27 Sep M&A Red Flag — Beware of Dependence on Auctions
M&A RED FLAG Beware of Dependence on Auctions
By Kamal Mustafa, Invictus Group Chairman (and former investment banker)
M&A transactions initiated through an auction process have become de rigueur in the community banking marketplace. In the right situation, they have several advantages that include speed, limited due diligence and (generally considered most important) the opportunity to create a feeding frenzy that leads to a higher-than-expected price.
If you are a profitable bank that dominates an attractive footprint and your balance sheet and P&L reflect this position, then an auction is an excellent idea.
On the other hand, negotiated transactions have the potential to create far greater shareholder value, while also protecting employees and customers within a bank’s footprint. Unfortunately, community banks rarely pursue these types of deals through sheer habit, expediency and/or the absence of appropriate data and analytics.
For most community banks, whether a buyer or seller, the footprint by its very nature creates balance sheet strengths and weaknesses that are reflected in operating performance. This is where negotiated transactions provide the best option for shareholders, management and a bank’s client base. Smart investment bankers understand this.
Negotiated Transactions: A Better Reality
It is the responsibility of management (in order of priority) to:
- Maximize value to shareholders.
- Protect management and employees.
- Preserve best interests of community stakeholders.
This is difficult to achieve under an auction scenario because:
- Acquirer/seller due diligence is limited due to time pressures, management distraction and availability, and competitive pressures.
- Management’s control of the selling process practically disappears the moment the auction starts and the transaction takes on a public life of its own.
- Considerable amount of proprietary/competitive information is released to bidders.
- A failed transaction in an auction can be devastating to the bank’s reputation, staff morale and customer loyalty.
- There are relatively fewer “greater fool’s” in the community banking market that will overpay.
- Auctions are inevitably driven by a bias toward historical and year-to-date operating performance rather than a true detailed understanding of the banks’ balance sheet characteristics that will have considerable impact on future performance under expected market conditions. Auctions tend to favor form over substance.
There are numerous benefits to negotiated transactions because:
- Management retains control throughout the discussion and closing process, enabling them to ensure protection for shareholders, staff and client base.
- Management can identify and discreetly communicate with potential acquirers, showing how the bank’s unique balance sheet strengths can enhance an acquirer’s balance sheet and/or mitigate an acquirer’s balance sheet weaknesses (loan-to-deposit ratios, loan concentration issues, loan diversity, etc.). This is clearly the best way to maximize shareholder value and leverage the selling bank’s strengths.
- Often, the selling bank’s weaknesses can be offset by the acquiring bank’s strengths, creating a real quantifiable synergy that bodes well for the future.
A classic example would be a bank with a low loan-to-deposit ratio and cost of funds acquiring a bank with strong yielding loan portfolios that are offset by a high cost of funds. The excess low-cost liquidity of the acquiring bank would flow into the target bank, resulting in a substantial synergistic increase in pro forma operating profits. In a negotiated transaction, the seller can highlight and benefit from sharing this true synergy.
- Management can evaluate the acquirer’s culture and its potential impact on their own organization.
- Negotiations can be discreet and confidential without disrupting existing operations and morale.
- With the right non-disclosure agreements in place, the selling bank can prioritize and investigate several potential buyers without the potential negative effects associated with a sale of the bank and the broad dissemination of proprietary information.
- Management roles and board of director positions in the acquiring bank can be properly negotiated as part of the transaction. These board roles could be important to existing shareholders/directors of the selling bank, especially where stock is part of the transaction.
- Transactions can be structured taking into consideration shareholder taxpayer issues, further increasing shareholder value.
In summary, the benefits of negotiated transactions far outweigh any potential benefits from an auction for most community banks. It is unfortunate that many community banks, after spending decades building up their balance sheets and capital base, end their existence in the uncontrolled chaos of an auction.
Some bankers mistakenly think they are fulfilling their fiduciary obligation by conducting an auction. They assume that if they only talk to one buyer in a negotiated deal they may not be getting the best price. This, of course, is a myth.
While the concept of a selling bank using the right analytics to investigate and thoroughly analyze potential acquirers seems new to the marketplace, it is one of the most valuable actions management can take to maximize shareholder value. Negotiated transactions allow banks to take a proactive approach to M&A, gaining a competitive edge and solving their deposit issues.