Mellon Financial And The Bank Of New York Case on Growth And Value Creation

Submitted by Group 6 Ankit Gaurav Bansal Vaibhav Jha Shipra Jha Prachi Khaitan Akshat Pareek Raghvendra Raghao Piyush Upadhyay

Presented to: Dr. Mayank Joshipura

Contents

Part 1: Estimation of Synergy Value .................................................................... 3

Question 1: What is the value of the cost savings synergies created by the deal? 3

Question 2: How much confidence do you have in your estimate of synergies?3

Question 3: Will synergy cash-flows allow the banks to increase their debt? . 4

Question 4: Under that terms of proposed deal, what fraction of the synergies will be captured by Mellon legacy shareholders? By BNY legacy shareholders? (“Legacy” shareholders are the former shareholders of BNY or Mellon, after they become shareholders of the new company.) ................................................................ 4

Part 2 - Accretion vs. Dilution of Earnings per share ........................................... 5

Question 5: Based on the last closing stock prices, and assuming no synergies, what exchange ratio would leave the per share values of Mellon and BNY stock the same? (This is sometimes called “Zero premium” exchange ratio.) How does the actual exchange ratio differ from this number? Who benefits from the difference? (Hint: Chart discussed with ER1 and ER2 would be useful guide to answer this question.) ......................... 5

Question 6: In the absence of synergies, what exchange ratio would keep the earnings attributed to each legacy share in Q4 2007 equal before and after merger? ... 5

Question 7: In the absence of synergies, is the proposed deal accretive or dilutive for Mellon shareholders? For BNY shareholders? ................................................. 6

Question 8: How do synergies impact accretion/dilution of analysis? ............ 6

Part 3- The Deal .................................................................................................. 8

Question 9: BNY mangers have argued that their P/E multiple is temporarily low relative to their peers because of the “overhang” of recently completed deals. Do you buy their logic or is this simply a negotiating tactic? ...................................................... 8

Question 10: In the negotiations with BNY, should Kelly have held out for an exchange ratio that was more favourable to Mellon? Is he selling out shareholders of Mellon and the city of Pittsburgh by doing the deal on disadvantages terms? ......................... 8

Part 1: Estimation of Synergy Value

Assumption: We assume that both the banks are fairly valued. i.e,, their market values are equal to their

intrinsic values.

Question 1: What is the value of the cost savings synergies created by the deal? Assume that: a. The combined company will have a tax rate of 38% b. Deposits, Short-term borrowings, Long term debt and equity are part of a bank’s capital structure. “Other liabilities” are not. c. An aggregate debt beta of 0.1 is a reasonable estimate of the (average) beta of the debt that supports the assets that give rise to the merger’s synergies. d. The equity betas reported in Exibit-2 may be used as estimates for the betas of the equity that supports the assets that five rise to synergies; and e.The market risk premium is 6.2%.

Answer 1

On the basis of our calculation shown in the attached excel sheet, we have derived the following value of the

cost saving synergies

Group_6_M&A_MellonBNY_Calc.xlsx

Synergy Calculations Amount (Million $)

Terminal present value of synergy by GGM 13,704.70

NPV of synergy 13,624.38

Question 2: How much confidence do you have in your estimate of synergies? Answer 2 In this case we are allocating the cost savings to both the entities separately in terms of the extra EPS in case of synergies for each and then valuing them with their respective WACCs. We are assuming the cost savings would be utilized in their respective companies. Also, for the onetime cost for the merger, we are discounting it at a rate which is the weighted average of WACCs of both the companies. By doing this we are ensuring that,

1. The cash flows are discounted at the rate at which they are going to be invested

2. The two entities have different betas, which mean we should use different WACCs for the cost savings from each of them.

3. For the onetime costs we do not have enough data to calculate the company wise expenses so, we discount it at a rate that seems reasonable. In this case which we have assumed to be the mean of the WACCs of the two entities.

Question 3: Will synergy cash-flows allow the banks to increase their debt? Answer 3

Since, cost synergies will not change the book values of equities for the merged entity, but they will be transferred to the retained earnings which will increase the overall equity. An increase in the equity will leave some leeway for the debt which can be used to get additional debt.

Question 4: Under that terms of proposed deal, what fraction of the synergies will be captured by Mellon legacy shareholders? By BNY legacy shareholders? (“Legacy” shareholders are the former shareholders of BNY or Mellon, after they become shareholders of the new company.)

Answer 4 The calculation of the synergy captured by the Mellon Legacy shareholder has been shown in the attached excel sheet

Group_6_M&A_MellonBNY_Calc.xlsx

Synergy to Mellon shareholders 4949.50

Synergy to BNY shareholders 8674.88

Part 2 - Accretion vs. Dilution of Earnings per share

Question 5: Based on the last closing stock prices, and assuming no synergies, what exchange ratio would leave the per share values of Mellon and BNY stock the same? (This is sometimes called “Zero premium” exchange ratio.) How does the actual exchange ratio differ from this number? Who benefits from the difference? (Hint: Chart discussed with ER1 and ER2 would be useful guide to answer this question.) Answer 5 The Exchange Ratio for No Premium or Zero Premium

As per the above calculation, we get the exchange ratio as 1: 0.8859. In the actual scenario, the exchange ratio

is 1: 0.9434. This actual ratio is less than that for No Premium ratio. Thus, this transaction would be accretive

in nature for the BNY shareholders.

From exhibit 16, we get the following information:

Case 1: Exchange ratio is 1: 0.9434

For BNY, the EPS grew at 5% (with synergies) and -1% (without synergies).

For Mellon, the EPS grew at 9.5% (with synergies) and 2.75% (without synergies).

Case 2: Exchange ratio is 1: 0.8859

For BNY, the EPS grew at 3% (with synergies) and -3% (without synergies).

For Mellon, the EPS grew at 13% (with synergies) and 5.5% (without synergies).

Thus the deal was less accretive for Mellon’s shareholders at the actual Exchange Ratio of 1:0.9434.

Question 6: In the absence of synergies, what exchange ratio would keep the earnings attributed to each legacy share in Q4 2007 equal before and after merger?

Answer 6

PT/PB 40.05/35.48 1: 0.8859

In the absence of synergies,

PRE-DEAL (Q4, 2007)

The Earnings of BNY 0.64*751.8 481.152m

The Earnings of Mellon 0.65*411.9 267.735m

Total Earnings 748.887m

POST-DEAL

The EPS of Mellon 0.65 (Pre Deal EPS)

Total no. of shares Post Deal

= Total Earnings/EPS of Mellon

748.887/0.65 = 1152.13

No. of Shares for Mellon Shareholders 411.9 (1:1)

No. of Shares for BNY Shareholders 1152.13-411.9 = 740.23

Hence, the exchange ratio for which the EPS in 2007 would have remained the same in both the Pre-deal and

Post-deal scenario is given as follows:

Post-deal no. of shares for BNY shareholders/ Pre-deal no. of shares for BNY shareholders

= 740.23/751.8 = 0.9846

Thus, the exchange ratio is = 1: 0.9846 (Mellon : BNY)

Question 7: In the absence of synergies, is the proposed deal accretive or dilutive for Mellon shareholders? For BNY shareholders?

Answer 7 In the absence of synergies, the proposed deal i.e. an exchange ratio of 1: 0.9434 is accretive for Mellon

Shareholders (the EPS increases by 1.5% to 3.5%).

But, for the BNY shareholders, it is slightly dilutive (the EPS is decreasing by less than 1%)

Question 8: How do synergies impact accretion/dilution of analysis?

Answer 8

Synergies impact in a positive way for the benefit of both the company's shareholders.

The increase in EPS for the Mellon’s Shareholders is approximately 8% to 13%.

With synergies the deal turns out to be accretive for BNY’s Shareholders also. The increase in their EPS is

approximately 3% to 10%.

Part 3- The Deal

Question 9: BNY mangers have argued that their P/E multiple is temporarily low relative to their peers because of the “overhang” of recently completed deals. Do you buy their logic or is this simply a negotiating tactic? Answer 9 The P/E ratio of 14 is justified as other banks having higher P/E ratio have lower betas or higher ROE.

Question 10: In the negotiations with BNY, should Kelly have held out for an exchange ratio that was more favourable to Mellon? Is he selling out shareholders of Mellon and the city of Pittsburgh by doing the deal on disadvantages terms? Answer 10 No, because the forecast of EPS in Exhibit 16 at the current agreement does not indicate any loss to Mellon shareholders compared to the case of no mergers. Though, in this case the synergies are more evenly distributed across both the entities compared to the case where exchange ratio equals the ratio of recent stock prices. The city of Pittsburgwill is getting more jobs and the community services are well taken care of even before the merger takes places.