Stifel Financial - Bolt On Acquisition Of KBW Is Applauded

| About: Stifel Financial (SF)
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Stifel Financial Corporation (SF) announced on Monday that it will acquire KBW (KBW) in an attempt to create a premier middle-market investment bank. Shares of Stifel Financial rose 2.1% in Monday's trading session after the company furthermore announced its third quarter results. Shares of KBW rose 7.2% in Monday's trading session, closing at $17.47 per share.

The Deal

Stifel Financial announced that it will acquire KBW to create a premier middle-market investment bank. Under the terms of the agreement, Stifel will pay $17.50 per share for KBW. Shareholders in KBW will receive $10 in cash and $7.50 per share in Stifel's shares.

The share component is fixed at $7.50 per share, provided that shares of Stifel trade between $29 and $35 per share in the ten days before the closing of the deal. If Stifel's shares trade above $35 per share, the exchange ratio will be fixed at 0.2143 shares. If shares fall below $29 per share, the ratio increases to a fixed 0.2586 shares.

The deal values KBW at roughly $575 million. The bank's $250 million in excess capital will be made available to Stifel.

The combined company will focus on investment banking, sales and trading. The research division of KBW will continue to operate as an independent subsidiary.

CEO and Chairman Ronald J. Kruszewski commented on the deal, "This transaction is expected to be accretive to shareholder value. This merger with KBW, a premier, specialized financial services firm, provides Stifel with an exciting opportunity to grow and become a market leader in the financial services sector. Our shared culture and platforms are highly complementary, and this combination expands our capabilities at a time when we believe the financial services sector is poised to benefit from improving fundamentals. I am confident our clients will benefit from our expanded services and expertise."

KBW reported $249.2 million in annual revenues for 2011. The company reported a net loss of $31.7 million for the year.

KBW ended its second quarter with $143.4 million in cash and equivalents and it operates with $4.3 million in total debt, for a net cash position of $139 million. Based on KBW's current value of $527 million, this values operating assets at $388 million. As such KBW is valued at 1.6 times annual revenues.

Excluding the $250 million in excess capital which KBW currently holds, this values the firm at 1.3 times annual revenues.

Stifel had identified "significant" synergies that will leverage the integrated platform, and take advantage of Stifel's global wealth management capabilities. The merger is subject to regulatory approval and approval by KBW's shareholders. Next year's earnings per share will be accretive by 5 to 7% as a result of the deal.


Stifel Nicolaus furthermore reported its third quarter earnings today. Stifel net earned $37.7 million in the quarter, or $0.60 per diluted share. Revenues rose 26% to $420.1 million. Total client assets rose 23% to $136 billion as the book value per share rose to $26.62 per share.

For the first nine months of 2012, Stifel reported revenues of $1.19 billion. The company net earned $98.6 million, or $1.57 per diluted share which includes a $0.09 share gain related to the rescue of Knight.

At this rate the company is on track to generate revenues of almost $1.6 billion. The company could earn $125 million, or around $2 per share for the full year.

Stifel Nicolaus is currently valued at $1.75 billion. This values the firm at 1.22 times the book value, 1.1 times annual revenues and roughly 14 times annual earnings.

The company currently does not pay a dividend.

Investment Thesis

Year to date, shares of Stifel Financial are trading largely unchanged. Shares rose from $33 in January to highs of $40 in March. Shares fell back to $29 in July amidst concerns about the Eurozone crisis. Shares are currently exchanging hands at $32.50 per share.

Shares of Stifel rose from lows of $20s in 2009 and peaked at $50 in 2011. Between 2008 and 2012, Stifel boosted annual revenues from $891 million in 2008, to an estimated $1.6 billion this year. Net income rose from $55 million to an expected $125 million over the same time period.

The deal with KBW boosts Stifel's presence as a more serious investment bank, but it is not transformational. The deal will boost annual revenues by approximately 15%, expected to exceed $1.8 billion in 2008. KBW's shares have fallen almost 40% over the past five years as the company struggled to boosts revenues and generate net earnings.

While KBW is currently struggling, Stifel thinks it can profitably integrate the franchise into its own business. The deal is not cheap based on the headline numbers, however the excess capital of KBW can be profitably deployed by Stifel's current operations. The strong capital position of KBW brings valuation multiples down to a more acceptable ratio.

Shareholders applaud the deal, in Stifel's ambition to bolster its investment banking ambitions.

Disclosure: I 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.