Northern States Financial (NSFC) – Merger Arbitrage – 4% Upside

Current Price – $0.94

Merger Consideration – $0.977

Upside – 4%

Expiration Date – October 4th, 2018

Proxy statement

 

First Midwestern Bancorp (FMBI – regional bank) is offering to acquire Northern States Financial (local community bank with 8 branches) for 0.0369 in FMBI shares. Although the spread is small, I believe this transaction has very high likelihood to close shortly as seen with other microcap bank acquisitions. NSFC shareholder meeting is scheduled for 4th of October. Fed approval has already been received and thus spread is expected to narrow after the meeting.

First thing to note is that merger consideration depends on FMBI share price. $0.9775 fixed price is applicable if average FMBI share price on 20 trading days preceding 5th day prior to closing is greater than $26.49 (currently average closing price stands at $27 at c. 1.5xBV). If FMBI trades between $22.86-$26.49 merger consideration will be 0.0369 FMBI shares per each share of NSFC. This is important for hedging considerations, especially with FMBI hovering around the $26.49 threshold point.

Second thing is that NSFC does not file with SEC since 2013. Limited financial disclosures can be found on their investor relations page. It’s being acquired at 1.75xBV and as many other small community banks does not seem to be operating efficiently (ROE before income taxes stands below 3%). So acquisition clearly to make sense for both sides and price looks fair.

The biggest question here is whether NSFC investor will vote in favor of the deal. A note in 2015 financial statements indicates that out of 92m currently outstanding shares majority were issued to previous preferred shares owners as well as to participants of 2014 private placement:

On April 30, 2014, the Treasury exchanged its Series A Preferred Stock (carrying amount $17.2 million), its right to accrued but unpaid dividends of $4.6 million and all of its warrants to purchase common stock (carrying amount $681,000) for 20,079,500 shares of common stock. On April 30, 2014, the Company completed a capital raise through a private placement, with investors acquiring all of the shares issued to the Treasury plus an additional 63,253,833 shares of common stock from the Company. These investors each own less than 5.0% of the outstanding shares of the Company’s voting stock of any class or series. Net cash proceeds to the Company were $18.9 million net of $1.8 million of offering costs of which $15.0 million was downstreamed to NorStates Bank.

This press release indicates slightly different amounts of funds raised but shows similar price per share paid:

The recapitalization was effected through a private placement of its common stock, primarily with institutional investors and with additional participation from certain directors, officers and existing shareholders <…> The Company’s common stock was offered and sold for a per share price of $0.30 in a private transaction.

With current acquisition offer valuing the company at >3x private placement price just 4 years ago and management likely having consulted these investors (or even owning large chunks of stock themselves) before agreeing to the offer I think vote is already in the bag.

FMBI has completed a number of similar sized bank acquisition in Illinois over the recent years. The last few were closed promptly after receiving shareholder approval.

NSFC traded at $0.78 before the announcement, so downside of 17% if the deal fails.

9 COMMENTS

  1. Martin Hernon

    dt, one thing to add re the hedge, there is an $.11 div payable on FMBI shares, record date 9/27/18.

  2. dnitka

    Seems like FMBI has fallen under 26.49. Seems like this is worth revisiting closer to 10/1 when there will be a better idea of whether the deal closes at the higher threshold.

    1. dt

      That makes sense, especially keeping in mind that consideration calculations will be based on 30 day weighted average. So assuming the merger closes some time in mid-Oct, I would guess that by the beginning of October we could have a pretty good estimate on the exchange ratio.

  3. bz

    every microcap bank deal has a similar spread to deal close. occasionally they do not go. I can recall 3 over the past yr. as a matter of fact, if I am lucky enough to have a stock that gets bought, I usually give them the extra 4-5% that I could get UNLESS I want the acquirer’s stock

    1. dt

      I believe that due to comments outlined above (owners from private placement, 3x return already, 2x BV valuation achievable only in sale of the company, FMBI track record in acquisitions) this microcap bank deal has significantly higher chances of closing than the average.

  4. Pavel V

    Can you, please, explain why 1.75xBV on ROE below 3% considered as a “fair” price?
    Even if they manage to double its ROE to 6%, that would be just industry average

    What can you recommend to read in order to understand banks valuation more deeply?

    1. dt

      I meant to say that BV multiple is in line with multiples seen in other community bank acquisitions. Profitability is far less relevant here as it will shoot up dramatically when tiny bank becomes part of the larger structure and eliminates most of the overhead. Here are some stats on community bank acquisitions:

      https://mercercapital.com/article/emerging-community-bank-ma-trends-in-2017/

      And here are some thoughts from fellow blogger on community bank valuations (if you search through his blog, you will find more resources on bank valuations):

      http://www.oddballstocks.com/2014/07/valuing-community-banks.html

  5. dt

    As expected FMBI/NSFC merger closed early and all NSFC shares are converted already.

    Each NSFC share was exchanged into 0.0363 FMBI shares. Average FMBI trading price ended up at $26.85. I hedged assuming $27 average price, i.e. 0.0362 exchange ratio. So almost all of the hedged position cancelled out after conversion.

    Result: +4% in a month..

Leave a Reply

Your email address will not be published. Required fields are marked *