Management Strategies

01:30 PM
Arjun Sethi
Arjun Sethi
Commentary
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Banks Win Bigger When They Acquire Tech Companies

How buying a technology company helps improve a bank's bottom line.

My recent blog post on the ways that technology is disintermediating the financial services value chain -- and the ways these disruptions may prompt mergers between banks and technology companies -- stirred reader interest. Could a technology company really enter banking? Would one even want to enter that field?

But mergers go both ways. To test my hypothesis that there's value in these cross-industry acquisitions, a team at A.T. Kearney conducted a study of the value generated by bank acquisition activity over the last four years. We studied 30 top banks in all global regions, examining their stock performance for the 12 months following an acquisition.

Sometimes a bank acquires another bank. For example, Banco Santander acquired Poland's Kredyt Bank. (Of course, few financial services companies today are pure banks; they provide many adjacent services. When we refer to bank-on-bank mergers, we simply mean those within the financial industry.) These transactions lead to an average share price increase of 4-6%. But other times, a bank acquires a technology company -- and these transactions have a return of 10-15%.

The market rewards smart investments of a bank's M&A dollars, and it finds technology companies to be the smarter investments. What kind of tech companies? We dug a little deeper. We broke the tech acquisition targets into three categories:

  1. Heavy lifters, such as payment processors, have unique execution capabilities that banks can lift and shift into their back-office operations to cut costs. These acquisitions, such as US Bank's 2012 purchase of FSV Payment Systems, generate an average uptick of 20-25%.
  2. Innovators push the envelope on social media or mobile platforms, helping banks serve young, tech-savvy customers better. These deals, such as Barclays' 2012 acquisition of the social couponing startup Analog Analytics or Capital One's 2011 purchase of ING Direct USA and its mobile platform -- bring average gains of 15-20%.
  3. General technology companies develop traditional hardware or software and bring an average gain of 5-10%.

In other words, the stock market finds that the smartest bank acquisitions can enhance efficiencies through transformative technology enablement (the heavy lifters) or those that represent planning for broader digital disruption (the innovators). General technology acquisitions, as well as bank-on-bank acquisitions, imply a less focused strategy and thus create less value.

Thus I continue to believe that, as banks seek future growth, they should be looking at technology. As I'm writing this, I'm seeing that Wells Fargo is eyeing potential Silicon Valley partners (subscription required). And amid rumors that eBay may soon be ready to spin off PayPal (subscription required), I wonder what would happen if it (or perhaps a smaller payment processor) were acquired by, say, American Express or MasterCard.

Such a transaction would represent profound change in the financial services landscape. But would it be the cause of that change or an effect? At the root, it's technology -- the impact of digital disruption -- that is causing these changes. The implications of digital disruption are so extreme that such cross-industry merger activity may even be inevitable.

Learn more about the Internet of Things at Interop's Internet of Things Summit on Monday, Sept. 29.

Arjun Sethi is a partner with A.T. Kearney, where he leads the Strategic IT Practice for the Americas. He focuses on developing strategies that transform clients' middle and back-office functions and enhance revenue growth. He has led engagements for CIOs of leading North ... View Full Bio

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Byurcan
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Byurcan,
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9/23/2014 | 10:06:22 AM
M&A
Interesting analysis Arjun. As you mention, this a trend we are starting to see more of in the industry. I wonder if it will continue even more so.
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