Takeover Talk Buoys Firstar in Midst of Disappointments

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By Erle Norton
Staff Reporter

There's nothing like takeover talk to make investors overlook a company's mistakes.

Firstar

(FSR)

spent two years on its much-ballyhooed Firstar Forward restructuring program, which was designed to ratchet up its earnings at a faster rate. But when the company disclosed the program's results on July 17, analysts dug into the numbers and found that the Milwaukee-based banking company had actually fallen short of its goals, despite Chairman Roger Fitzsimonds' unwavering comment that "Firstar Forward was a success."

Sounds like a perfect formula for a stock meltdown, right? Not in the intense world of bank takeovers. Despite the sputtering results of Firstar Forward, the bank's stock has climbed nearly 9% since July 17, outpacing a 5% gain by a group of major regional banks tracked by

Baseline

. Several analysts who admit to being disappointed by Firstar's restructuring program rate the stock a buy, in part because of the possibility that another bank will come calling. Just last week, Tom Hanley,

UBS Securities'

bank analyst, initiated coverage of Firstar with a buy, citing a $48-a-share buyout price target. Firstar is trading at about 34.

"With a lot of bank stocks this is the box that you're in," says Deno Mokas, a vice president with

Massachusetts Financial Services

, which owns Firstar shares. "If things are going well, you like the company. If the company is not doing well but has a great franchise, it can be bought at a great premium. So either way I win. Firstar is in that sweet spot."

But given its current fundamentals, many observers say Firstar's stock is fully valued. It's trading at 2.9 times book value, according to Baseline. A takeover, of course, could change that. Hanley's $48-a-share buyout price would value Firstar at more than four times book value, a steep valuation. But don't forget that underperformer

Signet Banking

(SBK)

agreed last month to be acquired by

First Union

(FTU)

for a heady 3.5 times book value. First Union justifies the steep price by saying it will drastically reduce costs, effectively cutting the purchase price. Mokas says a similar potential exists at Firstar.

Firstar also is attractive because it has a strong franchise. "Its mix of business is extraordinarily attractive," including trust, credit cards and a strong presence among small businesses, says Ben Crabtree, an analyst with Minneapolis-based

Dain Bosworth

, which hasn't participated in any Firstar underwriting projects.

Although its fundamentals disappoint, Firstar's financial measures are considered good, though not stellar. Its return on equity, a key profitability measure, was 18.9% at June 30. Potential bidders include

U.S. Bancorp

(USB:NYSE),

Norwest

(NOB)

,

Banc One

(ONE) - Get Report

and

First Chicago NBD

(FCN) - Get Report

.

Of course, Firstar maintains that it will go it alone. "We will earn the right to remain independent," says spokeswoman Ann Weninger. But the failure of Firstar Forward makes the company's task even tougher.

What went wrong?

"With a restructuring people tend to lose focus on going out and getting business," says Joseph Roberto, an analyst with New York-based

Keefe Bruyette & Woods

, which hasn't participated in any Firstar underwriting projects. As a result, Firstar estimates it lost $33 million in net interest revenue as loans fell.

Firstar also failed to cut as deeply as it promised. Its efficiency ratio -- which measures how much it spends to gain $1 of revenue -- at the end of the second quarter was 58%, above its target of 55%. "Any good bank can cut that by five percentage points," says James Schutz, an analyst with Chicago-based

ABN AMRO Chicago

, which hasn't participated in any Firstar underwriting projects.

The result was that while the bank says it produced $143 million in savings and revenue enhancements -- $3 million better than its goal -- it also noted that it experienced some temporary expenses and lost business that offset those savings. So the net number was more like $100 million, estimates Crabtree at Dain Bosworth.

Firstar says the infrastructure is in place for the $143 million mark. For instance, the company says it experienced temporary expenses totaling $10 million for items such as consultants, but adds that those costs will disappear. It promises to push its efficiency ratio down to 55% next year.

But at the same time, Firstar must boost revenue. "We're the first to say that we've got to rev up the revenue machine," says Weninger. Yet that's easier said than done. Roberto at Keefe Bruyette notes that it took

Fleet Financial Group

(FLT) - Get Report

two years to rebuild revenue lost during a restructuring. Adds Crabtree, "There's a lot of uncertainty relative to that revenue number."

Even if Firstar can boost revenue, the bank remains at what Roberto calls an "awkward" size. At $20 billion in assets, Firstar has a hard time offering all the services of a

Chase Manhattan

(CMB)

but also can't promise the personal service of a community bank.