BB&T (BBT) and SunTrust (STI) have reached a deal under which both banks will enter into a merger of equals agreement with a massive equity value of $66 billion, in an effort to create the 6th largest US bank based on assets and deposits.
The deal makes perfect sense given the overlap and need for scale with technology investments seen up sharply in the coming years, in order to guarantee a competitive positioning in the years to come.
I like the deal and see the rationale, as well as potential for shareholders, yet note that projected synergies need to be delivered upon to drive appeal from here.
Deal Terms & Rationale
Terms of the deal between both banks show that investors in SunTrust will receive 1.295 shares of BB&T for each share they own, making BB&T the surviving entity in this merger. While the deal is presented as a merger of equals, this is not really the case, with equity holders of BB&T holding 57% of the pro-forma share count on closure of the deal, although the board and leadership positions are divided equally between both firms.
The deal is of course driven by cost synergies, as the combination has more diversified operations and is able to support the investments needed to transform the business from a technological point of view.
With some 10 million customers, the combination holds $442 billion in assets, $301 billion in loans and $324 billion in deposits as the banks aims to integrate both banks under one brand name which still has to be determined. Managers of both banks praise the cultural alignment of both organisations as well as potential for synergies, seen as high as $1.6 billion, although these will only be fully realised in 2022. Full integration is expected to take up to three years, with the deal expected to close in the final quarter of 2019. Part of these synergies will be invested in technology and systems in order to improve the competitiveness of the business.
As there is a lot of overlap between both banks, prospects for synergies look good. While SunTrust has a large presence in Florida, BB&T is hardly active in that state, and vice versa in Texas. Both firms are active in similar regions and states in the Northeastern part of the US. Note that a quarter of the combined branches are located within 2 miles of each other! Total synergies are seen at 12.5% of the combined operating expense base of both banks with as much as 50% expected to be realised in 2020, and 90% in 2021.
Equal Size, Not Equal Contribution
Both banks are very similar in terms of their size. BB&T holds $226 billion in assets while SunTrust holds just $10 billion less. BB&T had $149 billion in loans on its books, some three billion less than its merger candidate. In terms of deposits, both are very equal as well.
Yet, there is a difference in the valuation ahead of the deal, with BB&T supporting a $37 billion equity valuation while SunTrust is valued at $26 billion. This relatively large gap is the result of an efficiency ratio of 57% for BB&T, some 3 points better than reported by SunTrust, as well as the better long-term track record of BB&T. This is seen on the bottom line, as adjusted earnings of BB&T of $3.3 billion are considerably higher than the $2.6 billion reported by SunTrust.
About The Market Reaction
With 776 million shares of BB&T outstanding and shares being up 5%, or $2.50 per share in actual dollar terms, the move adds up to $1.9 billion in value being created.
SunTrust has 447 million shares outstanding, as those shares trade 12% higher, having moved up some $7 per share to $66 per share at the moment of writing. This move is equivalent to $3.1 billion in value being created on the back of the deal.
The combined increase in the value of both banks amounts to $5.0 billion on the back of the projected $1.6 billion pre-tax costs synergies, although this comes at a one-time cost of $2.0 billion. Both banks already made a calculation on how much "value is created" by pointing out that $1.2 billion in after-tax synergies works down to $14 billion in value on the back of an 11.5 times earnings multiple. After incorporating $1.5 billion in after-tax costs to be incurred to realise these synergies, the combination pegs the value created in this deal itself at $12.5 billion.
If that is realistic, the $5 billion accretion makes that the market "recognises" 40% of the projected benefits, as both banks have to first go through a lengthy approval process, and second, they have to deliver on the cost synergy promises as well, not to mention the timing element of the associated cash flows.
Combined current earnings run at $5.9 billion, as there will be 1.35 billion shares outstanding. That makes for earnings of $4.37 per share. Including $1.2 billion in after-tax synergies, earnings could improve to $5.26 per share, driving accretion equal to 20%. This percentage exceeds the 13% cash GAAP earnings per share accretion projected for BB&T in 2021 and the 9% accretion seen for SunTrust for the same year. This comes as these estimates already include some organic earnings per share growth and are based on the year 2021, while full synergies are only seen in 2022.
No Longer Regional
The deal to create the 6th biggest US bank means that the combination has escaped the regional label and has become one of the big boys in town, with more scrutiny and legislation to go with it. Nonetheless, these are no convincing reasons to not chase $1.6 billion in projected pre-tax synergies.
The regional and conservative nature of the business is part of the long-term success of BB&T as it has survived the 2009 crisis in a good way. This means that it has not incurred too large losses or dilution, which means shares now trade above the 2007 peak, which cannot be said for most banks, including SunTrust to a smaller degree. After all, BB&T is the surviving and leading franchise in what is presented as a merger of equals, but in reality is not really a merger of equals.
The deal looks good on paper, and while valuation metrics across the banking sector are quite low overall, with this combination not being an exception, I am not naturally inclined to buy the shares in response to the merger announcement, although the strategic and economic rationale behind the deal is sound. Hence, I am watching shares of BB&T with great interest, although I would be inclined to pick up a few shares in the mid-forties on the back of the valuation and incremental value creation as a result of the deal in the years to come.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.