The NatWest Takeover Battle Jim Mahar St Bonaventure University by byp85627

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									                                    The NatWest Takeover Battle




                                              Jim Mahar
                                      St. Bonaventure University




                                       This Version: April 2002
                                       First Version: April 2001




I would like to thank Erin Bergstrom, Rebecca Eschler, Ryan Ferguson, and Chris Mickelson for their help on
this case. Of course all errors are mine and mine alone!
This case deals with the Takeover of National Westminster Bank. During late 1999 and
early 2000, the company was the target of two unsolicited takeover bids. The resulting
takeover battle was one of the hardest fought in recent years. Valuation of any synergy
created by the deal was of paramount importance, as the bidders did not want to bid too
high yet both sides wanted to win the bidding war.

Banking Industry

The banking industry in the late 1990s can be categorized by three major trends:
Deregulation, Technological innovation, and Globalization. These trends combined to induce
a consolidation in the industry that knew no borders.

The mantra heard in corporate boardrooms and analyst conference calls was “bigger is
better.” The rationales for this were largely twofold. On the operational side, banks believed
that only by being larger than the competition could they take full advantage of the economies
of scale and economies of scope that the technology revolution was offering. Thus, from an
operational point of view, by getting larger, banks hoped to reduce their expense ratios while
enjoying greater market power, thereby earning a higher net interest margin.

On the marketing side of the business, banks also felt that bigger was better. Deregulation in
the US and elsewhere had made the buzzwords of "relationship banking" and "cross-selling"
more than academic musings. To bank executives everywhere, these words represented the
keys to winning back some of market share that banks had been losing to equity markets and
other financial intermediaries. (Tables I and II)

Table 1 Relative Share of Total Financial Intermediary Assets (in Percent) US Data

                             1960         1970         1980         1990         1994      1999
Depository Institutions
 Banks                          38.6         38.5         37.2         30.4         28.6      22.6
 S&L (Mutual Savings)           19.0         19.4         19.6         12.5          7.0       4.3
 Credit Unions                   1.1          1.4          1.6          2.0          2.0       1.6
Total Depository                58.7         59.3         58.4         44.9         37.6      27.5
Institutions
Insurance Companies             24.0         19.1         16.0         16.4         17.6      14.9
Pension Funds
  Private                           6.4          8.4      12.5         14.9         16.2      18.7
  Public (state and local)          3.3          4.6       4.9          6.7          8.4      11.0
Finance Companies                   4.7          4.9       5.1          5.6          5.3       3.7
Mutual Funds
 Stock and Bond                     2.9          3.6          1.7          5.9      10.8      17.2
 Money Market                       NA           NA           1.9          4.6       4.2       6.0

Total                          100.0        100.0        100.0        100.0        100.0     100.0

Source: US Board of Governors, Flow of Funds
Table 2 Relative Share of Total Financial Intermediary Assets (in Percent) UK Data
1913-1995

               1913     1930      1939      1950      1960      1970      1980      1990      1995
Banks           64       60        55        65        40        30        31        33          28
Building         4         8       12         9        12        18        22        17          11
Societies
Insurance       32       31        32        26        30        28        23        23          30
Companies
Pension        NA        NA        NA        NA        14        16        18        25          27
Funds
Investment     NA        NA        NA        NA        NA         7         4         3           3
Trusts
Finance        NA        NA        NA        NA        NA         1         1         1           1
Companies
Total as %      71       99        109       112       106      131       129       251          310
of GDP

Source: The Complete Finance Companion


It was in this environment that National Westminster Bank PLC of England, a bank with
takeover and diversification plans of its own, became the acquisition target of two smaller
banks in late 1999. The ensuing battle lasted five months and ranks as one of the most
famous takeovers in recent history.

The participants

A. National Westminster.

In the late summer of 1999, National Westminster Bank PLC of England (NatWest) was the
fourth largest bank in the UK. The bank had a rich history that could be traced back, at least
indirectly, to 1658 when Smith’s of Nottingham was founded. The current version of the
company had come into existence in 1968 when National Provincial and Westminster banks
merged. Partially as a result of a lack of a clear strategic plan, the firm had hesitated on
several occasions, and even reversed paths on some issues. The firm had earned the
reputation of being poorly managed and the company’s stock had suffered as a result.

In spite of NatWest's poor stock performance, the firm was still very much a household name
because of their 1700 branches, their former ownership of NatWest Towers, and their
sponsorship of the UK Cricket Championships the firm was still very much a household
name. Due in part to their suffering stock price, management had decided that that to remain
a viable player (and not be taken over themselves) they had to grow. On September 3, 1999
they announced a merger with Legal and General for approximately L10.75 billion. It was
hoped that this merger would allow NatWest to sell Legal and General’s Insurance products
and services to NatWest’s larger client base.

The news of this merger upset many NatWest stockholders who saw it as further proof that
NatWest was being managed poorly and triggered more selling of the stock, which proceeded
to fall by 26% over the next three weeks.1


B. Bank of Scotland

While significantly smaller than NatWest, the Bank of Scotland (BOS) also had a long history
that could be traced directly back to its founding in 1695 by Act of the Parliament of
Scotland. It was from this history that the Bank could lay claim to being the first bank to
issue paper currency.

Throughout most of its history, the bank had earned a solid reputation. However, in recent
years the Bank had not lived up to its reputation. While technologically competent, the firm
had suffered a 2 million-pound loss, as well as a loss of reputation, after public outcry forced
the dissolution of a planned joint venture with evangelist Pat Robertson. Following this
debacle, the firm publicly announced they would continue with international expansion plans.


C. Royal Bank of Scotland

The Royal Bank of Scotland (RBOS) could trace its history back to 1727, but it was probably
most known for its consistent innovation. From offering what amounted to the world's first
overdraft in 1728, to being one of the most technologically advanced banks in 1999, the bank
had prided itself on a strong management team and its willingness to try new things, including
being pioneers in ATMs, personal lending, and telephone banking.

The firm grew both through acquisitions as well as internal growth. Some of the acquisitions
had already made Royal an international player with the largest being the 1988 purchase of
Rhode Island based Citizens Bank. At the time of the first bid, Royal had 650 branches and
had earnings of over a billion pounds.




1
 NatWest Takeover: a chronology. BBC, February 10, 2000
http://news6.thdo.bbc.co.uk/hi/english/business/newsid_626000/626198.stm
Table 3: Operating Statistics of the participants involved *

                            NatWest              Royal Bank            Bank of Scotland
                                                 (RBOS)
   Branches                 1730                 650                   325
   Employees                64,400               22,000                21,000
   Annual profits           2.142bn              1.21 bn               1.01bn
   Assets                   186bn                75bn                  59.8bn
   EPS                      0.97                 0.88                  0.44
   P/E                      12.25                9.27                  12.51
   Shares Outstanding       1.67bn               891.83mn              1.24bn
   Market cap on 9/22/99    17.3bn               10.2bn                8.62bn
   Market cap on 9/24/99    22.66bn              11.4bn                9.3bn
   Market cap on 3/10/00    19.84bn              7.26bn                6.89bn
   Ticker symbol on LSE     NWB                  RBOS                  BSCT
   Incorporation year       1968                 1727                  1695
   CEO                      David Rowland        George Matthewson     Peter Burt

* Profits, assets, and market capitalizations in pounds.


The Battle

On September 24, 1999, the Bank of Scotland (BOS) launched a hostile bid for NatWest.
This bid was partially the result of the price drop following already poor performance and
NatWest's Legal and General merger announcement. It was also a part of a strategy by BOS
that they had to grow to survive in an increasingly concentrated world financial industry.

The bid was for 20.8 billion pounds (or 1250 pence per share). This bid was notable for
several reasons. First it was hostile. Hostile bids, although not unheard of, were relatively
rare in the late 1990s and even more so in Europe. Secondly, the bid was from the Bank of
Scotland, which was a much smaller firm. The Bank of Scotland was roughly a third of the
size of NatWest (see table 3). Finally, NatWest was already in the midst of acquiring Legal
and General.

NatWest immediately brushed off the offer by saying the offer was inadequate, from an
inferior organization, and that they intended to remain independent. The initial market
reaction to the Bank of Scotland’s bid was an immediate jump in value of NatWest’s stock by
roughly 30% to 1350 pence per share. (See Figure 1) This price was well above the offer
price of 1250 pence and signaled the markets belief that other bids would be forthcoming.

Where these other bids would be coming from was uncertain. The most commonly rumored
firm was Royal Bank of Scotland who by various analysts was seen as another hostile bidder
or as a white-knight ready to save NatWest (and NatWest’s management) from the BOS.
Additionally, there were even rumors of a Pac-man defense where NatWest would launch a
hostile bid at its smaller rival.

With NatWest's stock price above the offer price, management of both sides went public in an
attempt to win shareholder approval for their plans. The public relations onslaught was one of
both positive and negative campaigning; each side attacked the other side while advocating
their own plans.

The Bank of Scotland argued that NatWest was poorly managed and that the combined firms
would save upwards of a billion pounds per year by making use of the Bank of Scotland’s
information systems and closing select branches.

While the Bank of Scotland looked for ways to take over its large target and change the
operations of the bank, NatWest looked for ways to remain independent. Deciding that no
single strategy would work, the Board of Directors launched a shotgun defense where they
tried many things at once.

On October 8, two weeks after the first announcement of a bid, NatWest's Board of Directors
ousted CEO Derek Wanless (although he was allowed to step down) and replaced him with
the well-respected Sir David Rowland, the former Chairman of Lloyds Insurance.

Rather than being the final shot in the battle, Rowland's hiring signaled an escalation of the
struggle for the bank. On October 11, Rowland announced that NatWest was abandoning the
Legal and General Bid. On October 27 NatWest implicitly admitted that critics were correct
and that the firm did have too much fat in their operations. Rather than let the BOS win,
NatWest announced their own cost savings plans that included layoffs, as well as selling off
of non-core assets. While in many ways mimicking the plans of Bank of Scotland, NatWest
still took every opportunity to belittle the BOS and to tell whoever would listen that the bank
was not for sale and that even if it were, the bid was insufficient, and that BOS could never
manage such a large firm.

While NatWest and the Bank of Scotland battled publicly, Royal remained quiet. Officially
they waited. However, behind the scenes, Royal’s analysts and Investment Bankers scurried
to value NatWest and decide whether to launch their own bid.

In England, as in most countries, the government must approve any takeover. The rational for
requiring governmental approval is to assure that shareholders are treated fairly, and to
prevent anti-competitive merges from taking place. In England, the government's OK makes
the bid official and begins the official clock. The deal must now be settled within the next 60
days. Since any bid must be open for a minimum of 14 days, the last day a bid could be
altered is day 46. (Table 4)
Table 4: Regulatory steps for a takeover

These are the steps that a company must take if it wants to take over another, as laid down
by the Panel of Takeovers and Mergers:


Once a firm intention has been announced, the company making the offer must post an offer
document to all shareholders within 28 days.
At least 50% of all shareholders must return their acceptance forms, backing the offer, by the
60th day after the company's mailing.
If fewer than 50% agree, the offer cannot go ahead and the bid has to lapse.
Since any revised offer has to be capable of being open for 14 days, the last date the company
can revise its bid is day 46 (14 days before the 60-day deadline).
The target company may want to put up arguments against the takeover. It is entitled to do so,
and the company making the offer is entitled to have seven days in which to react. So the last
date in which the target firm may put up its arguments is day 39 (seven days before day 46).
  Source: http://news.bbc.co.uk/hi/english/business/default.stm


On November 25, 1999, two months after the Bank of Scotland first announced plans to take
over NatWest, the smaller bank received governmental approval and the sixty-day clock was
started. The deal now needed to be done by mid February.

On November 27, the initial bid 1250 pence bid was raised to 1457 pence per share plus a
probable 120 pence dividend from the savings that the merger would create. The 1457 bid
would be made up of cash and notes for 190 pence plus 1.75 shares of the Bank of Scotland
(valued at 724 pence) plus a 120 pence dividend.

NatWest again countered that the offer was insufficient and that they were not for sale. This
bid, and the government's approval of the deal, forced Royal into more public action. After
two months of studying NatWest, Royal decided to make a friendly offer for the larger firm.
However, NatWest maintained its stance and said that it was not for sale.

Royal was now faced with a decision: should they walk away from the potential deal, or
should they enter into a potentially expensive bidding war with the Bank of Scotland for a
firm that was roughly three times the size of either of its suitors and that did not want to be
taken over?

The decision did not take long. On November 29, 1999, Royal launched a hostile takeover
bid for NatWest. The bid, which was worth 1590 pence per share, allowed shareholders to
convert each NatWest shares into .968 shares of Royal Bank stock.

At the heart of the valuation was how much synergy existed between the companies.
Synergy, which is notoriously difficult to estimate and has been the cause of many firms
overpaying in deals, is the idea that two firms are worth more together than the sum of their
combined independent values. One of the main sources of value in this deal was the cost
savings that would arise from the deal.
Royal felt that they could squeeze 1.18 billion pounds of savings per year from the combined
firms through a series of layoffs and asset sales. The Bank of Scotland similarly felt that
money could be saved, but they were not quite as optimistic. They believed that
approximately 1.02 billion pounds would be saved annually. However, the savings were not
guaranteed and there was considerable risk of being overly optimistic. NatWest's
management figured that its own cost savings plan would shave 525 million from expenses.

Since each side was offering roughly the same amount as the other, any decision would be
more than just a simple pound and pence decision. Thus, all three sides continued to actively
court shareholders’ votes. Top executives visited major shareholders in what was comparable
to an IPO roadshow. Indeed, some even traveled to America to speak with institutional
investors once it was found that a large block of shares was in US investors’ hands.

There were now two hostile bidders going after the same prize. After Royal’s bid cleared
regulatory hurdles, both sides repeatedly tried to increase their bids. Interestingly, this had
little effect because as both of the offers were partially for shares of the bidder, and the bidder
raised the offer, the value of the outstanding shares fell in value dragging down the value of
the offer. (Figure 1)

As the battle raged on and the campaigning continued, the stock prices continued to fall. The
price declines were part of the larger industry-wide decline caused by rising interest rates,
however, it soon became apparent that it was more than just rising rates, but that the market
was saying that things were not going as well as had been originally hoped. This is shown in
the industry-adjusted performances of the participants, which was decidedly negative over the
course of the takeover battle.

Consistently, as one side got an upper hand in the bidding war, that bank’s stock fell by more.
This was widely reported as evidence of a “Winners curse.” Further, since the bids were at
least partially in shares, the value of NatWest also fell.

The fact that the market prices did not rise dramatically strengthened NatWest's resolve to
keep fighting. They continued to resist the bids, and announced their plan to return 6.5 billion
pounds to shareholders. This payout would take the form of both a buyback and a dividend.
They intended a 3.5 billion-pound share buyback to occur immediately and ten they hoped to
sell non-core assets and segments and return 3 billion in proceeds to shareholders and cut jobs
to generate cost savings that would allow for a 31.9 pence dividend per share. In addition to
the planned disbursements to shareholders, they constantly disclosed various reasons why
either takeover would be detrimental to current NatWest shareholders.

Due to BOS' 60-day clock, their final bid had to be submitted on January 31. While not
significantly higher than previous bids, the new bid gave NatWest shareholders a variety of
options that had the basic effect of increasing the cash portion on the deal. This gave the
shareholders the option of reducing their exposure to the banking industry while generating
cash. (Table 5)

The final bids of each side were quite similar in value. Therefore, NatWest shareholders
needed to consider the allocation of the offers between cash and stock and the proposed
strategies once the takeover was complete. A week of intense debate followed BOS's
deadline. While shareholders officially had two weeks to consider the offers, it soon became
apparent that Royal was gaining the upper hand with institutional shareholders. On February
11, the Bank of Scotland admitted the battle was lost.

On February 14, NatWest gave up the fight and admitted that Royal had the votes to acquire
the larger bank. Victory was sustained because Royal was able to gain the support of many of
NatWest’s largest shareholders. However, the market was not happy with the deal and
Royal's shares fell. Some of the market's apprehension came from the daunting challenges of
making the deal work. The combining of the two banks, the personnel, the computer systems,
as well as marketing and cost cutting that would be necessary to make the deal work, would
be challenging to any firm, but especially so to a firm that had just acquired a much larger
rival.

Table 5: Summary of Bids for NatWest

Date                                  Bank of            Royal Bank            NatWest Share
                                      Scotland                                 Price
Sept. 24, 1999
                 Stock                1.6 @ 706.5
                                      pence per
                                      NatWest share
                 Loan**               120 pence per
                                      share
                 Value per share      12.50 pounds                             10.46 pounds
Nov. 27, 1999
                 Stock                1.75 @ 724.5
                                      pence per
                                      NatWest share
                 Loan **              190 pence per
                                      share
                 Value per share      14.57 pounds                             15.18 pounds
Nov. 29, 1999
                 Cash                                    305 pence per share
                 Stock                                   .968 @ 1328 pence
                                                         per NatWest share
                 Value per share                         15.9 pounds           15.18 pounds
Jan. 27, 2000
                 Loan **              110 pence per
                                      share
                 Cash                 190 pence per
                                      share
                 Stock                1.75 @ 660.5
                                      pence per
                                      NatWest share
                 Value per share      14.56 pounds                             12.34 pounds
Jan. 31, 2000
                 Cash                 356 pence per      400 pence per share
                                      share
                 Stock                1.75 @ 620 pence   .968 @ 1002 pence
                                      per NatWest        per NatWest share
                                      share
                 Special Dividend*                       70 pence per share
                 Value per share      14.41 pounds       14.40 pounds          11.88 pounds
Note:   - 100 pence are equivalent to 1 pound
        * The Royal bid on January 31st included a special dividend of 1 pound per share payable by 2003,
        which was equivalent to 70 pence on the valuation date
        ** Special stock units or a cash alternative
Table 6: A summary of the significant events in the saga to acquire NatWest
Event    Date              Event Description
1        Sept. 3, 1999     NatWest announces plans to pursue a merger with Legal & General
2        Sept. 22, 1999    NatWest share price down 26% as shareholders express concerns
                           over L&G deal
3        Sept. 24, 1999    BoS begins hostile bid for NatWest
4        Oct. 6, 1999      NatWest ends its merger attempt with L & G
5        Oct. 8, 1999      CEO Derek Wanless is fired and replaced by David Rowland
6        Oct. 27, 1999     NatWest plans to cut jobs and sell off businesses as part of its
                           defense
7        Nov. 2,    1999   Andersen Consulting questions BoS's savings estimates
8        Nov. 25,   1999   BoS gets clearance to bid
9        Nov. 27,   1999   BoS raises offer
10       Nov. 29,   1999   RBoS bid turns hostile after friendly negotiations with NatWest fail
11       Dec. 17,   1999   RBoS's bid is cleared
12       Dec. 20,   1999   NatWest's first official response to RBoS bid urges shareholders to
                           remain independent
13       Jan. 20, 2000     BoS increases its revenue estimates for NatWest if it gains control
14       Jan. 25, 2000     NatWest closing defense issued, promises to return 3.5bn pounds
                           to shareholders
15       Jan. 27,   2000   BoS increases its bid again
16       Jan. 31,   2000   Both RBoS and BoS increase bids
17       Feb. 11,   2000   BoS admits defeat by RBoS
18       Feb. 14,   2000   NatWest surrenders to RBoS
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Figure 1 A: Closing stock prices for participants in NatWest takeover battle.               2/
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                                                                                                                  Figure 1 B
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Figure 1 B: Bank industry adjusted returns for NatWest, Royal Bank of Scotland, and Bank of Scotland. Return equals bank's return -
average return for all other publicly traded UK banks.
Some questions that must be examined in the post merger evaluation:



   a) How did synergy enter the valuation process? Its

   b) Why do you think that NatWest tried so hard to maintain independence?

   c) The best defense is often taking away the reason for the takeover. Did NatWest try
      this? Was it successful?

   d) Do you think that managerial incentives played a key role in this case? How?

   e) Describe and discuss the possible takeover defenses that NatWest could have
      employed as an attempt to remain independent?

   f) Why did Royal wait and delay their entry into the contest?

   g) Explain what is meant by the "winner's curse" and its role in this case.

   h) What role did regulators play in the dealings?

   i) Discuss the role of institutional shareholders in the case.

   j) What impact did the merger have on the financial industry?

   k) If you were a manager in the banking industry, what would you do to gain market
      share? Why do many feel that cost cutting is so important in the industry?

   l) Briefly explain what has happened after this case.

   m) Examine the deal through the eyes of various stakeholders. Can you identify winners
      and losers?

								
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