As a bank M&A consultant for over 30 years, the question I get is always the same: is this a good deal? This question comes from both sides. So what do we mean when we say “It’s a good deal” from both the buyer’s and the seller’s perspective?
If You Are the Buyer
From a buyer’s perspective a transaction has to be accretive to book value, tangible book value, and earnings per share for the transaction to be a good deal. Accretion means the stockholders of the buyer are financially better off than if they had not done the transaction. It does not necessarily have to be accretive from the outset but it should be accretive over some defined period of time. All transactions are unique and entered into for various reasons.
The traditionally accepted norm says that if a transaction is entered into strictly for financial gain, the resulting tangible book value dilution should be paid back from earnings generated within three years. If the transaction is entered into because of strategic considerations, the transaction needs to be accretive within five years. Shareholder value has to be enhanced or there is no financial reason for an acquisition. However, there can be intangible benefits that sometimes cannot be quantified. Under those considerations management has to determine the value of those intangibles to the organization.
Buyers also have to take into account the type and amount of consideration used in a given transaction. Consideration in the form of cash usually enhances the earnings or earnings per share (EPS) going forward but creates dilution to tangible book value. The dilution is the result of marking the assets and liabilities to market. For publicly-traded banks, if their stock is trading at a high multiple and if they pay a lesser multiple for the target bank, then the transaction can be accretive from a tangible book value standpoint but hurts the EPS going forward. A balance between cash and stock used for consideration needs to be carefully evaluated to balance the impact on tangible book value and EPS.
If You Are the Seller
From a seller’s perspective a transaction must provide an increase in value over the current value of your bank. So how do you measure your bank’s current value? There are many measurements of value: accounting book value, trading or transaction multiples of peers, replacement cost valuation, liquidation value, etc. However, all these types of measurements base the value of organization on past performance. The only method which values the 2
bank on expected performance is the Discounted Cash Flow Valuation. This method values your organization based on the present value of future cash flows which also includes the terminal value at some future date. If the present value of the future cash flows for your organization is less than an offer to sell your bank, then you should sell because you are getting more value than your current value.
Conversely, you would not sell your bank if the offer was less than the present value of the future cash flows. Sellers also need to take into account the type of consideration received and the tax consequences of each. Cash has no risk but may be a taxable event depending upon your basis. Also, the value of that cash-producing future income is dependent upon how it is reinvested. Stock carries the risk of the acquiring institution. You would also be able to avoid taxes until the stock is sold and could have upside if the acquirer is a well-managed and profitable institution. However, with a minor position in the acquiring institution, you give up control of your investment.
If you are interested in M&A and whether a deal you are looking at is worth pursuing, contact Bob Fegtly at (501) 374-2600 or at bfegtly@ddfconsulting.com.
