As I noted yesterday, there’s a wave coming… Not political. Not physical… I’m talking about a wave of mergers and acquisitions. And no sector will be spared from aggressive takeover deals that can make you a lot of money.
Now, some sectors are more likely to experience more deals than others. And some sectors will see higher buyout premiums than others. But no matter how you cut it, the deal-making will likely surpass the record merger and acquisition activity that transpired in 2021. Here’s what you need to know…
Synergy: The Word of the Day
There are only a few words I dislike more than “synergy.” It makes my ears hurt – right up there with tenderloin, moreish, and yeast… YUCK. But it’s impossible to ignore “synergy” when talking about deal making in Corporate America. Synergy is one of the key reasons why businesses engage in M&A activity. Now there are different types of synergies…
Revenue synergy – for example – is when two companies are likely to generate more sales thanks to a deal. An example is when Facebook purchased Instagram. The latter company wasn’t really that successful prior to the merger. But Facebook rightfully believed that by combining the two companies and putting Instagram’s business in plain sight of its massive social media audience would increase sales at both organizations.
Then there’s financial synergy. A lot of businesses want to grow – and they need capital to do so. However, banks will set higher interest rates for businesses that are at a higher risk of default. When two companies merge, improve their combined balance sheet and reduce risk, to generate savings.
Finally, there are cost synergies. This signals when companies can achieve lower costs in supplies, slash headcounts, or achieve lower fixed and variable costs in other categories thanks to a merger. They might consolidate their supply chains and limit costs, they might achieve greater buying power thanks to increased leverage in negotiations, or they might be able to improve the utilization of various assets like factories.
In today’s environment – where the cost of everything is going higher due to inflation, supply chain constraints, and wage growth – the latter factor will be a massive drive of M&A. But there’s one industry facing a very specific COST FACTOR that will drive consolidation in the space not just this year… but for the next several decades.
Tech and Cybersecurity Bleeds Banks
JPMorgan Chase spent more than $600 million on cybersecurity protection in 2020. It’s a good thing they can afford it as one of the nation’s largest banks. But community banks – smaller financial institutions that have a market capitalization under $2 billion – are struggling.
They face incredibly high costs to address cybersecurity threats each and every year relative to their available cash on hand. And that’s just one single technology trend. Tack on demand for ATMs, mobile banking, other fintech – and they just can’t compete with big rivals.
Banks are also regulated by the Gramm-Leach-Bliley Act, a Federal law that forces companies to comply with costly – yet vital – data security standards. These tech trends are key reasons why smaller banks continue to sell to larger firms.
But M&A activity isn’t anything new to the banking sector. Back in 1987, there were more than 15,000 banks across the United States. Today, there are under 5,000. And that number is still high (Canada, by comparison, has just six banks).
M&A activity in the banking space has led to a consolidation trend of about 3% to 5% of banks each year. Tack on these cyber threats and data rules, and this consolidation will continue well into the coming decades.
Now, if you’re serious about making money in this space – it’s a pretty simple Buy and Hold strategy that you can follow. Simply buy banks that trade a tangible book value of under 1.
You see, banks trading under a Tangible Book Value of 1 are trading for LESS than the sum of their parts. If the banks liquidated tomorrow, the stock would be worth MORE than today’s price. A few banks trading under that level – in markets that are attractive for consolidation – are:
- Western New England Bancorp (WNEB) – 0.99x
- Northeast Community Bancorp (NECB) – 0.84x
- Republic First Bancorp (FRBK) – 0.91x
This is a VERY boring strategy. Banks are boring. But the risks are lower and these trades can be quite lucrative, especially if a larger bank comes and purchases the community bank for 1.4 times tangible book value. These stocks could sell for 50% higher than today’s current price in the months or years ahead.