a successful acquisition is not overpaying for what the acquirer realistically estimates the net improvement in operating efficiency — I call this "synergy" — will be from the deal. This relies on the successful integration of the acquired entity to ensure the realization of the synergies.
The acquirer's net value added is the difference between the expected synergies attributable to the acquisition and the premium paid. The right price to pay for the expected synergies is based on the acquirer's chosen strategy and ability to execute the strategy.
But investors may not agree with bank management about projected synergies, which are really just opinions, as well as the expected net value added.
A key investor consideration is the price or premium offered. The premium is driven by current market conditions and expressed as an increase over the seller's pre-bid share price. The current range of premiums paid in the market for mergers and acquisitions is between 20 and 30%.
Investment bankers ensure the M&A market is reasonably efficient. That means that, unlike the crisis and its aftermath, there are few if any bargains. Most acquisition targets today are fully priced.
In 2008, early M&A movers like Wells Fargo, which inked a highly favorable deal for Wachovia, were looked upon favorably by investors. In contrast, current transactions like the KeyCorp-First Niagara deal receive poor marks. Investors recognize that high premiums require more synergies to break even, let alone generate superior returns. Eventually the level of required synergies grows beyond credible to become incredible. As Warren Buffett noted, while deals may fail in practice, they never fail in spreadsheet.
The type of synergies available also affects investor beliefs. All acquisitions create synergies; the question is whether the buyer or seller captures the net benefits. The seller typically claims certain common synergies such as cost reduction benefits from the elimination of duplicate facilities and activities. The value of those synergies is reflected in the premium. But the synergies available to the buyer may be unique and determined by the buyer's specific profile. Those synergies are the basis of the transaction's net value added. If you cannot identify a credible unique sustainable competitive advantage making you the best owner of the target, then you should not bid.
It is also important to note that synergies can be both positive and negative. Examples of negative synergies include the increased regulatory costs of exceeding certain asset size thresholds such as $50 billion and $250 billion, which subject institution to heightened rules. Additionally, larger acquisitions are more complex with increased integration costs and risks.
Fortunately, not all acquisitions are the same. In some cases, an acquisition is indeed the fastest path to success for growth-challenged management teams. Transactions that are part of an established strategy based on credible, reasonably-priced and unique synergies — and which close at the beginning of an M&A wave — will be rewarded.
But investors are aware that most acquisitions fail to deliver despite management's best intentions, and react negatively to merger announcements. Absent the right deal characteristics, acquirers and their shareholders should expect setbacks and even failed deals when trying to ride the recent M&A wave. Perhaps, instead of buying, some potential acquirers should consider selling.
J.V. Rizzi is a banking industry consultant and investor.