A Future IBanking Powerhouse

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The pending merger between New York-based KBW ) and St. Louis-based Stifel Financial (NYSE: SF) looks to create a medium-sized financial firm that may punch above its weight on the global markets.
Announced on November 5, 2012, the deal involves an exchange of cash and stock valued at nearly $600 million. The company formed as a result of the merger will have annual revenue of nearly $2 billion and employ nearly 6,000 full-time traders, analysts and support personnel. Assuming that it is not delayed by regulatory hurdles or a shareholder approval vote scheduled for February 12, 2013, the transaction should close before the end of the first quarter of 2013.

Not an ordinary deal

The terms of the deal are rather complex. KBW common shareholders of record on December 24, 2012 received a flat cash payment of $10 per share of KBW. In addition, KBW shareholders will receive a tranche of fractional Stifel shares valued at $7.50 per share for every KBW share that they own. Fractional shares left over after the issuance of this tranche will be converted to cash and distributed proportionally among former KBW shareholders. Meanwhile, certain holders of "vested" KBW shares will receive fractional Stifel shares valued at $17.50.

This arrangement is conditioned upon Stifel's stock remaining range-bound between $29 and $35 during the 10-day trading period leading up to the merger's closing date. This yet-to-be-announced date is expected to be set at KBW's February 12 shareholder meeting.

Should Stifel's stock price rise above $35 per share, current KBW shareholders will not receive fractional Stifel shares equal to $7.50 per unit. Instead, they will receive 2.143 Stifel shares for every 10 shares of KBW that they own. If Stifel's stock price falls below $29 per share, current KBW shareholders will receive 2.586 Stifel shares for every 10 shares of KBW. In both cases, fractional shares will be converted to cash and distributed in accordance with the terms of the "original" deal.

In conjunction with the merger agreement, KBW also declared a special dividend of $2 to common stockholders of record as of December 10, 2012. The dividend was paid out on December 17.

Relative to KBW's pre-announcement closing price of $16.30 per share, the merger provides its shareholders with a return of about 7.5 percent. Since the amount of the special dividend was retroactively subtracted from the cash component of the pending transaction, it will not have an impact on the deal's overall rate of return. As such, shareholders who purchased KBW stock before the special dividend's record date will be entitled to compensation equal to $15.50 per KBW share. Post-dividend shareholders will still receive $17.50 per share if SF is within the range.  However, currently SF is beyond the high point of the range so KBW shareholders will receive 2.143 SF shares per 10 KBW shares owned.  That is equal to $7.51 per share plus $10 in cash, which is a 12.5% return on Tuesday’s closing price.

Complimentary consolidation

One of KBW’s competitors is also getting acquired.  Jefferies ) is getting acquired by Leucadia National Corp in an all-cash deal.  Jefferies, much like KBW, has had a rocky year in the market; however they are much different investment banks when you look at their financialsJefferies is a profitable business with moderate debt whereas KBW is losing money but has a stockpile of cash and little debt at all.

Stifel is a far larger concern that operates a number of subsidiaries and deals with clients across the developed world. It operates a retail brokerage and wealth-management fund that caters to wealthy clients across the United States. Its 290-branch retail-investment subsidiary specializes in fixed-income vehicles like municipal bonds, annuities and preferred stocks.

Stifel also operates an investment banking arm that performs many of the same functions as KBW's in-house investment bank. It appears likely that the pending merger will result in considerable consolidation between these two complementary divisions. However, the lack of client overlap between the two companies suggests that there is a strong potential for organic growth at the newly-merged concern.

The pending deal is attractive for Stifel due to KBW's relatively deep reserves of excess capital. Currently valued at approximately $250 million, these funds will be at the newly-merged company's disposal and may finance a wave of new transactions soon after the merger has been finalized. Tellingly, Stifel's shares jumped by more than 2 percent on the trading day that followed the announcement of the deal. Meanwhile, KBW has steadily traded lower since 2010 and appears undervalued at its current share price.


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