Creating a ‘Win-Win’ in M&A, Part I

Viewing life in partnership terms is a generally healthy perspective. Successful friendships, teams, marriages, civic organizations, and local communities all have partnership characteristics. The key to successful partnerships is focusing on making the relationship win-win. Obviously, sometimes creating win-win relationships is almost impossible. To the degree practical, win-lose or lose-win partnerships should be avoided because they are likely to fail.

During my tenure at BB&T, we executed over 100 mergers. We approached mergers as creating win-win partnerships, which is one reason practically all of our mergers were successful. It was our responsibility to analyze the facts thoroughly and objectively to be sure that a merger was in our constituents’, specifically our shareholders’, best interest. Secondly, we thoroughly analyzed why it was rational to believe a partnership with BB&T would be beneficial to the majority of the constituents of our potential merger partner.

Let me describe the merger process at BB&T. While this is a concrete example, hopefully you will see the general principle applicable to practically all cases of creating partnerships.

The first question to be asked is: Why are you interested in creating this partnership (or category of partnership)? In terms of bank acquisitions part of our motivation was that without the growth potential from mergers, we did not have the scale to be successful in a consolidating industry. We could have chosen to sell instead of grow. However, we were convinced that our culture and operating model were superior to that of the potential acquirers. Even though our shareholders would receive a premium on the front end, we would out earn the premium over time as an independent company. Also, given the characteristics of our shareholders, most would hold the acquirer’s stock for the long term, and we were not willing to effectively sanction the potential acquirer’s stock as a healthy long-term investment. This position turned out to be totally correct. Even shareholders who received significant front-end premiums but chose to hold the stock of Wachovia/First Union or Bank of America (who would have practically acquired BB&T) have been sorry.

A merger, like a marriage, should be entered into in the context of creating a successful long-term relationship.

In the case of nonbank acquisitions, our motivation was to diversify our income stream to reduce risk. Most of our bank acquisitions were plain-vanilla companies with limited sources of revenues except from lending. This concentration of income from lending made us more vulnerable to economic cycles.

The general principle is that we were clear about what our motivation was in pursuing these mergers. The mergers were not ends in themselves but goals toward creating a rapidly growing but relatively low-risk business, which is what we achieved. When doing a merger becomes an end in itself, the merger usually fails. The same goes for partnerships.

Before becoming involved in a merger, it is critical that your own organization be running well. You are extremely unlikely to fix a broken system with an acquisition. Our community bank structure allowed us to easily accommodate community banks and savings and loan (S&L) acquisitions.

The next step in bank/S&L acquisitions was to broadly define the type of institution we were interested in acquiring. We decided the potential partner had to meet several criteria. There needed to be a reasonable cultural fit, or we would not be able to effect the cultural integration, which is essential to a successful merger. (Are your partners reasonable cultural fits?) Secondly, in general, we did not want to “bet the bank,” so we would focus on smaller or cleaner mergers, where if something went wrong it would not sink our ship. We wanted to build a franchise that would be competitive in the long term, so we put energy into in-market mergers in which we would have a relatively large market share, which created efficiencies and brand value.

It was also decided that our focus would be on solid or medium performing institutions. Dysfunctional organizations are typically difficult to fix. Also, it is hard to improve the performance of high performers. Why would a high performer sell if there were not hidden issues?

Of course, the economics had to work from our shareholders’ perspective. We created rigorous criteria in terms of the impact on earnings per share, book value per share, and the rate of return. More important, discipline was applied to ensure we did not fool ourselves by being overly optimistic with projections of savings and revenues. In this regard, the board members were told that for 10 years after an acquisition was effected, they would be provided with a report on how well the acquisition performed relative to our projections. It is tough to remind your board for 10 years that you made a significant mistake, so this discipline encouraged rational, objective analysis.

Within this broad context, the next step was to develop a list of our top 100 prospects. The selection of prospects was based on cultural fit, economics of the acquisition, and the probability of the preferred acquisition choosing to sell. Solid institutions that might have a challenge maintaining their performance were prime candidates. Management succession was often a key issue from a potential seller’s perspective. We also focused on community banks and thrifts that had been in business a long time. These institutions were more likely to have a loyal client base. We tended to avoid companies that we perceived were created to be sold because this type of business is usually a short-term profit maximizer, and maintaining profitability would be a challenge.

After defining our list of possible partners, we began a systematic calling process. Our calling effort was led by Burney Warren, a CEO from one of our early acquisitions, who knew the thrift and community bank industry. Before making a call, we would carefully analyze the potential partner, looking for areas where a merger with us would objectively be to their benefit. When meeting with them, it was critical to communicate that we understood their strengths and weaknesses and that our discussion was based on the concept of a win-win partnership. We absolutely did not want to talk people into joining our team if they were not clear about what it looked like to be part of BB&T and what the cost and benefits of the partnership would be.

A merger, like a marriage, should be entered into in the context of creating a successful long-term relationship. You do not want to outsmart or mislead in any way your future partner. If people there are not objectively energized by the potential of the partnership, then it will be better for both parties to pass on the potential relationship.

If people from the potential merger partner were interested in moving forward, then they were invited to our headquarters, where we told them the BB&T story and introduced our key executive managers. In telling the story, the financials were discussed; fortunately, BB&T’s financial results were impressive. However, the focus was on culture. We believed that the merger partners who grasped the significance of culture to long-term economic performance would be the best partners for us.

John Allison is the president and CEO of the Cato Institute and a former chairman and CEO of BB&T.