FleetBoston Reaches the Summit Just as Revenue Growth Flags

FleetBoston (FBF) got to the Summit (SUB). How much higher can the Boston-based bank go from here?

Most bank watchers are embracing the deal, which has Fleet acquiring Princeton, N.J.-based Summit for some $7 billion, or $39.78 per share. But mergers often come with a subtext. In this transaction, it's possible that Fleet is making a big acquisition to offset sluggish growth in traditional banking revenue.

Returns

Without a doubt, Fleet will be able to reap much better returns from Summit's franchise than Summit itself. Through its absorption of BankBoston, which closed a year ago, Fleet has proved it can successfully execute big mergers. To boot, it has a much wider range of financial products to offer Summit's affluent customer base, including asset management services as well as its brokerage, Quick & Reilly.

Fleet is paying a reasonable-seeming 2.4 times Summit's book value, though the takeout price is over 40% higher than the price Summit was trading at before merger rumors leaked out last week. Indeed, the deal works out at 12.2 times 2001 earnings, as forecast by analysts at First Call/Thomson Financial. Such a premium may seem steep, and some may wonder why Fleet is paying 12 times next year's earnings for a bank that's expected to post earnings growth of just 8% to 9% in 2001.

But Fleet could make the deal immediately profitable. Even without the likely revenue enhancements from synergies, Fleet thinks the deal could add a penny to projected 2001 operating earnings, bringing them to $3.73, and add 11 cents to 2002 operating earnings, taking those to $4.20.

Of course, the operating earnings forecast by the bank exclude $425 million in after-tax charges, consisting of $250 million in merger restructuring charges as well as $175 million in losses it expects to book when selling underwater bonds and loans. But nearly 90% of these once-off costs will be recouped in 2001 and 2002, the bank reckons. It expects to make cost savings in these two years of $275 million and book another $100 million in net profits from investing the proceeds from the bond and loan sales in higher-yielding instruments.

"This is a great transaction," says Andy Collins, banks analyst at ING Barings. (He rates Fleet a strong buy, and Barings hasn't done underwriting for the bank. He doesn't cover Summit.)

Even though Fleet isn't expecting any earnings dilution from the deal, which it expects to close in six months, its stock sold off Monday, falling $1.06, or 2.72%, to $37.94. Other large banks were 0.76% higher, going by the KBW Banks Index.

Top-Line Worries

So what's eating at the market about this deal? Some weren't keen to see Fleet increasing the share of retail banking in its postmerger revenue stream to 22%, from 17%. But that's not much of a jump. Interest revenue from lending operations, as opposed to fee revenue, will rise to 48% from 45% now, according to the bank. Again, hardly seismic.

Maybe Fleet is doing the Summit merger to boost its traditional banking revenue growth, which has hardly been impressive recently. Without capital markets revenue and brokerage commissions and fees, Fleet's second-quarter revenue totaled $2.73 billion, practically the same as in the year's first quarter and down 2.3% from the year-ago period.

Fleet responds that retail banking revenue was hurt in the first and second quarters of this year by the sale of 315 branches and $13 billion assets to Sovereign (SVRN) and other banks. These divestitures were a concession to bank regulators to assuage antitrust concerns about the Fleet merger with BankBoston.

One useful exercise is to add back revenue Fleet had to forgo because of the divestitures. Kevin Timmons, banks analyst at FAC Equities, estimates that Fleet would've been able to earn 1% to 1.2% on those $13 billion of assets annually. That means Fleet did without some $40 million in revenue in each of the year's first two quarters (1.2% of $13 billion equals $156 million, which has to be divided by four to give the quarterly revenue number: $39 million.).

But even with the $40 million added back, Fleet's nonmarket revenue in 2000's first two quarters was still (marginally) below the level in 1999's second quarter. A Fleet spokeswoman replies that this approach ignores the big cost savings and synergies that Fleet would've enjoyed had it kept the divested assets and branches.

All said, investors shouldn't be too surprised if Fleet is doing this merger mainly to maintain revenue growth. As Timmons says, "Acquisitions have always been a business line for Fleet." (Timmons rates Fleet a buy, and his firm hasn't done any underwriting for the bank. He doesn't cover Summit.)

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