James Kaplan's law firm was negotiating a handful of bank mergers when the stock market collapsed two weeks ago. All of them are bogged down in new squabbles over whether the seller can say "deal's off" if the buyer's shares tank.
"It is a big issue right now. I have a deal that is on the rocks because of it," said Kaplan, partner and chair of the Midwest banking practice of DLA Piper in Chicago. "In today's market it is all about price protection."
Talks over so-called walk-away rights in stock-swap deals are always touchy. But they are becoming deal breakers after the 21% dip in bank stocks in the past three weeks. The sell-off underscores the risks of paying for mergers with stock. Most deals have at least some stock component because banks are wary of depleting capital. Relying on stock as currency can punish either party if one institution has a huge swing in market value.
Say a buyer agrees to give the seller a half share of its stock for every single whole share the seller has outstanding. If that exchange ratio is fixed, the buyer could end up paying more if its shares soar in value and the seller's shares don't. If the buyer's shares fall sharply in value, the deal becomes cheaper, and thus less rewarding to selling shareholders.
Simply adjusting the ratio to does not solve the problem. The seller wants the same price. If the buyer's stock loses value, the new share-for-share exchange ratio would make dilution an issue by forcing the buyer to issue more shares.
The recent upheaval has sellers asking for more freedom to kill a deal without being punished if the buyer's shares depreciate. Buyers are scoffing.
The essential hang-up is over what are known as "double trigger" and "single trigger" walk-away clauses.
Buyers favor double-trigger clauses. The seller can only pull the plug if the buyer's shares decline in value against a group of its peer banks or broader index. In a typical double trigger, the buyer has to decline 10% to 20% against an index. That type of decline is rare because bank stocks — and stocks in general — tend to increase and decrease in value in tandem. Right now all banks stocks are down: The KBW Bank Index of 24 large and midsize banks was down about 21% for the month of August as of mid-Friday.
Single triggers work in the seller's favor because the buyer's share price simply has to decline on its own, not against an index. Buyers think that is unfair. It says nothing about its performance if its shares are down with all bank shares. That just means investors are bearish on banks.
Also, the single trigger makes acquirers more vulnerable to the so-called buyer's curse: Investors tend to place an immediate discount on banks after they announce acquisitions on dilution or integration worries.
James Kaplan, a partner and chair of the Midwestern banking practice of law firm DLA Piper in Chicago, said it is "a rational thing" for banks on both sides of the negotiating table to want extra protection. But triggers could further stymie the industry's merger ambitions, he said.
"It's hard enough to get buyers and sellers to agree now. You put that extra piece of buyer protection, you might have even fewer deals," Kaplan said.
Buyers have had most of the leverage in bank mergers so far this year. That is reflected in at least three mergers in the last six months that have had some variation of a double trigger: Lititz, Pa.-based Susquehanna Bancshares Inc.'s $345 million deal in June to buy Tower Bancorp., of Harrisburg, Pa.; Brookline, Mass.-based Brookline Bancorp Inc.'s $234 million deal in April for Bancorp Rhode Island Inc. of Providence; and Wayne, N.J.-based Valley National Bancorp.'s $237 million deal for State Bancorp Inc. of Jericho N.Y. in April.
In the Valley National-State Bancorp deal, State Bancorp can walk if the 10-day average prior to the closing date of Valley National's shares is lower than $11.04, and if its shares depreciate against the Nasdaq by more than 20%.
Valley National's traded at $10.65 mid-day Friday, down 1.66%.