Summit Bancshares (SMAL) – Merger Arbitrage – 37% upside

Current Price: $40.99

Offer: $56.13

Upside: 37%

Expiration Date: TBD

Press release

This case was shared by Ilja.

 

Acquisition of nano-cap Summit Bancshares has recently caught my attention as the spread has widened to 37% (compared to <5% for over half a year) as regulators voiced concerns over the merger. Downside is limited as bank is unlikely to trade down to unaffected levels due to strong Q4’18 and Q1’19 financial performance (both reported after merger announcement).

The acquisition has been announced in Nov’18 at $56.13/share in cash. Transaction needs the approval of SMAL shareholders and blessings from FDIC and California Department of Business Oversight. On June 18th the board has announced that FDIC is inclined to recommend a denial of the application and requested Summit to withdraw its application.

The problem is that acquisition is tied to launch of a new business plan, which involves providing financial services to MRBs (marijuana related business), so reportedly this merger marks the first time “FDIC has been asked to directly grant or deny a bank access to cannabis banking”. Although marijuana is legal in California it is still an illegal activity at federal level and FDIC is not able to approve it. So the regulator is not really against the merger itself, but rather is opposing the new business plan (which gets implicitly approved if the merger is allowed). Interestingly though, the board argues that FDIC is hypocritical as there are other banks (apparently a lot of them) that provide services to MRBs and regulators are fine with that only because they haven’t officially made any request and just kept “moving on with their business plan”. SMAL board has decided not to withdraw their application and is continuing the dialogue with FDIC. The whole process now will have to get back to the board of FDIC and it may take several months before anything gets resolved. Although the topic of marijuana is definitely gaining a momentum in Congress (here and here), most likely changes won’t come fast enough for the merger.

Faciam seems to be only interested in cannabis banking rather than SMAL itself (more details below), yet it still might change its tactic – amend business plan and start serving MRBs without the official blessing. On the other hand, California’s banking sector is in a stage of consolidation and given the strong fundamentals of SMAL another buyer might appear quickly even if the deal with Faciam eventually goes south.

So given these points as well as limited downside (considering strong Q4’18 and Q1’19 results), the idea here would be to hold SMAL and simply wait to see if anything turns out from the merger with Faciam.

 

Valuation

Summit is a community bank that offers traditional financial services to SME (almost ¾ of loans are for real estate and ¼ for commercial/industrial purposes). It owns only 3 branches (all in California) and yet still manages to operate profitably. The company went dark in 2003, but uploads the annual reports on their website (2018 is not out yet). Financial statements are also available on FDIC. Since the announcement of the merger SMAL reported strong Q4’18 as well as Q1’19 results –  quarterly ROE of 3.1% (vs 2.4% for Q1 2018) and BV growth of 2% s QoQ.

Given this strong performance I do not think that bank will trade down to pre-announcement prices of c. $32/share – at this level it would be valued at only PE=14.6, significantly below Californian peers.

 

Looking current valuation SMAL trades at 1.58x TBV versus 1.74x TBV multiple for western peers (Mercer).

Faciam offer values SMAL at P/TBV=2.16 and TTM PE=20.1, which seems to be in line with other bank acquisition in the western U.S – 1.90x BV (Deloitte, Mercer Capital) and P/E=19.2 (Mercer). Thus in case merger with Faciam breaks, there should be other potential suitors at similar multiples in the consolidating Californian banking industry.

 

Faciam Holdings

Faciam Holdings is a Santa Barbara-based private holding company, for which SMAL is the first acquisition. Its CEO is Andrew Nash is also a head and co-founder of El Capitan Advisors (financial advisory) and several other private firms with little information available. It seems that Andrew is very interested in cannabis banking and according to this press release last year El Capitan has became a partner of Colorado Credit Union including its cannabis banking subsidiary Safe Harbor Private Banking. Moreover, to the board of SMAL Faciam plans to add Sundie Seefried, who is not only a chairman of Safe Harbor and CEO of Colorado Credit Union, but reportedly “also educates financial institutions entering cannabis banking on compliance requirements”.