Market Value vs. Investment Value in Bank M&A

by Jim White, Porter White & Co.

In bank merger and acquisition transactions parties to the deal usually engage valuation experts to render “fairness opinions” opining on the fairness of the pricing and other aspects of the transaction to the respective shareholders of the participating banks.  Fairness opinions provide comfort to bank boards of directors that they are exercising sound business judgement in approving the transaction, and knowledge that a fairness opinion is going to be rendered tends to discipline the negotiations as neither party wants to see a deal fail because it is deemed “unfair.”

Valuation experts rendering fairness opinions usually state that the deal price and terms fall within a range of reasonableness based on an analysis of recent similar deals, traded market prices for banks in general and similar banks in particular (if similar banks can be identified), and in some cases values determined by discounting estimates of future cash flows to present value.   A bank selling for cash wants comfort that there is unlikely to be a materially better offer from another buyer.  A bank buying for cash wants comfort that it is not diluting future earnings per share by paying too much.  In the case of mergers or stock for stock deals where no cash changes hands and both sides end up with stock of a combined enterprise, experts for both the buyer and the seller face the task of valuing (i) the seller, (ii) the buyer, and (iii) the combined enterprise going forward, in order to make sure that stockholders of both parties are receiving new stock worth at least as much as what they had before the transaction.  The type of analysis described in this paragraph produces “market value,” the value that an economically unconstrained buyer might pay for a banking enterprise.

Most business combinations have the potential to increase value through realization of “synergies.”  The combined organization might not need as many employees as the separate organizations.  Larger loan volumes of the combined bank might result in a reduction in expenses as a percentage of revenues.  A bank with a productive commercial lending activity may be able to increase interest earnings on deposits of an acquired bank with limited ability to attract commercial loans.   Synergies which are present in many merger and acquisition transactions lead to consideration of the “investment value” of a deal, i.e. what the transaction is worth to the acquiring party or the bank resulting from a merger.  Investment value may be more than market value because of the ability of the buyer to reduce expenses or enhance revenues.

In most merger and acquisition transactions, synergies are available to more than one potential acquirer. However, occasionally two banks are such a good fit that the synergies are unique to the two banks: no other combination of banks will produce equivalent economic benefits, and no other bank can afford to make a “topping” offer to break up a deal.  In these cases there is potential for the shareholders of both banks to receive value beyond what they will likely achieve separately.  In other words, the whole is greater than the sum of the parts.

Preparation of the fairness opinion should address both market value and investment value and should marshal and summarize the facts relevant to both standards of value.

Since 1968 Jim White has advised businesses, individuals, non-profits and municipalities on a wide range of financial matters. He founded Porter White & Company in Birmingham in 1975 and presently serves as chairman. Jim can be reached at (205) 252-3681 or