by Michael S. Murphey
Size Matters
As mentioned in prior Board Briefs and as evidenced by the following graph reflecting Market Capitalization to Tangible Book Value (“TBV”) of all publicly traded community banks, size and scale is a proven way to enhance bank valuation.
Clearly, bigger banks generate more shareholder value than smaller banks.
Quality Matters, Too
Size is important, but so is quality. The following graph shows 58 M&A transactions from 2010 to 2020 where the acquiring bank was later sold. The graph estimates annual value creation based on the difference between purchase multiples the bank paid as an acquirer, versus the selling multiple that same bank received when it sold, adjusted for the number of years between acquisitions and ultimate sale. The findings indicate 68% of the transactions generated annual valuation growth greater than 10% of TBV, while 22% of the reviewed transactions had value creation of less than 10% per annum and 10% of the deals resulted in value destruction. The lesson of this chart for acquiring banks is that a bad acquisition increases the odds that the acquirer will become the acquired before long. The balance of this article discusses how well-crafted financial models minimize the risk of low or negative shareholder value deals.
Why Financial Models Matter
Issues negatively impacting M&A performance include (i) lack of compelling strategic rationale, (ii) excessive purchase price, (iii) exaggerated synergies, (iv) inadequate due diligence, (v) poor integration, and (vi) conflicting cultures.
Financial models will not cure these problems. But utilization of a well-designed, easy to use model will support rationale deal pricing by the acquiring bank and help address cultural challenges and improve post M&A integration as acquiring and target management teams use the model to quantify synergistic revenue and cost synergies.
Community Bank M&A Model
The schematic below reflects inputs and outputs suitable for community bank M&A models. Inputs should be tested under various purchase price, economic, market and synergy scenarios for both the standalone acquiring bank and the proposed acquisition. Acquiring bank management should focus on the purchase price with the greatest probability of providing the most favorable output and not pursue a deal unless merger driven earnings per share accretion meaningfully exceeds standalone bank earnings.
Inputs
Excel’s power is its flexibility, and the model should implement this capability in a user friendly, intuitive manner. Typical inputs are reflected in the circles in the graphic on the bottom left, and are designed to incorporate financial performance, market outlook and operating synergies into a purchase price/consideration structure compatible with return requirements of the buying and selling shareholders.
Outputs
Typical outputs are reflected in the black lettering below the inputs. EPS accretion and leverage evidence profit and capital available to shareholders, TBV earnback reflects TBV accretion. EPS accretion from acquisitions needs to significantly exceed standalone bank only EPS accretion to justify acquisition risk. Modeled leverage
needs to exceed the 8.50% Community Bank Leverage Ratio in 2021 and 9.00% post 2021. TBV earnback should occur in less than five years.
Summary
Well-designed financial models are essential to optimize M&A shareholder value. The quantitative outputs are helpful, but the model’s highest value is the dialogue it engenders between the acquiring and target management teams. Investment banks are proficient in modeling applications and would be happy to work with you and your bank as you develop your strategic plans.
Michael S. Murphey is a senior advisor who supports Porter White’s Community Banking practice. He has spent 40 years in the southeastern U.S. banking industry in various capacities related to commercial lending, including relationship management, underwriting, credit, and portfolio management.
