Bank of Montreal's Marshall & Ilsley Deal Will Require Investor Patience - Analysts
December 20 2010 - 12:15PM
Dow Jones News
Bank of Montreal (BMO) investors will need patience before they
start to benefit from the Canadian lender's US$4.1-billion takeover
of U.S. regional bank Marshall & Ilsley Corp. (MI), sell-side
analysts say.
Analysts say the deal, unveiled Friday, makes good geographic
and strategic sense. BMO gets more than 374 more branches across
nine states, primarily in the U.S. Midwest, from Milwaukee-based
M&I. But, most of them cut their 12-month price targets on
Monday primarily because of the steep price, integration risk and
near-term earnings dilution.
"The optimistic scenario rests on the bank leveraging newfound
scale advantanges and a recovery of the U.S. economy," Credit
Suisse analyst Gabriel Dechaine says in a note. He reduced his
target to C$55 from C$62. "Looking ahead, we are now focused on
execution risk."
In Toronto on Monday, BMO is off C$1.40, or 2.4%, to C$56.61 on
4.32 million shares. The stock fell 6.5% to C$58 on Friday.
The Toronto-based bank will issue about 67 million BMO common
shares, valued at US$4.1 billion, in exchange for 100% of M&I
shares and plans to sell C$800 million in common stock to firm up
capital levels before completing the transaction before July 30.
M&I shareholders will hold 11% of BMO shares. The bank is also
repaying M&I's US$1.7 billion Troubled Asset Relief Program
loan.
But, it's paying a rich price.
BMO provided some clarity on its view of the purchase price on
the weekend, justifying an adjusted trailing price to earnings
ratio of less than 10 times and a price to adjusted tangible book
value of just over 1.5 times, says Barclays Capital analyst John
Aiken. He estimates the trailing PE ratio is above 15 times and the
price to adjusted tangible book value is significantly higher.
"Regardless, the acquisition is not as much of a steal as it may
have appeared at first glance," Aiken says.
BMO is now the Canadian bank with the most U.S. exposure, says
Credit Suisse's Dechaine.
With this transaction, BMO increases its U.S. loan book by 123%
to C$74 billion, which represents 34% of the bank's total loans.
That's more than its peers Toronto-Dominion Bank (TD, TD.T) at 26%
and Royal Bank of Canada (RY, RY.T) at 11%. If the U.S. economy
recovers faster than expected, BMO has added leverage, says
Dechaine.
But, TD offers a less risky way to play the U.S. recovery, he
adds.
BMO estimates future markdowns of around US$4.7 billion, or 12%
of M&I's US$38.8 billion loan book.
"We recognize that M&I's loan book is ugly, but BMO has
conducted extensive due diligence and significant additional loan
losses have been built into the deal economics," adds Desjardins
Securities analyst Michael Goldberg, one of the few analysts that
held firm on his C$68 price target.
M&I will significantly strengthen BMO's U.S. Midwest
property and casualty insurance franchise with more top five market
positions, says Goldberg.
He also believes that because BMO is using stock, not cash, to
pay for M&I, the Canadian bank will likely remain well
positioned to increase its dividend by this time next year.
CIBC World Markets' analyst Robert Sedran says BMO was attracted
"to the boring old part of the platform and is unlikely to devote
substantial resources to the supposedly faster growing states where
competition is intense, the collapse of the housing market hit
disproportionally hard and the franchise has much less value."
Provided that this contention proves to be correct, this
transaction is one that carries strategic potential - albeit with
some short term challenges," he says.
Sedran dropped his target to C$63 from C$67.
Stonecap Securities' analyst Brad Smith also sees some merit in
the acquisition.
"However, the risks are omnipresent for all Canadian banks
trying to advance U.S. personal and commercial banking strategies,"
he says. "BMO's brand strategy and the eventual competitive
reaction will be key determinants of success or failure."
The potential benefits probably won't start to accrue until
2013, and the longer term benefits of the deal could exceed
management's guidance, says RBC Capital Markets analyst
Andre-Philippe Hardy in a note. He dropped his target to C$68 from
C$73.
"We like the acquisition as it illustrates that Bank of Montreal
wants to be a meaningful player in the U.S.," Barclay's Aiken
says.
He thinks that value should "ultimately be unlocked in this
acquisition" but it won't be reflected in BMO's valuation "for some
time."
"Investors will need to be patient," says Aiken.
-By Caroline Van Hasselt; Dow Jones Newswires; 416-306-2023;
caroline.vanhasselt@dowjones.com
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