Smart Planning Can Make Mergers Pay for Shareholders

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Smart Planning Can Make Mergers Pay for Shareholders

Mergers can add value to shareholders and result in sustainable competitive advantages, but only if correctly priced and well implemented.

Recent analysis by my firm indicates that mergers can generate significant scale benefits.

In larger in-market mergers, for example, the cost savings alone can generate incremental shareholder value equal to 1.3 times the book value of the acquiree. This assumes a typical regional bank business mix and average going-in expense control.

For contiguous-market acquisitions, the savings can be even greater.

Further, the new Chemical Banking Corp. has demonstrated that additional earnings can be generated through improved debt ratings. This impact is seen in lower funding costs and increased acceptability as a counterparty in derivative-products businesses.

Critical Factors

Finally, mergers can provide the scale to afford investments in new products that will be necessary given the lack of growth in many traditional businesses. This is now a critical issue for many leading retail institutions.

Through a combination of projects and discussions with banks that have captured these benefits, we have formulated a list of critical factors for success in merger integration.

Many of these "best practices" are relatively simple to articulate but often prove difficult to put into place.

Here are the key ones:

Understand and articulate how shareholder value and competitive advantage will be created.

Successful acquirers determine how the acquisition premium will be earned back or, if there is no premium, how much value will be created - and why.

The leading acquisition-oriented banks use proper methodologies to assess what financial improvements must be accomplished in order to serve shareholders.

This includes a recognition that discounted cash-flow analyses are preferable to earnings-per-share dilution calculations, and that discounted cash flow approaches can give a materially different perspective. These banks compare what is needed against what is feasible, and only proceed when value creation is possible.

Set aggressive but feasible targets for expense savings, which provide income with infinite return on equity. Such dollars have very high value. For example, depending on growth-rate assumptions, $100 million in savings (pretax) could increase market capitalization by $700 million.

Delivering these savings quickly is also key. For example, BankAmerica's target of $1.2 million in expense savings translates to $5.2 million a day in pretax earnings. If the program is accelerated 10 days, shareholders are enriched by $52 million.

With such potential, it is critical for top management to drive expense savings targets and timetables aggressively. This requires developing an initial perspective on the potential for savings in each major line of business, and for each support function.

Further, once the institution is merged, bottom-up efforts should be initiated to validate and ensure "ownership" of the targets by down-the-line managers.

The importance of this target-setting step cannot be overemphasized. We know of no bank that has achieved its full potential without setting such targets.

Favor-efficient decision-making, Top management should define its organization structure as quickly as possible. …