Merger and Acquisition Growth Strategy in the Banking Industry - Essay Example

Topic: Finance topic: Merger/Acquisition of Bank One by Chase a. Introduction This paper seeks to analyze what has been the impact of themerger/acquisition of Bank One by JP Morgan Chase including that on the stock price of the company, and the overall performance of the company after the merger. 1. b. Background of Merger and Acquisition Growth Strategy in the Banking Industry Both JP Morgan Chase and Bank One are players in the banking industry and to understand their business is to undertand the industry where they are into. Merger or acquisition is normally adopted as strategy for growth. Hence different firms of various industries have adopted merger or acquisition as growth strategy. Every now and then, the strategy is adopted just to survive the competition in the industry where profits are declining as a result of the diverse economic events. The banking industry has its share of merger and acquisition. The situation in the industry is best described by Philip Mattera (2003) in his article, The Free-for-All in Financial Services: An Overview of The Banking Industry when he said: “Once the epitome of security and stability, the U.S. banking industry has undergone a remarkable transformation over the past three decades. It has faced a series of crises but managed not to fall into the abyss. It succeeded in shattering federal regulations that limited its activities, opening the way for banks to morph into financial supermarkets. The big bank holding companies have been gobbling up their rivals at an amazing rate, while trying to deflect criticism of their policies in poor communities.” The same author observed the disappearance of the safe and comfortable life of banks in the 1970s, with events such as the collapse of Franklin National Bank and the growing realization that third world countries might not be able to make good on the huge volume of bank loans that had been bestowed on them by their first world benefactors. He noted too that the 1980s saw the virtual meltdown of the savings and loan industry and of numerous commercial banks that had gone overboard in their real estate and energy lending. He attributed the huge bailout launched by the administration of Bush I which could saved the day while rewarding many of those wheeler dealers who had caused the problems in the first place under the banking industry. The author however added: “Once the crisis atmosphere was lifted, the banking industry moved full speed ahead in its quest for the holy grail: the abolition of federal regulations barring banks from entering the securities business. This rule, embodied in the Glass-Steagall Act of 1933, was not an arbitrary exercise of government power. It was an attempt to restore stability to the financial world after the 1929 stock market crash--the culmination of a speculative boom fuelled in large part by bank lending for margin-account stock purchases.”1 (Paraphrasing made) 2. Analysis and Discussion 2. a. The Merger of Bank One with J.P. Morgan Chase J.P. Morgan Chase & Co. bought Bank One Corp. to have one of the biggest histories of merger in the US banking industry for about $58 billion. The merger resulted to the second largest bank franchise in the United States with combined company assets of $1.1 trillion and having 2,300 branches nationwide. This has permanently made them as one of the top banks in retail banking and customer lending, credit card servicing, the very lucrative investment banking, asset management, treasury services and the stock market or simply customer securities management. The company estimated that the merger will result to forecasted cost saving of $2.2 billion to be allocated over a three year period and a combined market capitalization of approximately $ 130 billion. Minus the merger, J.P. Morgan would have fallen to No. 3 after Bank of America Corp.s $47 billion deal to buy Fleet Boston Financial Corp. is completed. Bank One, which currently ranks No. 6, complemented the power of J.P. Morgan Chase, making it to reach second highest ranking. Extended J.P. Morgans reach through the Midwest and the Southwest, and reduced dependence on investment banking and trading, and benefit from a strong retail and credit card presence present themselves as expectations in the future. The latter expectation is closely related to the fact that Bank One is worlds largest Visa card issuer.2 (Paraphrasing made) 2. b. Results of the Merger Every business and financial person would likely be interested to see that really happened after the merger. Testimony of the 108th Congress showed: “The evidence shows that increased concentration in the banking industry has not benefited bank customers and has not had a positive effect on the convenience and needs of the communities served by the acquired banks. The economies of scale that supposedly justify large bank mergers either do not materialize or are not passed on to customers. For example, large bank mergers often have an adverse effect on consumer deposit pricing and often result in higher fees to consumers. A Harvard study showed that instances of improved operating results after a large bank merger were due primarily to higher re-pricing, not economies of scale, suggesting the use of increased market power by the large banks to raise prices. Year after year, the Federal Reserves own annual survey of bank retail fees shows that the average fees charged by multi-state banks are significantly higher than those charged by single-state banks. We therefore urge the Board to examine closely the effect that this merger will have on deposit pricing and fees in areas where the merger partners overlap such as in Texas and Florida, and whether consumers will be adversely impacted by the merger.” (Testimony of the 108th Congress, Merger of Bank One Corporation into J.P. Morgan Chase & Co.)3 (Emphasis supplied) One of the advantages of merger is said to be synergy. It is believed that synergy can result in the ability to spread fixed costs over a larger number of units produced. Theory says that with merger, combined entity may be able to do away with one of its duplicate accounting, personnel, or other staff departments, consolidate a line department, or even share a facility. Hence, an article on Merger Strategy: Reaching for Corporate-Level Goals4 has reason to say: “A popular choice is to have both sales forces sell both product lines and thereby increase the ratio of sales per salesperson. Thus the combined entity may be more efficient than either of the separate firms, and that is the definition of synergy. If synergy is established, future after-tax earnings and dividends should be higher than for either party alone. It is here that stockholders benefit from the synergy of a merger.” It would seem that the result does not confirm theory in case of merger. Based on the above there was a Harvard study that showed that instances of improved operating results after a large bank merger were due primarily to higher re-pricing, not economies of scale, suggesting the use of increased market power by the large banks to raise prices. The claim of synergy therefore would seem to be misplaced in the case of J P Morgan Chase merger with Bank One. An article on Merger Strategy5 described antitrust action as an attempt by one of the various state or federal agencies to block a merger and that state agencies regulate intrastate commerce and have less impact on large firms than on small ones. It has mentioned too that Federal agencies jurisdictions are defined by interstate commerce activities and apply to virtually all large firms (and actually to most, if not all, small businesses as well) and that although many federal agencies have antitrust responsibilities. These agencies include the major ones like the Antitrust Division of the Department of Justice and the Federal Trade Commission.6 The same article went even further to say: “To ‘block a merger’, the government, under Section 7 of the Clayton Act, need to substantiate that a "substantial lessening of competition might occur" because of it.” 28 It added too that since there is no statute of limitations in antitrust law, a long-standing combination can be dissolved and cited as an example a January 1982 decision requiring AT&T to divest $84 billion worth of local operating subsidiaries. J.P. Morgan and Bank One’s merger showed that although there is approval of the merger by the Federal agencies, the same could still be dissolved and thereby dislocating the employees that would have affected because of the merger. The possibility of happening is always there especially in the light of the Harvard findings that the increase in profits was not through economies of scale but of higher prices and therefore detrimental to the economy. Hence, the same article on Merger Strategy warns s that before a merger materialized, firms should estimate the likelihood of approval and it be reminded that because of costs in executive time, legal expenses, and staff support, a merger that would have been successful if uncontested can become unprofitable. 7 By providing three general guidelines that can be used to assess preliminarily whether a merger will be challenged, the same article cautioned that if any of the following conditions is met by a merger, the merger is illegal:8 (1) Substantial actual or potential competition exists between the proposed buyer and seller, (2) Vertical merger would prevent competitors from access to supply or customer markets or otherwise lessen competition between firms in buyer-seller related industries, and, (3) Potential reciprocal dealing exists such that the merged firms could force a supplier to buy from one of them under threat of cancellation of purchases from it. However, as mentioned earlier, although the companies which are subject of merger might have made these requirements sure, there are still possibilities of anti-trust violations afterwards. Adding this to the fact that there is no statute of limitations as to possible violations of anti-trust laws, the merged companies hoping to get their synergy might actually be facing a problem of dissolution and given the expenses and cost spent for the merger could actually put the firms in situation worse than before the merger. 2 c. Additional Analysis of Other Results of the Merger Using data on Table I (See Appendix A); the profitability ratio expressed in net income to revenues of JP Morgan could be seen before and after the merger. The theoretical claim synergy possibility and hence higher profits because of economies of scale appear not much evident at this point. The Merger’s approval in January, 2004 should have its effect seen in December 2004 above. Before the merger the net profit margin in December, 2003 above is already 15 % and in December, 2004, the year of the merger, it even declined to .08. What does this mean? Is it now a case of non-confirmation of the claim of synergy? The ready answer would seen no because quarterly rates starting March 31, 2005 to March 31, 206 showed an increasing trend in net profit margin from 8% to 10%, then 13%, 13%, 13% for each of the consecutive quarters respective. It could be explained that may be during 2004, some adjustments will have to be made but the moment every thing is in place, the benefits of combined business will come into play. But as pointed out earlier by a study conducted by Harvard, the increase in profits was mainly to higher prices. But seeing now the figure after the Harvard Study, will not the consistent higher profit margin serve as evidence of better profitability because of merger? 2.d. Effect of merger on the stock price Based on the date as per Appendix B, stock prices have been increasing since the merger was approved in January, 2004, confirming a successful merger involving JP Morgan and Bank One. 3. Conclusion and Recommendation As to whether the JP Morgan and Bank One merger into one organization is likely to achieve a sustainable competitive advantage through the adoption of such growth strategies, will depend on how will it survive the challenges of competition that have been driving other mergers in the industry and the rules of the game on possible action or anti-trust. The approval to merge by Federal agencies is not unlimited. The merger is still under regulation. Having survived the challenges of competition and having played the game rules on anti-trust, JP Morgan Chase operation, after the merger, could mean that operations will be streamlined, unnecessary cost will be eliminated and hence more efficient operation will follow. More efficient operation connoted low cost for business and low cost for business implied better prices for customers or borrowers of funds which are made possible through desired economies of scale. As of the latest statistics from the NASDAQ9, there is evidence to say that the merger between JP Morgan Chase and Bank One was a successful one in terms on increasing prices and improving profitability. It could therefore be stated that mergers will always be there a strategy not only in the banking industry but also in other industries. One reason is that the state because it wants to allow competition to bring down prices of lending financial resources to business or lowering interest rate as macroeconomic target. However, the state also sets limits to such mergers to prevent the creation of monopolies which could hurt the public. A balancing act on the part of the state is how the state performs its function in allowing ang regulating mergers. 4. Recommendation JP Morgan has done well after the merger and there is a good optimism the growth and further improvement if financial statistics will continue. But as analyzed and concluded the possibility of anti-trust violation will always be there hence, it must play the rules of the game well. Although there is basis to say that not all companies must go for merger because of certain disadvantages from the experience of J. P. Morgan Chase, the move was strategic enough as evidenced by a greater than before profitability, enhanced debt to equity ratio and increasing stock prices. Economically speaking, one may find easy to appreciate because, synergy is hard to disregard as valid claim in case of merger. Appendices Appendix A- Table I Table I JP Morgan Per Quarter Net profit Margin 31-Mar-06 0.13 31-Dec-05 0.13 30-Sep-05 0.13 30-Jun-05 0.10 31-Mar-05 0.08 31-Dec-05 0.13 31-Dec-04 0.08 31-Dec-03 0.15 31-Dec-02 0.04 source: extracted from http://finance.yahoo.com/q/is?s=JPM Appendix B- Stock Price from 2002 to Present STOCK PRICES Date Open High Low Close Avg Vol Adj Close* May-06 45.38 46.80 41.59 43.23 12,511,645 43.23 Dec-05 38.52 40.56 38.32 39.69 9,972,704 39.04 Dec-04 37.80 39.48 37.25 39.01 9,770,709 36.92 Dec-03 35.61 36.84 34.50 36.73 6,907,554 33.58 Dec-02 24.01 24.15 23.61 24.00 9,910,150 21.21 * Close price adjusted for dividends and splits. Download To Spreadsheet Reference: http://finance.yahoo.com/q/hp?s=JPM&a=11&b=30&c=2002&d=11&e=30&f=2006&g=m Work Cited: 1. CNNMoney to Subscribe to Money Magazine,{www document} URL http://money.cnn.com/2004/01/14/news/deals/jpmorgan_bankone/, (2005), Accessed May 31,2006. 2. Joy, O.M., Introduction to Financial Management, Homewood, Ill.: Irwin, (1980) 3. Mattera, Philip, February, The Free-for-All in Financial Services: An Overview of The Banking Industry, Corporate Research E – Letter No.9, (2003) [On line] available: , Accessed May 31,2006 4. Merger Strategy: Reaching For Corporate-Level Goals, no date,[On line] available: (n.d.) , Accessed May 31, 2006 5. Van Horne, James C., Financial Management and Policy, Englewood Cliffs, N.J.: Prentice-Hall, (1960) 6. Yahoo Finance, JP Morgan Chase ,{www document) URL, (2006) http://finance.yahoo.com/q/is?s=JPM> (Accessed May 31, 2006) Read More