Current Price – $12.75
Acquisition Price – $14
Upside – 10%
Expiration Date – Q4 2017
This is straight forward merger arbitrage opportunity in nanocap land. Liquidity is very low – thus limit orders and lots of patience are needed to accumulate the position. I consider current spread (10%) to be attractive as I see limited risks of this deal falling apart. Low liquidity is likely the main reason for the spread to exists.
OCB Bancorp is being acquired by Sierra Bancorp (BSRR) at $14/share in stock. Both banks are based in Southern California with BSRR having 33 branches and OCB only 4. Merger is conditioned on OCB shareholder approval and receipts of government agency approvals. The acquisition price is also subject to certain potential adjustments (more below).
At acquisition price OCB is valued at 1.83x TBV and 22x TTM earnings, which looks reasonable valuation for a bank that seems to be on strong growth trajectory over the last few years (loans have grown at 29% CAGR, deposits at 15% CAGR). Also, on top of that there should be material cost synergies from personnel reductions, which will disproportionally affect the acquired OCB’s profitability – net income during 2016 amounted to only $1.3m, thus even if only a few top level execs are let go, net income boost will be material. Factoring in the potential synergies the acquisition looks even cheaper from earnings perspective. Sierra Bancorp itself trades at similar earnings valuation and only slightly cheaper (1.74x) with respect to TBV.
All of this suggests that Sierra Bancorp is unlikely to walk away from the transaction – in the presentation the company is indicating less 4 years TBV payback period and 20% IRR on this acquisition (not exactly sure how did Sierra’s management arrive at those figures).
While I have limited understanding in what kind of hurdles might surface from regulatory approvals, at least from geographical location perspective merger seems a natural fit (see slide 3 of the presentation) and is unlikely to cause any market concentration concerns.
This leaves us with OCB shareholder approval. Ownership structure is not disclosed (not SEC registered) but as OCB is a combination of 4 community banks, I would expect share ownership to be rather concentrated locally, potentially among insiders. All insiders have signed agreements to vote their shares for the merger. Also, during the last few years OCB stock traded in the range of $5-$6/share with very low liquidity, thus any other shareholders not related to management seem to be well rewarded and would probably support the merger (just speculation from my side).
Potential price adjustments
Merger agreement contains two potential price adjustments:
1) If OCB’s transaction related expenses are over $2.6m, then acquisition price will be adjusted by the amount above this threshold;
2) If OCB’s book value is below $16.6m, then acquisition price will be adjusted by the amount below this threshold;
I do not think any of these thresholds will be triggered. The BV continues to grow and as of Q1 2017 stood at $17.1m. With regards to transaction related expenses $2.6m is almost 10% of the market cap and this amount seems to offer plenty of leeway (albeit I am less confident on the expense threshold vs book value threshold).
Also worth noting that even-though the per share consideration is fixed at $14/share, this will be paid in Sierra Bancorp shares and the number of shares one gets will be determined by the volume-weighted average price of the common stock of Sierra over the 20 trading days immediately preceding, but not including, the 5 business days before the anticipated closing date. Thus, hedging might be required during the last month before the merger consummation. However, I would expect the spread to close before that – catalysts will be OCB shareholder approval (meeting expected in Q3 or Q4 2017) and any approvals from federal agencies.
If the transaction is cancelled, there will clearly be some short term pressure on the share price from arbitrageurs unwinding their positions. But I would expect the shares to settle above the unaffected share price of $8/share (although due to almost no trading before the announcement, it is hard to judge what the true unaffected price is). The OCB Bancorp is clearly for sale and valuation even at $14/share is not very demanding, especially after taking into account the potential cost synergies (which are very real for tiny community bank acquisitions). In the era of bank consolidation there should be more than one interested party.