Counting on bank M&A: Why Piper Jaffray bought Sandler O'Neill

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In some ways, the seeds of Piper Jaffray Cos.’ deal for Sandler O'Neill, one of the last independent investment banking boutiques focused on financial services, were planted several years ago, with a much smaller deal in a completely different sector. That deal, a 2016 acquisition of Simmons & Co. Intl., a leading investment bank specializing in the energy industry and based in Houston, reinforced the view of Piper executives about scale. To effectively compete in a line of business – and like many companies, Piper’s stated objective is to be a leader in the industries in which it does business – it would have to buy its way to sufficient scale.

The Minneapolis-based boutique investment bank currently dominates some of the sectors it serves, especially healthcare. With the acquisition of New York-based Sandler O’Neill & Partners LP, it will instantly become a leading investment bank in financial services, a sector it has sought to expand in for several years.

“We’ve had conversations with Sandler for many years, and we’ve admired their franchise,” Chad Abraham, CEO of Piper Jaffray Cos. (NYSE: PJC), explained. “Our strategy has been focused on growing our investment banking platform. We’ve had the most success in areas where we can drive market leadership. We’ve had historic success in healthcare, consumer and technology – these industry groups go back many years. But we realized we were participating in only half the economic market. We were missing out on energy and financial services and some other sectors.”

Buy versus build
While Piper Jaffray grew organically and through hiring over the last 10 years, Abraham concluded that acquisitions were needed to fuel expansion in some sectors. “It was hard to imagine getting enough scale fast enough without acquisitions.”

To grow in the energy sector, Piper Jaffray bought Simmons & Co. Intl., a leading investment bank specializing in the energy industry and based in Houston, in 2016.

“We learned many things from the Simmons acquisition,” Abraham said. “We also recognized they were the best in their business, and there was not a lot we needed to change.”

To grow its business in financial services, Piper Jaffray made several moves in 2015, including hiring five managing directors from Sterne Agee. Piper Jaffray also acquired two Chicago firms: River Branch Holdings LLC, an investment banking boutique that serves clients in the financial institutions industry, and BMO Capital Markets GKST Inc., BMO Capital Markets’ former municipal bond sales, trading and origination business.

But those initiatives pale in comparison with the Sandler merger. Slated to close January 2020, the deal marks Piper Jaffray’s biggest acquisition to date. The price is $485 million (including $350 million in upfront cash and $135 million of restricted consideration, primarily restricted stock). Total consideration could climb to $600 million, with an additional $115 million for employee retention incentives (primarily restricted stock). However you do the math, the deal represents more than half of Piper Jaffray’s roughly $930 million market cap. It is expected to add $300 million in annual revenues for the merged company, which will be named Piper Sandler Cos.

“Sandler O’Neill has ranked No. 1 in both M&A and capital offerings in the space since 2012 (based on the number of deals),” wrote Devin Ryan, an analyst with JMP Securities LLC, in a research note. “Outside of the large global banks, which often focus on other areas of financial services, Sandler O’Neill, along with KBW (a subsidiary of Stifel), have consistently held the top two spots in full-service financial services investment banking, with competitor market share dropping off materially from there.”

Ryan continued: “Sandler’s brand is strongest in the fragmented depository space, where the firm has built its reputation over the past 30 years (and arguably has created its biggest moat), and while smaller contributors, it has also been focused on (with success) scaling in other financials sub-sectors, including insurance, specialty finance, asset management, real estate, and financial technology.”

Assuming the combined company is as productive as the two entities have been previously, Piper Sandler is “in a position to become a clear market share leader in depository M&A financial advisory work,” said S&P Global Market Intelligence. “Combined, the two companies have worked on 99 bank and thrift M&A deals since 2018. Keefe Bruyette & Woods Inc. has the second-highest number of deals, at 53.” KBW itself was bought by Stifel Financial Corp. (NYSE: SF) back in 2013.

Regulatory role
Following the merger, financial services will be one of the top two revenue generators for the combined Piper Sandler, with healthcare being the other. Some of the same dynamics present in the healthcare industry are also at play in the financial services industry, Abraham points out.

“The financial services segment is highly regulated, like healthcare,” Abraham said. “And in that world, scale matters – to pay for those increased costs.”

Recent regulatory changes have paved the way for consolidation among banks. “A change in the regulatory regime, probably most importantly, the Crapo Bill, has been driving discussions with the Systemically Important Financial Institutions (SIFI) threshold raised, relieving one material headwind to consolidation,” JMP’s Ryan told Mergers & Acquisitions. “Scale and diversification matter, and now a large group of banks have more of an opportunity to take their scale to another level without tripping material regulatory levels.”

Dam-break
Sandler’s strategy team cheered legislative changes in May 2018 in a research note, predicting “nothing short of a dam-break for banks above the $50 billion asset range – and those nearing that range that have been under SIFI or quasi-SIFI designation strategic restraints and impediments.”

The research note, co-written by Sandler chief strategist Robert Albertson and colleague Thomas Killian, continued: “This dam-break will be continuously fed by more banks approaching the $10 billion threshold that have found the tolerance, will, or means to cross into the larger merger stream by successfully managing the loss of Durbin revenues and increased supervision burdens such as higher FDIC risk premiums and CFPB review. Put more quantitatively, with the new SIFI fencing there are 102 regional and community banks approaching $10 billion and ranging just shy of $250 billion in assets, representing $4 trillion in U.S. banking assets. This excludes a plethora of foreign domiciled banks, brokers and specialty finance companies. All of these are now in a sea about to undergo a sea change.”

Indeed, bank M&A sizzled all summer, with dozens of deals being announced, creating the perfect backdrop for the Piper Sandler merger. “There has been a lot of consolidation in the bank space,” Abraham told Mergers & Acquisitions. “Frankly that’s been very consistent over the last 10 years and has created a great opportunity for Sandler. But there are still 5,000 banks, and we expect the pace of consolidation to continue.”

Piper Jaffray is determined to be the market leader in all the industries it does business in. The acquisition is not expected to change the overall strategy or leadership, Abraham said. “Jon Doyle and Jimmy Dunne, who have run Sandler for many years, will be very active going forward.”

Dunne, senior managing principal at Sandler, will become a vice chairman of Piper Sandler and senior managing principal of the company’s financial services business. Doyle, senior managing principal at Sandler, will become a vice chairman, senior managing principal and head of Piper Sandler’s financial services group. He will also join the Piper Sandler board and the company’s leadership team.

The Piper Sandler deal caps an 18-year effort to rebuild Sandler after tragedy, Bloomberg News pointed out. Sixty-six of the firm’s 171 partners and employees died in the September 11 World Trade Center attacks. Herman Sandler, a co-founder of the firm, and Chris Quackenbush, the head of investment banking and Dunne’s best friend since childhood, were among those who perished. As a memorial to Quackenbush, Dunne bought all the duck ties he could find at the Brooks Brothers store across the street from Sandler O’Neill’s office and handed out the “quack ties” the day the deal was announced.

Recession proofing
Because the deal increases scale and diversity across investment banking industry sectors – including healthcare, financial services, energy, consumer and technology – it may better position the future Piper Sandler in the event of a recession.

“With different economic cycles, different industry teams perform differently,” Abraham said. “Having more top-tier franchises across broader industries is an advantage.” But, he hastened to add, “We didn’t really do this deal based on the timing of where we were in the economic cycle. Where are we? When might M&A turn? The honest answer is: We still see our clients do very well growing their businesses, with good access to inexpensive capital. There are certain disruptions strategically in certain industries, but there’s a nice background for the M&A market now.”

Abraham takes the long view. “I’ve been in banking for 28 years, and I’ve seen several cycles, and some last longer than others. We really don’t invest, or enter into, any of these businesses focused on what’s going to happen in one tough year, or one economic cycle. We grow and strengthen franchises in good times and tougher times. It’s a long-term business.”

As for the future, the combined Piper Sandler is likely to look for more acquisitions. “We’ll continue our two-pronged strategy, focused on developing our own talent and organic growth while also continuing to look at acquisitions when it’s in places where we need other areas of expertise and can’t grow organically,” Abraham said. “But for now, we’ve got our hands full with the Sandler acquisition. We’re focused on making that successful.”

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