The Canadian Western Bank’s first Eastern branch in Mississauga, on Oct. 31, 2021.Christopher Katsarov/The Globe and Mail
For all the hype around corporate mergers and acquisitions, a good number are ugly ducklings dressed up as visionary projects. Executives love to talk about synergies and value propositions, but executing a smart takeover, one that won’t become an albatross a few years out, is tough to pull off.
So give credit to National Bank of Canada, NA-T which landed a takeover of Canadian Western Bank CWB-T that seems to check this box. By acquiring the Edmonton-based lender, Quebec’s leading bank is combining with a regional institution that largely operates in a completely separate geography – and that specializes in commercial banking, an area where National has been trying to grow.
On Bay Street, they’re calling it the most logical deal in Canadian banking.
National Bank deal for CWB a vote of confidence in Western Canada, Danielle Smith says
But strategy is only half of the success equation. The other component is price – and there are lots of questions swirling as to whether National overpaid by offering a 110-per-cent premium to CWB’s closing price when the deal was announced.
Typically, merger premiums land in the 30- to 40-per-cent range. And CWB’s business has been subdued by muted loan growth and rising loan losses, particularly in the troubled trucking sector that is suffering through what is called a freight recession.
To protect itself, National structured its payout in the most sensible way possible. Instead of shelling out $4.7-billion in cash, which would be a big cheque for the smallest of the Big Six lenders to write, National negotiated an all-share transaction that uses its hot stock as currency.
National’s shares are by far the best performers of the Big Six over the past five years, up around 90 per cent before the deal was announced, allowing the bank to use stock that trades around 11.5 times earnings to buy income at only seven times earnings.
And while National is still raising $1-billion in cash to help backstop the deal – the huge purchase premium creates goodwill, which must be backstopped by capital, or a cash cushion – the lender is doing this by selling shares that are trading around an all-time high instead of taking on debt. Far too often, mergers become trouble when the acquirer loads up on debt and then hits some economic bumps.
At the same time, the stock market premium is only one of multiple metrics that must be considered. In banking, mergers are often valued on the price paid relative to the target’s book value. Before this takeover was announced, CWB was trading around 0.7 times its book value, roughly half of the Big Six average of around 1.4 times.
By offering $52.24 per CWB share, National’s takeover price amounts to 1.4 times CWB’s book value – so, average for the bigger lenders. For comparison, Royal Bank of Canada recently bought HSBC Canada, which was a stellar asset, for 2.5 times book value.
National, of course, had a few variables to weigh. The bank has been trying to expand its core personal and commercial banking business outside Quebec for years, and it’s been a slog. Quebec still makes up 77 per cent of this division’s revenue, despite multiple pushes to grow in Ontario, and some of its expansion bets have backfired. To win business in Alberta about a decade ago, National lent heavily to the junior oil and gas sector, but loan losses piled up when energy prices crashed in 2014 forcing National had to pull back, angering its borrowers. Buying an established franchise to do it is a much safer bet.
National has also scoffed at expanding in the United States, first under former CEO Louis Vachon and now under CEO Laurent Ferreira, who rose up through the ranks as Mr. Vachon’s close deputy. In a new book looking back on his career, Mr. Vachon stressed that the U.S. banking market is simply too competitive to be worth it. Just ask Toronto-Dominion Bank, whose return on equity in the U.S. has been challenged.
Because quality small-to-mid-sized Canadian lenders are hard to come by – unlike unprofitable fintech companies, CWB made $324-million last year – National was always going to have to pay a scarcity premium to win the deal. Then consider that National wants to make sure it didn’t leave an opening for a rival bidder, such as Bank of Nova Scotia or Canadian Imperial Bank of Commerce, to enter the fray.
The question, though, is whether it could accomplish all of that with something less aggressive, say a 75-per-cent premium to CWB’s market value. Because, as it stands, the deal looks like it’s priced close to perfection, meaning there isn’t much wiggle room for unforeseen events.