Tài liệu MERGERS AND ACQUISITIONS IN BANKING AND FINANCE PART 2 pdf

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Why Financial Services Mergers?

The first chapter of this book considered how reconfiguration of the fi￾nancial services sector fits into the process of financial intermediation

within national economies and the global economy. The chapter also ex￾plored the static and dynamic efficiency attributes that tend to determine

which channels of financial intermediation gain or lose market share over

time. Financial firms must try to “go with the flow” and position them￾selves in the intermediation channels that clients are likely to be using in

the future, not necessarily those they have used in the past. This usually

requires strategic repositioning and restructuring, and one of the tools

available for this purpose is M&A activity. The second chapter described

the structure of that M&A activity both within and between the four major

pillars of the financial sector (commercial banking, securities, insurance,

and asset management), as well as domestically and cross-border. The

conclusion was that, at least so far, there is no evidence of strategic dom￾inance of multifunctional financial conglomerates over more narrowly

focused firms and specialists, or vice versa, as the structural outcome of

this process.

So why all the mergers in the financial services sector? As in many

other industries, various environmental developments have made exist￾ing institutional configurations obsolete in terms of financial firms’ com￾petitiveness, growth prospects, and prospective returns to shareholders.

We have suggested that regulatory and public policy changes that allow

firms broader access to clients, functional lines of activity, or geographic

markets may trigger corporate actions in the form of M&A deals. Simi￾larly, technological changes that alter the characteristics of financial ser￾vices or their distribution are clearly a major factor. So are clients, who

often alter their views on the relative value of specific financial services

or distribution interfaces with vendors and their willingness to deal with

multiple vendors. And the evolution and structure of financial markets

Why Financial Services Mergers? 61

make it necessary to adopt broader and sometimes global execution ca￾pabilities, as well as the capability of booking larger transactions for

individual corporate or institutional clients.

WHAT DOES THE THEORY SAY?

Almost a half-century ago, Miller and Modigliani (1961) pioneered the

study of the value of mergers, concluding that the value to an acquirer of

taking over an on-going concern could be expressed as the present value

of the target’s earnings and the discounted growth opportunities the tar￾get offers. As long as the expected rate of return on those growth oppor￾tunities is greater than the cost of capital, the merged entity creates value

and the merger should be considered. Conversely, when the expected rate

of return on the growth opportunities is less than the cost of capital, the

merged entity destroys value and the merger should not take place.

To earn the above-market rate of return required for mergers to be

successful, the combined entity must create new cash flows and thereby

enhance the combined value of the merger partners. The cash flows could

come from saving direct and indirect costs or from increasing revenues.

Key characteristics of mergers such as inter-industry versus intra-industry

mergers and in-market versus market-extending mergers need to be exam￾ined in each case.

Put another way, from the perspective of the shareholder, M&A trans￾actions must contribute to maximizing the franchise value of the com￾bined firm as a going concern. This means maximizing the risk-adjusted

present value of expected net future returns. In simple terms, this means

maximizing the following total return function:

n E(R )
E(C ) t t NPVf
t t0 (1  i  α ) t t

where E(Rt

) represents the expected future revenues of the firm, E(Ct

)

represents expected future operating costs including charges to earnings

for restructurings, loss provisions, and taxes. The net expected returns in

the numerator then must be discounted to the present by using a risk-free

rate it and a composite risk adjustment αt

, which captures the variance of

expected net future returns resulting from credit risk, market risk, oper￾ational risk, reputation risk, and so forth.

In an M&A context, the key questions involve how a transaction is

likely to affect each of these variables:

• Expected top-line gains represented as increases in E(Ft

) due to

market-extension, increased market share, wider profit margins,

successful cross-selling, and so forth.

• Expected bottom-line gains related to lower costs due to economies

of scale or improved operating efficiency, usually reflected in im￾proved cost-to-income ratios.

62 Mergers and Acquisitions in Banking and Finance

Figure 3-1A. Strategic

Positioning.

• Expected reductions in risk associated with improved risk man￾agement or diversification of the firm across business streams,

client segment, or geographies whose revenue contributions are

imperfectly correlated and therefore reduce the composite αt

.

Each of these factors has to be carefully considered in any M&A trans￾action and their combined impact has to be calibrated against the acqui￾sition price and any potential dilutive effects on shareholders of the ac￾quiring firm. In short, a transaction has to be accretive to shareholders of

both firms. If it is not, it is at best a transfer of wealth from the shareholders

of one firm to the shareholders of the other.

MARKET EXTENSION

The classic motivation for M&A transactions in the financial services

sector is market extension. A firm wants to expand geographically into

markets in which it has traditionally been absent or weak. Or it wants to

broaden its product range because it sees attractive opportunities that

may be complementary to what it is already doing. Or it wants to broaden

client coverage, for similar reasons. Any of these moves is open to build

or buy alternatives as a matter of tactical execution. Buying may in many

cases be considered faster, more effective, or cheaper than building. Done

successfully, such growth through acquisition should be reflected in both

the top and bottom lines in terms of the acquiring firm’s P&L account

and reflected in both market share and profitability.

Figure 3-1A is a graphic depiction of the market for financial services

as a matrix of clients, products, and geographies (Walter 1988). Financial

institutions clearly will want to allocate available financial, human, and

technological resources to those identifiable cells in Figure 3-1A that

promise to throw off the highest risk-adjusted returns. In order to do this,

they will have to appropriately attribute costs, returns, and risks to specific

cells in the matrix. But beyond this, the economics of supplying financial

Why Financial Services Mergers? 63

Figure 3-1B. Client-Specific

Cost Economies of Scope, Rev￾enue Economies of Scope, and

Risk Mitigation.

Figure 3-1C. Activity-Specific

Economies of Scale and Risk

Mitigation.

services often depend on linkages between the cells in a way that maxi￾mizes what practitioners and analysts commonly call synergies.

Client-driven linkages such as those depicted in Figure 3-1B exist when

a financial institution serving a particular client or client group can supply

financial services—either to the same client or to another client in the

same group—more efficiently. Risk mitigation results from spreading ex￾posures across clients, along with greater earnings stability to the extent

that earnings streams from different clients or client segments are not

perfectly correlated.

Product-driven linkages depicted in Figure 3-1C exist when an insti￾tution can supply a particular financial service in a more competitive

manner because it is already producing the same or a similar financial

service in a different client dimension. Here again there is risk mitigation

to the extent that net revenue streams derived from different products are

not perfectly correlated.

Geographic linkages represented in Figure 3-1D are important when

an institution can service a particular client or supply a particular service

more efficiently in one geography as a result of having an active presence

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Figure 3-1D. Client, Product,

and Arena-Specific Scale and

Scope Economies, and Risk

Mitigation.

in another geography. Once again, the risk profile of the firm may be

improved to the extent that business is spread across different currencies,

macroeconomic and interest-rate environments, and so on.

Even without the complexities of mergers and acquisitions, it is often

difficult for major financial services firms to accurately forecast the value

to shareholders of initiatives to extend markets. To do so, firms need to

understand the competitive dynamics of specific markets (the various cells

in Figure 3-1) that are added by market extension—or the costs, including

acquisition and integration costs. Especially challenging is the task of

optimizing the linkages between the cells to maximize potential joint cost

and revenue economies, as discussed below.

ECONOMIES OF SCALE

Whether economies of scale exist in financial services has been at the heart

of strategic and regulatory discussions about optimum firm size in the

financial services industry. Does increased size, however measured, by

itself serve to increase shareholder value? And can increased average size

of firms create a more efficient financial sector?

In an information- and distribution-intensive industry with high fixed

costs such as financial services, there should be ample potential for scale

economies. However, the potential for diseconomies of scale attributable

to disproportionate increases in administrative overhead, management of

complexity, agency problems, and other cost factors could also occur in

very large financial firms. If economies of scale prevail, increased size will

help create shareholder value and systemic financial efficiency. If disecon￾omies prevail, both will be destroyed.

Scale economies should be directly observable in cost functions of fi￾nancial services suppliers and in aggregate performance measures. Many

studies of economies of scale have been undertaken in the banking, in￾surance, and securities industries over the years—see Saunders and Cor￾nett (2002) for a survey.

Why Financial Services Mergers? 65

Unfortunately, studies of both scale and scope economies in financial

services are unusually problematic. The nature of the empirical tests used,

the form of the cost functions, the existence of unique optimum output

levels, and the optimizing behavior of financial firms all present difficul￾ties. Limited availability and conformity of data create serious empirical

problems. And the conclusion of any study that has detected (or failed to

detect) economies of scale or scope in a sample selection of financial

institutions does not necessarily have general applicability. Nevertheless,

the impact on the operating economics (production functions) of financial

firms is so important—and so often used to justify mergers, acquisitions,

and other strategic initiatives—that available empirical evidence is central

to the whole argument.

Estimated cost functions form the basis of most empirical tests, virtu￾ally all of which have found that economies of scale are achieved with

increases in size among small banks (below $100 million in asset size). A

few studies have shown that scale economies may also exist in banks

falling into the $100 million to $5 billion range. There is very little evidence

so far of scale economies in the case of banks larger than $5 billion. More

recently, there is some scattered evidence of scale-related cost gains of up

to 20% for banks up to $25 billion in size (Berger and Mester 1997). But

according to a survey of all empirical studies of economies of scale

through 1998, there was no evidence of such economies among very large

banks (Berger, Demsetz, and Strahan 1998). The consensus seems to be

that scale economies and diseconomies generally do not result in more

than about 5% difference in unit costs.

The inability to find major economies of scale among large financial

services firms also pertains to insurance companies (Cummins and Zi

1998) and broker-dealers (Goldberg, Hanweck, Keenan, and Young 1991).

Lang and Wetzel (1998) even found diseconomies of scale in both banking

and securities services among German universal banks.

Except the very smallest banks and non-bank financial firms, scale

economies seem likely to have relatively little bearing on competitive

performance. This is particularly true since smaller institutions are often

linked together in cooperatives or other structures that allow harvesting

available economies of scale centrally, or are specialists not particularly

sensitive to the kinds of cost differences usually associated with economies

of scale in the financial services industry. Megamergers are unlikely to

contribute—whatever their other merits may be—very much in terms of

scale economies unless the fabled “economies of superscale” associated

with financial behemoths turn out to exist. These economies, like the

abominable snowman, so far have never been observed in nature.

A basic problem may be that most studies focus entirely on firmwide

scale economies. The really important scale issues are likely to be encoun￾tered at the level of individual financial services. There is ample evidence,

for example, that economies of scale are both significant and important

for operating economies and competitive performance in areas such as