Bid for a California Banking Giant : INVESTORS : Wall Street Gives Thumbs-Up
Wells Fargo & Co. is offering a high price for rival First Interstate Bancorp, but Wall Street applauded the bid anyway Wednesday.
With legendary stock picker Warren Buffett as Wells’ largest investor, many smaller shareholders may simply assume the bank’s management can’t be making a dumb move, some analysts say.
Wells shares jumped $15.375 to a record $229 on the New York Stock Exchange, as First Interstate’s shares zoomed $34.25 to $140.25.
Wells’ unsolicited offer--consisting of 0.625 of its shares for each First Interstate share--is the latest takeover proposal in a year of banking mega-deals.
And while the merger mania has lifted bank stocks overall to levels that some veteran investors are increasingly leery of paying, Wells seemed to have no trouble convincing Wall Street that its bid isn’t too high to preclude a healthy payoff in the long run.
Wells was so intent on making that point that it dispatched its vice chairman and chief financial officer, Rodney L. Jacobs, to the Palace Hotel in New York on Wednesday morning for a highly unusual slide-show briefing for bank analysts.
Wells stressed that a marriage with First Interstate would “substantially increase cash [flow] and reported earnings” over time, thanks to an estimated $700 million in annual cost savings.
Moreover, the San Francisco bank chose to structure its offer as a purchase rather than a stock-pooling arrangement, which has been more common in bank mergers. The differences are technical, but Wells said its method would free it to continue repurchasing its own shares both before and after the merger.
Wells has had one of the most aggressive stock-buyback programs on Wall Street, repurchasing 10% of its shares in the last year. Buybacks help boost the price of the stock and increase per-share profits--highly popular moves with investors, naturally.
“To an unusual degree, Wells is a financially driven company. That’s why they attract an investor like Warren Buffett,” said David Berry, director of research at Keefe Bruyette & Woods.
Buffett’s investment firm, Berkshire Hathaway, began accumulating Wells shares in October, 1990--in the depths of the last bear market, when Wells’ price was $42--and it now owns 13.3% of the stock, worth nearly $1.5 billion.
Another wealthy investor, TV Guide founder Walter Annenberg, has also become a major Wells investor in recent years, and now controls 8.8% of the stock.
Buffett, in particular, has long been known for his attraction to companies that focus on building long-term wealth and franchise value. Wells said it discussed the deal with major shareholders.
By using an accounting method that would allow it to defend its stock price via buybacks, Wells sought to demonstrate that it has the ability to offset the potential negative pressure on the stock from a merger’s initially depressing effect on earnings per share.
Wells’ stated earnings would decline at first because it would be forced to gradually write off $7.6 billion in goodwill--an accounting term for the amount that an acquisition price exceeds the “book” value of the company being acquired, or the difference between its assets and its liabilities.
As the jump in Wells’ and First Interstate’s stock prices showed Wednesday, investors overall appeared enthused about the proposal, even though Wells is offering nearly three times book value.
Christopher Davis, manager of the Davis Financial Value stock fund in New York and a Wells holder, said Wells’ management is superb and has a track record as a “proven cost cutter,” thus enhancing the likelihood of decent long-term payoff from a merger.
“My feeling is that if Wells offers you a good price, it’s in the best interest of shareholders [for First Interstate’s management] to go with it,” Davis said.
But Michael Stead, whose SIFE Trust stock fund in Walnut Creek, Calif., also invests exclusively in financial industry shares, believes Wells may have to raise its bid. “I think there’s potential for Wells to go as high as $150 a share,” Stead said. At Wednesday’s share prices, the bid’s value was $143.
Interestingly, First Interstate’s largest shareholder is investment firm Kohlberg Kravis Roberts, which holds 7.6% of the stock. KKR, like Buffett, has one of Wall Street’s most spectacular investment records. The firm had no immediate comment on the offer.
Although bank mergers have been occurring with increasing frequency since 1990, the pace picked up this year with some mega-deals that have focused investors on bank stocks’ appeal.
The fundamental backdrop is healthy for banks: Strong loan demand, falling deposit interest rates and lower federal deposit insurance fees have put bank earnings on track to rise 10% to 20% this year overall.
But the surge in takeover activity has clearly added a speculative tone to the market for bank stocks, and many of the shares now are up more than 50% this year.
That has caused some veteran bank investors to pare their holdings. The Vanguard Windsor stock fund, for example, had 22% of its assets in bank stocks at the start of the year, but has cut that to 16%, said co-manager Charles Freeman. Some of the stocks “have gotten into our selling zone,” he said. “The easy money has been made.”
At the start of this year, many bank stocks were priced at just slightly above book value. Now the stocks are typically twice book value or more, a high level for banks historically.
Likewise, although the stocks’ prices relative to estimated 1996 earnings per share appear low compared to the average price-to-earnings (P-E) ratio of about 16 for U.S. blue-chip stocks, the highly cyclical nature of the banking business makes some investors nervous about paying more.
Beyond the cyclical risk, even the banking industry’s biggest fans concede that it is basically a low-profit-margin, low-growth business that is under attack by brokerages, insurance companies, mutual funds and other competitors.
“Banks are being surrounded,” Davis said. “They have to be the best in the business to survive.”
For that reason he thinks the game of trying to pick takeover targets is too risky. “We’ve been consolidating our holdings, focusing on the banks we really like” as survivors, Davis said. His favorites include Wells, Banc One, First Bank System and Citicorp.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
How The Stocks Have Run
Bank shares have rocketed this year as interest rates have dropped, and many of the stocks now are priced at nearly two or more times “book” value, the theoretical value of the business. But because the stocks’ price-to-earnings (P-E) ratios are relatively low, many investors still view the shares as bargains.
*--*
Wed. price 1995 Price to P-E on Bank and change Gain book value ’96 est. Wells Fargo $229.00, +15.38 +58% 3.2 11* First Interstate 140.25, +34.25 +107% 3.0 12 First Bank System 51.63, -0.38 +55% 2.5 11 BancOne 38.00, unch. +50% 2.0 11 Bank of Boston 49.38, +1.50 +91% 1.9 10 Barnett Banks 60.13, +1.75 +56% 1.9 11 Citicorp 69.13, -3.63 +67% 1.9 9 NationsBank 72.63, +0.75 +61% 1.7 9 First Chicago 71.75, +0.13 +50% 1.5 9 BankAmerica 63.50, +0.25 +28% 1.4 9
*--*
* based on earnings expected before merger bid was announced
All stocks trade on NYSE.
Source: DLJ Securities
