Firstar

(FSR)

could be preparing a takeover of a large Midwestern rival, a deal that would make the Milwaukee-based institution one of the nation's 10 largest banks, and dramatically break the acquisitions drought that has sucked life out of the financial sector for over a year, according to several analysts and investors.

Firstar's putative acquisition targets include

U.S. Bancorp

(USB) - Get Report

, the most frequently mentioned prey, as well as

KeyCorp

(KEY) - Get Report

and

National City

(NCC)

. All three banks are larger than Firstar in terms of assets, but in recent months they have reported slowdowns in their businesses that have clobbered their stock prices.

But why would Firstar want to launch a big acquisition? After all, it's still absorbing its 1999 purchase of

Mercantile Bancorporation

, and today's Firstar is itself the product of the 1998 merger between

Star Bank

and the old Firstar. A number of observers claim the only way for Firstar to maintain its healthy profits growth is to keep on acquiring. And they add that Firstar may have to move quickly, since first-quarter numbers show signs that a revenue slowdown has already begun.

An investment banker familiar with Firstar's acquisition strategy says the bank won't be doing a major deal in the next year. But a range of analysts and investors, as well as the banks' recent stock price moves, suggest that it might.

Growth Spurt

"Firstar needs to do a deal to keep the growth going," says the manager of an East Coast hedge fund that invests in bank stocks. The fund is long U.S. Bancorp shares and short Firstar, and the manager requested anonymity.

"I don't think first-quarter numbers were very good, which, ironically, is why Firstar might be thinking about doing an acquisition," says a New York-based banks analyst who also wished to remain nameless. His firm hasn't done any investment banking for Firstar or U.S. Bancorp. "I think a deal with U.S. Bancorp is doable," adds the analyst, who calculates that Firstar could offer as much as $35 per share for U.S. Bancorp, some 10 bucks over its current price, in a deal that would value U.S. Bancorp at around $26 billion.

Firstar Stalking?
Stock Prices for U.S. Bancorp and Firstar

Source: Yahoo! Finance, TheStreet.com

Joe Messinger, investor relations chief at Firstar, rejects the view that his bank has hit a revenue wall, and he asserts that Firstar doesn't need to make big acquisitions to sustain its robust profits growth. Operating income in the first quarter was 21% higher than in the year-earlier period. Firstar, U.S. Bancorp, National City and Keycorp all declined to talk about takeover theories, citing a policy of not commenting on merger talk concerning their banks.

Perhaps reflecting the takeover chatter, U.S. Bancorp shares Thursday rallied 1 1/2, or 6.2%, to close at 25 3/4, but they were down slightly Friday morning. Though its shares have recovered a lot of ground since March, U.S. Bancorp is still some 30% off its 52-week high. Firstar stock was down 3/16, or 0.8% Thursday, to close at 23 1/16, which is 22% below its 52-week high. Despite this decline, Firstar stock trades at 16.6 times 2000 earnings forecast from analysts surveyed by

First Call/Thomson Financial

. That multiple is quite high for a bank and it provides Firstar with a strong acquisition currency for any stock-based deal.

Thicker Than Water

Another unusual factor possibly adds weight to a Firstar-U.S. Bancorp merger: Jerry Grundhofer, Firstar's chief executive and president, is the younger brother of U.S. Bancorp's CEO and Chairman John Grundhofer. Firstar, the nation's 17th-largest bank, has $73 billion in assets, while U.S. Bancorp is the nation's 14th biggest with $83 billion in assets.

"Acquisitions are part of the growth equation" for Firstar, says Chip Dickson, banks analyst at

Salomon Smith Barney

, which rates Firstar an outperform and hasn't done any recent underwriting for the bank. But Dickson adds: "It'd be nice to see them get Mercantile behind them before they did something else."

In addition, two Firstar senior managers spoke to analysts and investors May 15 on a

Goldman Sachs

-hosted conference call. The executives spoke confidently about their ability to make mergers work. This led the analyst who requested anonymity to conclude: "To me, it was a blatant pitch to the Street that a deal is coming down the pike."

"That wasn't why we had the call," says Lori Appelbaum, banks analyst at Goldman. "They wouldn't have done the call if they had a merger planned." (Appelbaum rates Firstar a buy and Goldman hasn't done recent underwriting.)

Disappointed

Some analysts were a tad disappointed with Firstar's first-quarter numbers. Revenue -- net interest income plus noninterest income -- grew a mere 0.6% from the fourth quarter to the first quarter. If $10 million of extraordinary gains are excluded from the noninterest income, then revenue actually declined 0.36% over that period.

Also, eyebrows were raised because Firstar didn't give full details on $10 million of gains from accounting changes until it filed its quarterly financial statement with the

Securities and Exchange Commission

on May 16, five weeks after the bank first published first-quarter numbers in an April 11 press release.

On this matter, James Record, head of banks research at

SNL Securities

, the Charlottesville, Va.-based financial services research firm, says: "I'm a little bit surprised that Firstar wasn't able to quantify the accounting gains" on April 11.

"That might be an overreaction," says Firstar's Messinger. "It takes some time to analyze" the effect of accounting changes. The executive also says that the sums under question are small compared with the first quarter's $1.03 billion in revenue. "We have a tremendous record for revenue growth," says Messinger, who predicts his bank's revenue will grow by an annualized 8% in the second quarter vs. the first.

And one New York-based hedge-fund manager reckons that Firstar might not be able to get the necessary cost savings from U.S. Bancorp to make such a merger pay off. The fund manager says that U.S. Bancorp, due to John Grundhofer's tight expense control, has little fat to trim. By contrast, Jerry Grundhofer's two most recent acquisitions, the old Firstar and Mercantile, were quite inefficient, she says. (Her fund is long U.S. Bancorp but has no position in Firstar.)