Inside Financial Services

KeyCorp to Buy First Niagara:  A Terrible Deal!

Print Friendly, PDF & Email

In 35 years of covering the banking industry, I’ve witnessed in awe some banking deals that I knew from the get-go were doomed to be disasters. Typically, they ended up destroying vast amounts of the acquiring entity’s shareholder value while boosting, rather than reducing, its risk profile. But I’d assumed the era of dumb deals ended for good in the mid-2000s once Hugh McColl, Ed Crutchfield, and Ken Lewis left the scene, and that bank CEOs and boards since then have come to their senses. It turns out that’s wrong. KeyCorp’s $4.1 billion acquisition of First Niagara, announced late last week, is almost certainly a ticking time bomb of value destruction on par with some of the classic bank mashups of the late 1990s. The deal will dilute Key shareholders via the overpriced addition of a mediocre franchise, while increasing its operating risk and—worst of all—it might start a cycle of serial acquisitions by Key that will result in further and ever-greater dilution down the road. No one, apparently, has learned anything.

All this is especially disappointing since KeyCorp CEO Beth Mooney had been doing a fine job of improving the performance of the company. I’m amazed that CFO Don Kimble can keep a straight face as he tries to justify why this is a good use of the company’s capital.  I’m not amazed, by contrast, by Morgan Stanley, who’ll get a big fee for selling what it surely knows is a misbegotten deal to Key and its board. Investment bankers, after all, will be investment bankers.

Specifically, here are seven reasons why this is an awful deal:

  1. Too big! As a rule of thumb, deals in which the acquiree is 20% or less the size of the acquirer tend to have a much higher chance of success. In such deals, integration of everything from IT to corporate culture is much easier to manage. Political infighting can be held to a minimum. But in this case, First Niagara is 41% the size of Key. Combining these two entities into a coherent, smooth-running whole is going to involve the simultaneous execution of several huge integration efforts–and the battles that go with them. I’ve seen from experience that not all those integrations will go smoothly.
  1. The acquisition won’t improve the strategic composition of KeyCorp or increase its long-term growth rate. To say First Niagara is a mediocre banking company is an insult to mediocre banking companies. It’s poorly run, and has a core growth rate that’s lower than KeyCorp’s. So Key is boosting its risk—operating, integration, regulatory, and who knows how else—to reduce its overall growth.
  1. Way too expensive. Of course, just about any deal can be justified if the price is right. This is not one of those deals. KeyCorp is paying 1.7 times First Niagara’s tangible book value and 19 times its 2016 estimated earnings. The result is a 12% reduction in KeyCorp’s tangible book value, that the company says—and I can’t believe that I’m typing this—it will take ten years to recover. Earnings dilution will occur in 2015, 2016, and 2017 even if the company achieves all its plans. Which (see next item) it won’t.
  2. The economic assumptions are an embarrassment. Mooney and Kimble must think investors are idiots. There’s never been a significant acquisition where there wasn’t some post-deal revenue and client loss at the acquiree. Never! We know from experience in particular that the greater the reduction of the acquiree’s branch network, the greater will be its revenue and customer attrition. Yet KeyCorp says it plans to reduce expenses by $400 million, or 40% of First Niagara’s current base, and not lose a dime of revenue! That’s delusional. Worse, CFO Kimble even has the gall to say he thinks Key will generate $300 million of revenue enhancements. Both logic and experience says that won’t happen. To suggest otherwise is the sort of thing that should cause the board to question his judgment.
  3. Corporate governance will likely get worse. It’s my belief that companies should have a board that’s big enough to provide adequately diverse selection of viewpoints, but not so big that it becomes unwieldy and voices get lost. In my opinion, the right size is anywhere from seven to eleven seats. KeyCorp currently has 14 board members, and will add three more from First Niagara. This makes no sense to me, other than as a negotiating tactic aimed at bringing the First Niagara board around. But given the price KeyCorp paid, it shouldn’t have had to throw in anything else. If KeyCorp thought 14 was the appropriate number of board seats, it should have kept the total at 14 by, say, adding two directors from First Niagara and asking two existing board numbers to resign. Instead, Key will add three seats to the (already bloated) 14. KeyCorp’s management and board are simply being lazy and undisciplined with respect to corporate governance.
  4. Poor capital management. Asked why it made more sense to pay 1.7 times tangible book value for an inferior banking franchise rather than buying KeyCorp’s own stock a back at 1.3 times, Don Kimble said he didn’t think the regulators would approve of such a large buyback in 2016. That may be true, but it still speaks poorly of Kimble’s patience with excess capital. He seems to think it’s a better idea to fritter it away quickly rather than hold it and wait for better opportunities longer-term.
  1. What this deal says about the future is ominous for Key holders. The worst aspect of this deal for KeyCorp shareholders is what it says about the future. History suggests that large deals like this tend to take longer to integrate and be more costly than initially expected.  In the meantime, revenue will be disappointing and returns will fall generally. It usually takes 18 months or so for management to realize that it has a disaster on its hands, and that costly additional charges will be needed. When that happens, management will be tempted to hide the scale of the mess by . . . announcing another bigger, even more dilutive deal as a smokescreen! The charges associated with that new deal will conveniently obfuscate the added charges of associated with the earlier one, and a new round of self-delusion will begin. Then, after another 18 months or so . . . well, you get the picture. It’s rinse and repeat. The result is a systematic dilution and abuse of shareholders, all so management can hide its own incompetence. I’ve seen my share of serial diluters before, and can only hope someone at KeyCorp or on its board will wake up and prevent that from happening here.
    Consolidation in the banking industry is not only healthy, but a necessary outcome of the many external forces affecting the industry.  But managements and boards of acquirers need to balance the risk and reward they see in an acquisition with the price.

I use to get mad about such overpriced acquisitions, but now I get sick because I know we should have learned from history.  But human nature never changes. Morgan Stanley might at least take its fee in restricted KeyCorp shares—priced just before the deal was announced.

What do you think? Let me know!

10 Responses to “KeyCorp to Buy First Niagara:  A Terrible Deal!”

  1. Mike Foley / Robert W. Baird

    Come on, Tom. Tell us what you really think!

  2. Kevin

    When they described the acquisition of First Niagara as “transformational,” I concluded that there must be a mess of unknown issues at Key because no one in their right mind could conclude that its addition sould be characterized as such. Of course I may be overthinking it. Perhaps they don’t mean transformational in a positive way.

  3. Fred S.

    Thanks for the article Tom. I am a novice but couldn’t understand this merger so am glad to read your opinion; would love to read management’s discussion of the logic in why they think this is a good deal.

  4. Tom brown

    Management’s logic is tied to unrealistic economic assumptions like no revenue loss.

  5. Mike J.

    While I find that I disagree with you more often than not, in this case, I am 100% in your corner. There is no set of financial or market metrics that can justify this deal as the market prices of the companies amply prove. I wonder what the break-up fee is and whether Key should cut their losses now.

  6. Philip Timyan

    Well done Tom. You’ve been spot on about previous serial dilutors. I still recall Ed Crutchfield calling you the little red-headed boy who was mistaken. The world soon found out that Big Ed was all wet.

    You just cannot get around the fact that someone else’s cobbled together mess is not worth a a 30% premium to your own. Let’s not forget that the bulk of First Niagara consists of:
    195 branches HSBC didn’t want
    57 branches PNC didn’t want
    NewAlliance Bancshares, itself a cobbled together franchise
    Harleysvile National, another cobbled together bank
    Various other entities for which FNFG paid top dollar for.

    In my opinion Key never recovered from the 1994 MOE of Keycorp/Society.

    I’m with you, KEY shareholders would be much better served by buying back what stock of their own they can.

  7. Randall Grossman

    You are certainly right about the revenue, Tom. I was in the thick of a number of in-market acquisitions in New England in the 1990s. We typically assumed a 10% to 15% customer attrition within the first two years. But it doesn’t stop there if you are also closing branches. Every one of those branches is a sales outlet, so when you close it you reduce your sales production. It doesn’t matter if you consolidate the branch into another branch — it is number of sales locations that matter.

    Consider a sales area (neighborhood) with four banks, one of which is First Niagara and another of which is Key. A customer shopping for a new bank (perhaps because you moved into town), has a two in four chance of choosing either Key or First Niagara, all other things held equal. But if Key consolidates the two branches into one, that declines to one in three. Key loses two-thirds of the sales that would have gone to the closed branch.

    Yes, its a simple model and there are all kinds of mitigating (or exacerbating) factors, but we learned the hard way that number of sales outlets matter when we began falling far short of sales forecasts in the year after the Fleet/Shawmut merger completed. Key’s shareholders are about to learn that lesson, too.

  8. bill lunn

    Forget the overpay and operation risks part. This deal adds absolutely nothing of strategic value to Key that it could not have built or acquired in smaller pieces.
    Falling in love with footprints is for Dr. Scholl’s or people with fetishes, not thoughtful bank management. YIKES !

  9. North Left Coast

    Agree completely, Tom.
    Having lived through the Wells Fargo acquisition, i.e., debacle, of First Interstate, it should be tatooed on all bankers that no matter how great you think you are as a manager, there is never a good time for a bad idea! Even the great bankers of Wells Fargo were easy pickings for Dick Kovacevich and Norwest (who retained the Wells Fargo name) after they all but destroyed the original WF with the disastrous FIB acquisition. Key is not a good bank and just got a whole lot worse! Probably a good short at some point in the future.

  10. Anonymous

    “Consolidation in the banking industry is not only healthy, but a necessary outcome”

    How has this changed since Dodd-Frank where virtually no new banks are created any more and therefore when consolidation occurs there are just fewer banks instead of better banks and new ones coming along?

Comments are closed.