Consolidation among banks is on the rise. But investors do not seem happy with the developments. Shares of KeyCorp. KEY plunged more than 7% following the announcement of an acquisition deal.
KeyCorp is acquiring the Buffalo, NY-based First Niagara Financial Group Inc. FNFG in a stock-and-cash deal worth approximately $4.1 billion, leading to the creation of the 13th largest U.S.-based commercial bank (in terms of total assets). Then, why are KeyCorp’s investors not thrilled about the deal?
A bit of digging into First Niagara’s financials will provide you with the answer. The company has been facing problems owing to a continuous rise in expenses, which, along with strained revenue growth, is exerting pressure on its bottom line. A challenging industry backdrop added to its woes. Notably, in September, rumors about First Niagara having put itself on the block had emerged (read more: Why Is First Niagara a Good Takeover Target?).
Before we start looking for other reasons behind investors’ aversion to the deal, let’s discuss it in detail. KeyCorp is paying a premium of nearly 10% on First Niagara's closing price as of Oct 29. Specifically, the company is offering $2.30 in cash and 0.68 KeyCorp share for each share of First Niagara.
Notably, the transaction, expected to close in the third quarter of 2016, is still subject to regulatory approvals as well as consent from shareholders of both KeyCorp and First Niagara.
Upon completion, the combined entity will enjoy a diverse footprint across markets in the Northeast, Mid-Atlantic, Midwest and Pacific Northwest. The transaction will also help diversify KeyCorp's loan portfolio as well as strengthen its core retail deposit franchise. The company will have roughly $99.8 billion in deposits, $83.6 billion in loans and 1,366 branches across 15 states.
Additionally, KeyCorp expects the deal to be accretive to earnings in 2017, excluding merger and integration costs of approximately $550 million. Further, the company anticipates saving $400 million in annual expenses.
While KeyCorp and First Niagara share overlapping operations that will strengthen the former’s revenue base, KeyCorp did not quantify the top-line benefit. During the deal presentation, the company stated that it will “drives revenue synergies by deploying stronger combined product set to existing clients.”
The presentation also mentions another important item, which we believe mainly triggered the fall in KeyCorp’s price. The company has suspended its existing share repurchase program (to buy back $725 million worth of shares through the second quarter of 2016) until the closure of the transaction, while its regular dividend payments will continue. Also, the company’s plan to hike its dividend up to 8.5 cents per share in 2016 remains unchanged.
Further, Moody's Investors Service has placed the ratings of KeyCorp on review for downgrade. The rating agency is of opinion that the deal will increase the company’s “operational and asset risks.”
At a time when banks are struggling to remain profitable amid a challenging operating environment, mergers and acquisitions (M&As) are on a rise. Banks including BB&T Corp. BBT, CIT Group Inc. CIT and Regions Financial Corp. are acquiring smaller firms with an aim to bolster top line and overcome the pressure exerted by a low interest rate environment (read more: M&A Deals Gain Popularity Among Midsized Banks).
Nevertheless, investors are examining such transactions more closely to decipher the pros and cons, before giving their thumbs up. So regarding the above-mentioned deal, its wait and watch as of now.
Currently, KeyCorp carries a Zacks Rank #3 (Hold).
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