Case study
The Mardi-Gras Bank Merger

by Prof. Ian H. Giddy, New York University

As part of the consolidation of banks in Louisiana, Bank of Mardi and Gras Bank Holdings Inc are planning a merger. The proposed merger will occur through an exchange of shares, with Gras paying 1.5 shares for each share of Mardi. Bank of Mardi shares are currently trading at $55, while Gras shares are priced at $40.
The following are the details of the two potential merger candidates ($ figures in millions):

Revenues $4,800 $3,325
Expenses (w/o Depreciation) as % of Revenue 87.5% 89.0%
Depreciation $200 $74
Tax Rate 32%
Working Capital 10% of Revenue
10% of Revenue
Market Value of Equity
Outstanding Debt

Both firms are in steady state and are expected to grow by 5% a year in the long term. Capital spending is expected to be 90% of depreciation. The beta for Mardi is 1.7, and for Gras 1.5, and both firms are rated BBB, with an interest rate on their debt of 8.5%. The US government bond rate is 6%. Louisiana State bonds yield approximately 2% over US government bonds. The market return is about 5.5% over the risk-free rate.

As a result of the merger, the combined firm is expected to have a cost of goods sold of only 85% of total revenues. Earnings will grow faster, at 6%. The combined firm does not plan to borrow additional debt.

Estimate the value of Mardi and of Gras, operating independently. Then estimate their combined value, assuming no synergies. If it does not increase debt, the combined firm's rating will most likely be A+ (with an interest rate of 7.75%)

Now estimate the value of the merged bank, assuming synergies.

Finally, assume that, as a result of the merger, the Mardi-Gras Bank's optimal debt ratio increases to 20% of total capital from current levels. (At that level of debt, the combined firm will have an A rating, with an interest rate on its debt of 8.25%.

What is the value of the combined bank? Is Gras paying a reasonable price? What price should it offer?

Assignment: This is a merger negotiation exercise. One team will represent Mardi, and the other team Gras. Each should conduct an independent valuation of both banks, before and after the merger, and try to renegotiate the price. The two teams are required to sign a merger agreement, and each team must hand in their valuation analysis. | | | | contact
Copyright ©2003  Ian Giddy. All rights reserved.