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$35 billion deal will weigh on BofA stock
It's easy to see why Bank of America wants credit card issuer MBNA. But investors may penalize the stock until they get some questions answered.
By Robert Walberg
Like too many consumers with new plastic in their pockets, Bank of America (BAC, news, msgs) just spent too much money. And its free-spending ways will depress its stock for some time to come.
Charlotte, N.C.-based Bank of America on Thursday agreed to buy MBNA (KRB, news, msgs) for $35 billion in stock and cash. The message from the agreement is clear. Not only does Bank of America want to be America's bank, but also it wants to be the nation's leading credit card company.
By adding MBNA's near 12% share of the credit card market to its 7% share, Bank of America moves into a virtual tie with J.P. Morgan Chase (JPM, news, msgs) as the country's biggest credit card issuer.
Interestingly, this is the second time in about a month that a big consumer bank has agreed to gobble up a credit card company. A few weeks ago Washington Mutual (WM, news, msgs) cut a deal to buy Providian Financial (PVN, news, msgs) for roughly $6.5 billion, a relative bargain.
The pros
Why the interest in credit card companies, especially when their growth rates are leveling off? For Bank of America, adding MBNA makes sense, at least in theory. Here's why.
MBNA was the largest pure, standalone credit card company with a vast client base of relatively affluent customers.
MBNA's stock was trading at a discount to the industry after it tumbled in late April in response to a profit warning.
Natural cost savings and synergies. Bank of America expects to achieve after-tax expense synergies of nearly $850 million by 2007. It also sees a restructuring charge of $1.25 billion.
The deal bolsters Bank of America's brand name and improves its long-term competitive position relative to J.P. Morgan and Citigroup (C, news, msgs).
If only Bank of America had come up with a reasonable price for MBNA this deal would be easier to warm up to. But instead it acted like it just landed a card with a big credit limit and no interest payments for the first six months. Based on Wednesday's closing prices, the transaction is valued at $27.50 per MBNA share, a 30.5% premium.
The cons
Another way to look at this is that Bank of America agreed to pay a 21% premium to receivables. According to Prudential Equity Group, the standard premium to receivables is closer to 17%. In other words, Bank of America overpaid by nearly $4 billion. As it stands, the deal is expected to reduce earnings in 2006 by about 5 cents per share to $4.43.
Of course, Bank of America will try to justify its price by claiming that it acquired a superior company with a strong client base, but the numbers don't lie. This was a lot to pay for a credit card company that was struggling due to limited product offerings and increased competition, especially when you consider that big mergers rarely result in the cost savings originally anticipated, at least without more job cuts. And Bank of America already is planning to whack 6,000 employees (on top of the 1,000 staff reduction announced by MBNA) -- so much for worker morale.
Even assuming that the combined companies realize the expected synergies and savings from this deal, does Bank of America really want to increase its exposure to consumer debt at a time when debt levels are historically high and consumers are stretched pretty thin? On the face of it, this seems like a risky proposition made riskier by the excessive purchase price.
In credit card companies' favor
But the reason we've seen a couple of credit card companies get snapped up recently is that the acquirers see interest rates rising, something the Fed continued Thursday with its ninth rate hike. As rates rise, the spreads will benefit the credit card companies and their profits should pick up. Bad debt expense also will increase, but recent changes to bankruptcy laws and the relatively high income level of the average MBNA client should limit that risk in Bank of America's case.
Bank of America wants to be one of the top tier consumer banking and finance companies in the country and Thursday's deal will definitely increase its brand awareness and expand its reach. But for investors, management's decision to pay too much for MBNA will damage shareholder value over the near term. How the stock will recover will depend upon how quickly and successfully the company integrates MBNA into its culture and how consumers hold up in the face of rising debt and rising rates.
Until the Street gets a better handle on these issues expect Bank of America's stock to trade at a discount to its peers and overall market.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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