It will be some time before investors who lambasted Jay S. Sidhu for agreeing to sell an equity stake in Sovereign Bancorp Inc. to a deep-pocketed partner can say with certainty whether the fight was worth it.
One thing on which investment bankers and some of Mr. Sidhu’s peers agree is that by then there is a good chance another deal just like it will have taken place.
For executives who run banking companies of a certain size, selling a significant stake is emerging as a preferred way to fund growth, even if the sale occasionally alienates short-term investors.
Sovereign’s struggle to convince shareholders that selling 19.8% of its stock to Banco Santander Central Hispano SA echoes in some ways the resistance Banknorth Group Inc. (now TD Banknorth Inc.) initially got for its deal to sell a 51% stake to Toronto-Dominion Bank. Some investors were concerned that they would not be sufficiently compensated for giving up a majority stake in the Portland, Maine, company.
Private Capital Management LP, Banknorth’s largest investor before the Toronto-Dominion deal, and others initially considered voting against the sale. But the fund management firm decided to support the deal after discussions with William J. Ryan, Banknorth’s chairman and chief executive. At the shareholder meeting in February, 89% of the votes cast approved the sale.
John A. Kanas, the chairman and CEO of North Fork Bancorp. Inc., has put the strategy to work for himself — and says he would consider doing so again should the right situation arise.
“It’s a very legitimate financing structure, and it makes sense,” he said.
The $57.9 billion-asset North Fork has been an active acquirer for years; in October of last year it picked up GreenPoint Financial Corp. for $6.2 billion without outside help. But Mr. Kanas says he is aware that at some point, an opportunity may require a more flexible approach.
“If we were to go out and see something we wanted to buy that made great sense for North Fork, but it was going to dilute our tangible book value and we needed somebody to partner with to do this, I’d go take on a partner,” he said.
The partner would not have to be a foreigner, Mr. Kanas said. “We did it with Fleet when we busted up the Dime deal.”
In 2000 he launched a $1.88 billion hostile bid for Dime Bancorp of New York — with the help of a loan from FleetBoston Financial Corp. His attempt to acquire Dime failed, but Dime’s plans to sell to itself to Hudson United Bancorp. also fell apart. Washington Mutual Inc. ended up buying Dime a year later.
(Bank of America Corp. bought Fleet in 2003. Hudson United is selling itself to TD Banknorth.)
Mr. Kanas said he could foresee using an equity arrangement instead of a loan if he needed a partner for another deal.
Many investment bankers agree that such deals can help companies grow. For one thing, the bankers say, partial sales let experienced management teams stay in place, while providing them with funding to take on larger acquisitions than they could do otherwise — the stated goal of both TD Banknorth and Sovereign.
With the cost of capital rising, the merger and acquisition environment may well be ripe for bankers selling a stake of their stock, investment bankers said, despite the complexity of structuring them to the satisfaction of all stakeholders.
“I think they are very attractive deals,” but they don’t happen more often because “they are very hard to structure,” said Brian R. Sterling, the co-head of investment banking at Sandler O’Neill & Partners LP.
One investment banker, who did not want to be named, said the financial advisers themselves are partly to blame for the rarity of such deals. “It’s not really been a transaction that’s been heavily discussed in the marketplace with CEOs, candidly.”
However, several investment bankers said TD Banknorth and Sovereign could give more CEOs food for thought.
“Both the Sovereign and the Banknorth deals were driven by CEOs who want to stay independent but want the security and the ability to access capital,” the investment banker said.
Purchase accounting is also an incentive, for reasons alluded to by Mr. Kanas.
John Duffy, the chairman and CEO of Keefe, Bruyette & Woods Inc., said that Sovereign would have a sizable portion of goodwill on its balance sheet, and its tangible equity would be diluted, if it decided to use stock instead of cash to buy Independence Community Bank of Brooklyn, N.Y.
Financing with cash from a partner would alleviate that problem.
“You go to one investor who is sophisticated, who understands the business, you can work with,” Mr. Sterling said. “And we often find that strategic investors have more pricing latitude than purely financial investors, because they are looking for returns in other ways.”
TD Banknorth, Sovereign, and North Fork are also banking companies that, after years of acquisitions, have reached a size where small deals may not make much sense anymore, but they do not have enough capital or the necessary price-earnings multiple for large transactions.
Investment bankers can rattle off the names of a handful of companies that could look for a partner for a deal. Mr. Duffy suggested KeyCorp, BB&T Corp., and Fifth Third Bancorp. as possible candidates. All three companies declined to comment.
As for how such deals play out in the long run, observers say some predecessor transactions bode well. One that many point to is BNP Paribas’ step-by-step acquisition of BancWest Corp.
There are hazards that can emerge. Sovereign drew heat over governance issues and concerns about how much the company agreed to pay for Independence. (Sovereign has since changed some of the provisions regarding board members.)
Mr. Duffy said one thing bankers should work hard at is clearly defining the buyer’s intentions, and the contract should lay out the procedure for an eventual purchase of the rest of the stock, regardless of how big the initial stake is or whether the buyer actually wants to buy the rest of the company.
In selling a stake, “you’ve let the 800-pound gorilla under the tent, and what he can and can’t do you have to negotiate at the original investment,” Mr. Duffy said. “I think you go through that process whether the guy owns 20% or 51%. What protection is there for the remaining shares that they are not getting picked up cheap?”
That issue arose when HSBC Holdings PLC, which owned 51% of Marine Midland Banks Inc., sought to buy the rest in 1987. The initial offer of $70 a share was eventually raised by almost 20%, to $83. In the Sovereign-Santander deal, bankers say, the terms for how Santander would increase its stake were very specifically spelled out.
One factor that may limit how common such deals become is the number of possible buyers, investment bankers say. There are only so many foreign buyers to go around, and domestic acquirers tend to prefer full control of the companies they buy. For example, Wachovia Corp. insisted on a controlling stake when it entered into its brokerage venture with Prudential Financial Inc.
The history of Santander shows the endgame need not be a takeover. In 1991 the Madrid company bought a 13% stake in First Fidelity Bancorp. That stake had increased to just under 30% by the time First Fidelity sold itself to First Union Corp. in 1995. Santander paid an average of $28 a share for its stake, but First Union paid $64.29.
Santander wound up with an 11.4% stake in First Union, which it sold in 1997. In 2002 First Union bought the old Wachovia and took its name.
