Monday, April 1, 2013

No Do-Over's in M&A

Both Ralph and I have highlighted the perils of bad acquisitions and bad governance. Bad acquisitions share common characteristics including:

1)     Over Priced: reflected in high purchase price premiums and substantial goodwill and earnings per share (EPS) dilution. This is especially true for winning bidders in an auction (AKA the winner’s curse).

2)     Large Transformational Transactions: trophy deals driven by delusional CEOs with weak Board oversight.

3)     Serial Acquisition Program: some initial success breeds hubris. Eventually a “bump-in-the-road” exposes the real risk.

4)     Stock Used to Fund the Transaction

5)     Occurs Later in the M&A Cycle

A near perfect example of bad acquisitions is First Niagara (FN) an acquisitive rapidly growing Buffalo, NY community bank. They replaced their CEO, Koelmel, in mid March. He had embarked upon a serial acquisition program including 4 acquisitions in 3 years upon becoming CEO in 2006. FN grew from $10B to over $35B in assets during his tenure. Unfortunately, his growth for growth’s sake strategy proved disastrous for shareholders. The stock peaked at $15 per share in February, 2011 before falling to its current $8.50 level. During this same period the KBW Bank index rose by over 30%.You know it is bad when your stock increases 4% upon your CEO’s resignation. The stock is trading at 67% of its book value with an equally depressed price-to-earnings ratio.

Koelmels’s first few smaller acquisitions were moderately successful. They occurred during the peak of the 2008/2009 crisis and were attractively priced. Confusing luck with skill, he met his Waterloo with the mid 2011 $1B+ purchase of HSBC’s $10B+ in deposits with 195 branches up state NY franchise. The premium paid for the deposits was 6.67% compared to the expected 3.5-4 % range. Koelmel felt the premium was required to beat the much larger $85B in asset rival Key Bank who was also a bidder. The premium created significant goodwill and depleted FN’s regulatory capital.

Subsequently, FN sold 37 branches to Key Bank to satisfy antitrust concerns. Key paid only a 4.5% premium and turned out to be the real winner. As luck would have it, the market worsened after the announcement due to the beginning of the Euro crisis during the summer of 2011.This caused a substantial decline in operating performance. FN failed to obtain committed financing and decided to postpone a needed equity raise until May, 2012 when the deal eventually closed. Its stock price collapsed during that period resulting in a highly dilutive $467MM common stock raise at a 30% discount to the prior year price. They additionally raised $350MM in preferred stock with an 8.625 dividend rate compared to an expected 6-7% rate.

Integration problems compounded weak operating performance resulting in losses. Their dividend was cut for the first time.Koelmel’s credibility with investors and the Board was shattered and he had to go. He walked away with a $5MM+ severance package after nearly destroying FN in his vain attempt to become the 21st century version of Hugh McColl who created the modern Bank of America through acquisitions in the late 20th century.

Unfortunately for shareholders there are no “do-over” in M&A.Thus, it is critical that Boards have the strength to say “no-do” to strong CEOs before they embark on ill-fated acquisitions.

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