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An Analysis of the Takeover of the Bank of Melbourne

by Westpac Banking Corporation


Julian Buckley*
Rayna Brown*
*Centre of Financial Studies
University of Melbourne
Melbourne 3010
ph: 03 83447661
fax: 03 9349 2397
e-mail: r.brown@ecomfac.unimelb.edu.au

Abstract
A striking aspect of the recent wave of bank mergers has been the lack of consensus between
academics and bankers as to the benefits of such mergers. The empirical research suggests
the value gains anticipated from such mergers have not been realised. Piloff and Santomero
(1998) state that a new thread in the literature, which seeks to understand individual cases,
may help to resolve the quandary. This paper reports a case study analysis of the 1997
acquisition of Bank of Melbourne Ltd by Westpac Banking Corporation Ltd; specifically it
examines the size of the premium paid and the wealth effects of the merger.
It is found that regardless of how the pre-offer value of the equity of Bank of Melbourne is
calculated, a sizeable premium over value was implicit in Westpacs offer. However, the
finding of positive abnormal returns for a value-weighted portfolio of the target and bidder
companies over different event horizons, suggests that the market perceived the merger as
wealth enhancing.

Acknowledgments:
The authors wish to thank Rob Brown, Kevin Davis and David Robinson for comments on
earlier drafts.
Draft: May 2000
Please do not quote

An Analysis of the Takeover of the Bank of Melbourne


by Westpac Banking Corporation

1.

INTRODUCTION

Over the past two decades, the financial services sector in Australia has experienced
considerable regulatory and structural change. One feature of this change has been the exit
of various regional and state banks.1 In 1996, the Australian Government established the
Financial System Inquiry (the Inquiry) to consider the impact of deregulation and make
recommendations regarding future regulatory structure.

One of the principal recommendations of the Inquiry was relaxation of bank takeover laws.2
Prior to the Inquiry, the Australian Government had a stated policy (known as the sixpillars policy) which prevented a merger between any of the big four banks and the two
largest life assurance funds in Australia. 3 Although the Inquiry recommended the abolition of
this policy,4 the Australian Treasurer has since reaffirmed the governments opposition to any
merger between the big four banks.

These include the acquisition of Advance Bank by St George Bank in November, 1996, the Westpac
acquisitions of Challenge Bank (November 1995) and Trust Bank NZ (May 1996) and the acquisition of the
Bank of South Australia by Advance Bank in June 1995.
2
One key recommendation of the Inquiry was to amend existing banking and insurance legislation, to make
it clear that the only competition regulation of a financial systems merger should come under the Trade
Practices Act 1974 (Recommendation 82 , Financial Systems Inquiry (1997 pp 424 - 425)). Other relevant
recommendations were: 1. Only the prudential regulator should assess the prudential implications of mergers
(Recommendation 81, pp 421- 423), 2. Merger assessments under the Trade Practices Act should take
account of changes occurring in the financial system, including the evident increased competition in this
sector (Recommendation 84, p 473) and 3. The Foreign Acquisitions and Takeovers Act 1975 should be
applied, with the removal of the Federal Government policy prohibition on a takeover of the big four banks
(Recommendation 85, p 475).
3
The Big Four banks in Australia are the National Australia Bank, Commonwealth Bank of Australia,
Australia and New Zealand Bank and Westpac Banking Corporation.
4
Recommendation 83, p 428.

The Australian Competition and Consumer Commission (ACCC) has been a long-standing
advocate of retaining at least one major regional bank in each state. In Victoria, the Bank of
Melbourne was the last of the regional banks, and thus under ACCC policy, it appeared
unlikely that the takeover bid by Westpac would be approved. 5 The ACCCs approval of
Westpacs bid therefore represents a significant relaxation of its previous attitude towards
mergers involving regional banks.

It is likely that there will be further applications for mergers in the Australian banking sector.6
The unprecedented level of consolidation in United States where the number of operating
banks has declined by 30% since 1990 is said to be motivated by the belief that gains can
occur through expense reduction, increased market power, reduced earnings volatility and
scale and scope economies (Piloff and Santomero, 1998). For regional Australian banks
mergers may also provide a degree of operating diversification7 thereby potentially
alleviating their reliance on the market conditions of a single state.

A striking aspect of the recent wave of bank mergers has been the lack of consensus between
academics and practitioners as to the benefits of such mergers. There are two broad but
distinct streams in the literature on mergers and acquisitions. The first relates to an
examination of the motivation for undertaking mergers, traditionally considered to be either
the maximisation of shareholders wealth or managerial hubris. The second involves studies
5

ACCC approval is required before any merger can proceed: see s 50 of the Trade Practices Act 1974 (Cth).
At the current time (May 2000) the proposed takeover of Colonial State Bank by the Commonwealth
Banking Corporation is being considered by the regulatory authorities.
7
Provided that they participate in an across-market merger. Note, however, the traditional viewpoint of
Finance theory that individual investors can diversify at a much lower cost.
6

to determine the wealth effects of mergers. If managers act to maximise shareholders


wealth, then a merger can be seen as adding value to both target and acquirer through the
creation of synergies that produce economic gains and hence increase wealth. Berger et al
(1998) attribute the value-maximising gains from consolidation to two possible sources: an
increase in market power and hence the ability to set prices, or an increase in efficiency.

Empirical studies of bank mergers use either operating performance analysis or event studies
to examine the wealth effects of mergers. Event studies are designed to capture the financial
markets expectations of the overall performance results of mergers, whereas operating
performance studies focus on the ex post changes in profitability and efficiency measures due
to the merger. As discussed by Piloff and Santomero (1998) and Rhoades (1994) the
empirical evidence suggests that the expected efficiency gains have not been realised. In an
attempt to reconcile the research findings with the empirical reality, a new thread has
appeared in the literature (Piloff and Santomero,1998, p. 60). Whereas previously studies
involved only large samples, an interest has emerged in understanding the processes and
outcomes of individual cases.8

In presenting an analysis of the merger9 between Westpac Banking Corporation Ltd10 and
Bank of Melbourne Ltd this article falls within this new thread in the literature. This paper
addresses two issues. Firstly, the extent to which Westpacs offer included a premium over
firm value and secondly, the size of the wealth effects accruing to shareholders of the two
banks around the announcement of the merger. An examination of the wealth effects
8

See, for example, Calomiris and Karcuki (1996) and Frei, Harker and Hunter (1995).
The terms merger, acquisition and takeover are used interchangeably throughout the remainder of the
article.
10
Westpac Banking Corporation Limited will be referred to as Westpac in the remainder of the article.
9

accruing to shareholders of both firms may partially reveal managerial motives for
undertaking the merger.11 Where shareholders of the acquiring firm earn positive abnormal
returns around the merger announcement date, this signals that the market expects the
merger to be value-creating. Conversely, zero or negative abnormal returns to those
shareholders around the announcement may be seen as a reflection that the market questions
the gains from the merger. The market may believe that there are no real benefits from the
merger, or perhaps that the merger was undertaken primarily in order to maximise
managerial utility. It may also indicate that target shareholders gain at the expense of
bidding shareholders.12

A better understanding of the processes and outcomes of the Westpac and Bank of
Melbourne merger may assist in the decision making of regulators and shareholders in future
merger proposals.

The organisation of the paper is as follows. Section 2 contains brief descriptions of the
institutions involved in the case study. Section 3 provides an overview of the data sources
and methodology. Section 4 reports the results of the analysis and Section 5 contains a brief
conclusion.

2.

INSTITUTIONS INVOLVED

2.1

Institutional Characteristics

11

Evidence that the merger was wealth-enhancing for shareholders would substantiate the claims of potential
cost savings disclosed in the integration plan (Bank of Melbourne Information Memorandum, 1997, p.61)
12
For example where the offer premium is excessive.

The Bank of Melbourne was established in July 1989, following the granting of a banking
licence to the RESI-Statewide Building Society. The bank was listed on the Australian Stock
Exchange on 13 July 1989.

The Bank of Melbourne operated primarily as a specialist retail bank, with its branch
network and operations concentrated predominantly in Victoria, although there were also
branches in capital cities of various states in Australia. In May 1996, the Bank of Melbourne
acquired the Victorian business of Challenge Bank from Westpac for $659.7m.13 Following
this acquisition, the Bank of Melbourne became the fourth largest regional bank, and the
eighth largest of all listed banks in Australia. Immediately prior to the takeover offer by
Westpac, the Bank of Melbourne had 9.6% of the Victorian lending market, 11.6% of the
Victorian deposit market, and a network of 125 branches, the majority of which were
located in Melbourne.14

As a former building society, the Bank of Melbournes principal business activities had
traditionally been lending in the residential property market. However, increased
competition within this market saw the Bank of Melbournes operating profit after tax and
preference share dividend fall from $84.1 million (for the year ended 30 June 1996) to $78.1
million the following year.15 The Bank of Melbournes interest margin fell by 0.56% to

13

Note that this transaction may have unduly affected Bank of Melbourne results for 1996-97, and any
difficulties experienced in integration could possibly be related to the fall in profit experienced by the Bank
of Melbourne over the 1997 financial year.
14
Independent Experts Report, provided by Grant Samuel and Associates, Annexure 3, Bank of Melbourne
Information Memorandum 1997, p 139.
15
BARCEP Analysts Consensus Forecasts, 31/6/97, p 56.

2.74% over the same period.16 To a large extent, the declining margins were driven by the
impact of competition from mortgage originators17 in the home-lending market. This
increase in competition prompted the Bank of Melbourne to undertake a degree of
diversification in its activities, primarily into the area of commercial lending.18

Westpac Banking Corporation is one of the four major banks in Australia, and is engaged in
a variety of banking and financial services, including general banking, investment
management and insurance. It consists of three general business groups: Australian Banking
Group, Institutional and International Banking Group, and Australian Guarantee
Corporation. As at 1st August 1997, Westpac was ranked fifth in terms of market
capitalisation on the Australian Stock Exchange (Bank of Melbourne Information
Memorandum 1997, p 69). Prior to making the takeover offer, Westpac acquired the
Western Australian-based Challenge Bank in December 1995. The Victorian business of
Challenge was sold to the Bank of Melbourne in May 1996 for $659.7m.19

In 1997, Westpac had 212 branches in Victoria, including a large number of rural branches;
its share of the deposit market was 9.1% and its share of the lending market was 8.6%. 20
Westpacs primary business activity in Victoria was commercial and rural lending.

2.2

The Offer

16

General Information, Bank of Melbourne Information Memorandum 1997, p 52.


Mortgage originators source and package bundles of mortgages that are then sold through securitisation
programs to the wholesale market.
18
This diversification was assisted by the 1996 acquisition of Challenge Bank, which had a higher
proportion of commercial loans. The Bank of Melbournes loan portfolio comprised 82.9% residential
lending, 15.2% commercial lending and 1.9% other. See Independent Experts Report, p 138.
19
Thus Westpac spun-off a division of their operations to the Bank of Melbourne in May 1996, then
essentially bought the division back the following year when they acquired the Bank of Melbourne.
20
Independent Experts Report, p 139.
17

On 3rd April 1997, Westpac announced a bid to acquire 100% of the Bank of Melbournes
issued capital. The total consideration of the bid was approximately $1.43 billion.21 This
amounted to a nominal offer of $9.75 per ordinary share, comprising a special fully franked
dividend from the Bank of Melbourne of 90 cents per share,22 coupled with the choice of
either $8.85 in cash, or a combination of cash and Westpac shares.

Following the announcement of the offer, Bank of Melbourne shares traded in a range
between $9.60 and $9.80. Bank of Melbourne ordinary shares had not traded in this range in
the seven years since listing in 1989, to immediately prior to the announcement of Westpacs
proposal. Indeed, after reaching a peak of $9.50 in November 1996, the share price had
subsequently fallen to $8.00 in February 1997, following a reduced profit announcement.23
The price remained in the range of $8.00-$8.30 until the day before the takeover
announcement.

At $9.75, the offer price represented a 19% premium over the average price of $8.22
realised in the week prior to the announcement, and a 20% premium over the closing price
of ordinary shares one month prior to the announcement.

21

Independent Experts Report, p 163.


Due to the effect of the dividend imputation system in Australia, a franked dividend may be more valuable
(on an after-tax basis) than an unfranked dividend of equal dollar amount. This is the case where the
investor can use the imputation credits attached to the franked dividend to offset their personal tax payable
in Australia: no such imputation credits attach to unfranked dividends. Thus the actual value of the franked
dividend may need to be grossed-up from $0.90 to account for the value of the imputation credits, resulting
in an actual offer value in excess of $9.75. For further information, see Hathaway and Officer (1992).
23
For the six months ending 31 December, 1996.
22

The merger had yet to be approved by the three branches of the regulatory process, the
Australian Competition and Consumer Commission (ACCC), the Reserve Bank of
Australia (RBA) and the Federal Treasurer. Following extended negotiations, it was
announced on 25th July 1997 that both the RBA and the Federal Treasurer had given in
principle approval to the acquisition. Further, the ACCC had ruled that the proposed merger
did not contravene s 50(1) of the Trade Practices Act 1974.24 As such, the ACCC approved
the proposal, subject to certain written undertakings. Bank of Melbourne ordinary
shareholders voted on the proposal on 29th September 1997, with a minimum of 75% of the
vote required for acceptance of the offer; over 96% approved the takeover proposal.25

3.

METHODOLOGY AND DATA

3.1

The Premium

24

s.50(1) of the Trade Practices Act 1974 (Cth) reads: A corporation shall not acquire, directly or indirectly,
any shares in the capital of a body corporate where the acquisition is likely to have the effect of substantially
lessening competition in a market for goods and services.
25
Deane, S, Bank of Melbourne Shareholders Approve Westpac Bid, Bloomberg Financial Markets,
Commodities, News, 29/9/97

The premium may be described as an enticement offered by the bidder to the target to ensure
that the merger proceeds. A premium is offered in most mergers. Brown et al. (1997) report
that the average bid premium paid to target shareholders in Australia is 19.7%. 26
The methodology adopted is to measure the premium as the ratio of the offer price to the
book value of the target firm. This measure is the banking industry standard in the United
States (Palia, 1993, p.93) and has been used in the majority of studies that have measured
premiums in bank mergers.27 The valuations use information contained in annual accounting
statements and in consensus earnings and dividend forecasts obtained from BARCEP. The
cost of capital to be used is obtained from the Independent Experts Report in the Bank of
Melbourne Information Memorandum 1997, prepared by Grant Samuel.

Monthly share price data are obtained from the price relatives file of the Australian Graduate
School of Management (AGSM) Australian share price and price relatives database. Daily
stockmarket data is obtained from IRESS, with dividend adjustments made from data
obtained from the AGSM price relatives database. The All Ordinaries Accumulation Index is
used to proxy for the market return.

It is important to note that the size of the premium, calculated on the basis of historical cost
used in accounting figures, may be distorted, since assets and liabilities are not marked to
market on the balance sheet. It is tempting to dismiss this limitation, because it is industry
practice to use this accounting measure, and because many of a banks assets and liabilities
are recorded at close to market value, and are relatively short term. However, it is difficult
26

This is measured over the period June 1985 to November 1995, and is based on the offer value and an
expected pre-offer share price, as opposed to the accounting premium of Palia (1993).
27
Such studies include Rhoades (1987), Cheng, Gup and Wall (1989), Frieder and Petty (1991) and Palia
(1993).

10

to draw inferences regarding how accurately the market value of a bank is represented by
book value, particularly with the increasing usage of off-balance sheet instruments (such as
derivatives) for hedging and other purposes.

To mitigate this limitation, a number of valuations are used to determine the range within
which the value of the target lay prior to the merger. In conjunction with the above
accounting-based premium and the observed share price premium,28 these valuations will
provide a consensus as to whether a premium was paid.

Van Horne and Helwig (1966) suggest that only current earnings and the dividend payout
ratio are significant factors in the valuation process for small bank stock. More recently,
Mukherjee and Dukes (1989) conclude that other factors such as growth in earnings and risk
factors may offer explanatory power in the valuation process. For this reason, the pre-offer
market price is calculated using three models: a dividend discount model, a price/earnings
multiple and the residual income valuation model.29 Consideration of earnings, dividends,
growth and risk factors are incorporated into the three valuation models.

3.2

Wealth Effects

The wealth effects of the merger are examined by analysing the abnormal returns received by
both target and bidder shareholders around the first public announcement date of the merger.
Such analysis will reveal the markets expectations regarding the incremental effect of the
28

Following Kaufman (1988) this is measured as the ratio of the offer price to the expected pre-offer share
price (taken 61 days before the first public merger announcement).
29
This model is derived in Appendix One.

11

merger on the wealth of shareholders of each firm. In addition, the value-weighted,


consolidated sum of the abnormal returns to both bidder and target shareholders will be
examined, to allow assessment of the markets initial valuation of the single post-merger firm
as opposed to that of the two separate pre-merger firms.30

Normal returns are assumed to be generated by a single-factor market model:


R jt j j RMt jt
The parameters and are estimated from this model using ordinary least squares. The
parameters are estimated twice; first using monthly data, over the horizon t = 60 to t =
13, where t = 0 is the event month, and also using daily data, over the horizon t = 250 to
t=60, where t = 0 is the day of the merger announcement.

Standard event study methodology is used to compute abnormal returns. The month and
day that the merger is announced in the Australian Financial Review are specified as the
relevant respective event dates in event time for the two data frequencies. Following
Bishop, Dodd and Officer (1987), monthly abnormal returns are calculated and cumulated
for the seven-month window surrounding the event month, designated as (3, 3). Daily
abnormal returns are calculated for both a 21-day window (10,10) and a two-day window
(-1,0) surrounding the event day. The weights used to determine the consolidated abnormal
return are taken as the market values at the beginning of the event window to be analysed.31
30

Note that a positive abnormal return to target shareholders may be induced by the premium, and thus does
not necessarily reflect real potential gains to the combined firm.
31
For example, for the (3,3) month window, weights are determined as the market values of the banks as at
t=3 months. Similarly, for the (10,10) day window, the market values at the beginning of day 10 are
used as the weights. This approach is adopted from Piloff (1996) p 305.

12

Abnormal returns are calculated as:


AR jt R jt ( j j RMt )
where:
ARjt is abnormal rate of return of security j over time period t relative to the event date
Rjt is the observed rate of return of security j in time period t
Rmt is the rate of return on a value-weighted market portfolio over time period t
Monthly and daily abnormal returns are cumulated over the three relevant event windows32
to obtain cumulative abnormal returns (CAR) over the different event horizons. The
calculated CARs are the sum of the abnormal returns over the respective event windows.33

4.

RESULTS

4.1

The Size of the Premium

The Bank of Melbourne reported that shareholders' equity (including preference


shareholders equity) totalled $752 million at 30 June 1997, up from $626 million the
previous year.34 Assuming a constant flow of income over the financial year, this implies an
approximate book value of $720.5 million at the beginning of April 1997.35 The total
purchase price offered on the announcement date of the merger of 3 April, 1997, for both
ordinary and preference shares was $1.43 billion. Therefore, a significant premium of
approximately $709.5 million over book value was paid. The calculated ratio of purchase
32

Which are, respectively, (3,3) months, (10,10) days and (1,0) days.
Continuously compounded rates of return are used, allowing direct summation of abnormal returns.
34
Bank of Melbourne Information Memorandum 1997, p 240
35
This is calculated as $626 + 9/12($752$626), since April is 9/12 of the financial year, ending 30 June.
33

13

price to book value is 1.98 (or 98.47%). 36 This premium may present a distortion of the true
picture if accounting book value is unable to accurately reflect market value. Therefore,
three further valuations are made , to provide alternative estimates of the premium.

The first valuation model used is the dividend discount model based on the following
equation:
where:

D1999
)
ke g
D1998

1 k e ( 1 k e )2
(

P1997

(1)

P1997 is the 1997 share price


D1998 and D1999 are the forecast dividend payments in 1998 and 1999 respectively
g is the rate of growth of dividends
ke is the cost of capital of the firm
The valuations implied by the dividend discount model are in the range $6.81-$8.24. More
emphasis is placed on the lower end of the range, since the assumption of constant 5.5%
annual growth in dividends made in the valuations may be unrealistic.37 A comparison with
the per share offer price of $9.75 indicates a substantial premium in the offer.

The valuation implied by the price/earnings multiples of comparable firms (eg other regional
banks) is $1386.24 million.38 This represents a premium of only $43 million, or
approximately 3%. However, it is suggested that the price/earnings multiples for regional
36

This is close to the average purchase price to book ratio reported in Cheng et al (1989, p.530) of 2.041.
This may be compared with the share price premium of 13.7%, calculated as the ratio of the offer value to
the expected pre-offer value per share. The share price 61 days prior to the merger announcement is taken as
the expected pre-offer value.
37
See Appendix One for more detail regarding calculations, assumptions and discussion of all valuations.
38
This is based on a P/E multiple of 15.2. See Appendix One for further details.

14

banks were inflated at this time due to speculation regarding their potential involvement in
takeover activity,39 particularly with the then recent release of the report of the Financial
System Inquiry. This suggestion may be evidenced by the fact that regional banks were
trading at multiples of 15.2 times earnings, while the major banks were trading at multiples
of only 12.5 times earnings.40 Using the P/E multiple of the major banks, the offer represents
a premium of approximately 25%.

The valuation according to the residual income model is performed using the following
equation:41

P B t N I ( 1) B
T

t 1

t 1

RE

T 1

(2)

where:

P is the price at time 0


o

B is the book value at time 0


T

NI is net income at time T


E

is (1 + cost of capital)
RE is residual income
39

See Independent Experts Report, p 115.


Independent Experts Report, p.115.
41
The data considered for valuation purposes imply a constant perpetual residual income beyond the finite
horizon. This issue is addressed in Appendix One.
40

15

T is finite time horizon


t = time period

Equation 2 may be interpreted as the reported book value plus an infinite sum of discounted
residual income. Using a discount rate of 11% implies a valuation of $5.67. 42 The offer price
was $9.75. Therefore, compared to the estimated share value using the residual income
model this represents a premium of 72%.

Thus all three valuation methods suggest that a premium was paid. Taken in conjunction
with the accounting premium, and in light of the fact that a share price premium of almost
14% was paid, it is apparent that a premium was paid regardless of the measure used to
estimate the pre-offer value of the target.

4.2

Wealth Effects

The results of the event studies are presented in Table 1. Examination of the individual CAR
accruing to either the acquirer or the target around the first public announcement does not
reveal a clear market perception of the merger. The target firm earns a positive CAR around
the announcement, regardless of the event horizon or data frequency, which is consistent
with empirical evidence for many takeovers. However, at 0.1498%, the CAR over the
seven-month window surrounding the event date is close to zero, 43 while the CAR over the
two-day window is 14.977%.44
42

The discount rate is obtained from the Independent Experts Report, p 163. See Appendix One for further
details and calculations.
43
Tests of significance cannot be performed due to the small sample size.
44
As can be seen from Table 1, the CAR over the 21-day window to the target is 12.5%.

16

These findings are consistent with at least two explanations. First, they may reflect a
degree of uncertainty surrounding approval of the bid: the market initially revalued the target
shares upward when the takeover was announced, explaining the high, positive CAR over
the 2- and 21-day horizons. However, as it became unclear whether the bid would receive
ACCC approval,45 the markets original positive reaction was somewhat diminished, leading
to a low CAR over the seven-month horizon.

The second possibility is that the results could be influenced by the presence of confounding
effects, whereby another information event occurs during the event window, thereby
altering the information set and the market price. Possible events include other regular
market announcements such as an earnings or dividend announcement, which are more likely
to occur during the monthly data frequency, owing to the longer time frame examined.
Alternatively, the inconsistencies may be induced if it is inappropriate to assume the onefactor market model for the return generating process.46

The picture emerging from the CAR accruing to the acquirer is less clear. Over the sevenmonth window, shareholders of the acquirer earned positive cumulative abnormal returns of
4.82%. This finding is consistent with the existing Australian empirical evidence outlined in
Section 3. However, examination of daily data in Table 1 reveals that the acquirer earned a
negative CAR over both event horizons studied.
45

ACCC approval of the bid took almost three months, with approval coming on 25 July, 1997. This is
almost contemporaneous with the end of the (3,3) event window.
46
This is an instance of the joint-test issue. Event studies involve a test of both market efficiency and the
return generating process (RGP) assumed to generate normal returns. Abnormal returns may have
implications regarding market efficiency, or they may be driven by an inappropriate RGP. See Strong
(1992).

17

Table 1
CAR over different event horizons
Data
Frequency
Monthly
Monthly
Monthly
Daily
Daily
Daily
Daily
Daily
Daily

Firm
Characterisation
Target
Acquirer
Consolidated
Target
Acquirer
Consolidated
Target
Acquirer
Consolidated

Event
Horizon
(3,3)
(3,3)
(3,3)
(10,10)
(10,10)
(10,10)
(1,0)
(1,0)
(1,0)

CAR
0.001498
0.048231
0.022902
0.125031
0.07461
0.03174
0.14977
0.03876
0.061674

Again, this inconsistency may be caused by the presence of confounding effects in the
monthly data, or inappropriateness of the market model for the return-generating process.
Alternatively, the positive CAR over the seven-month window may be a result of the
resolution of uncertainty surrounding the bid.47
It is possible that Westpacs previous acquisitions contributed to the CAR. There is some
empirical evidence to suggest that bidders undertaking an expansion program may earn a
positive CAR.48 Further, there is the potential for loan processing efficiencies derived from
bank acquisitions49 to be magnified by frequent acquirers that are experienced at identifying
and realising these efficiencies.50
The above analysis of the individual CAR earned by bidding or target shareholders does not
allow general conclusions regarding the wealth effects of the merger. However, the valueweighted consolidated CAR does provide a consensus. Regardless of the data frequency or
event horizon, the consolidated CAR is positive, as can be seen from Table 1. This indicates
47

The bidder earned negative AR in event months 0 and 1, and positive AR in event months 2 and 3, which
is consistent with what would be expected following the resolution of uncertainty. See Appendix Two.
48
Asquith, Bruner and Mullins (1983) find evidence of significant abnormal returns to bidders engaged in
acquisition programs, over a 41-day event horizon.
49
See Sushka and Bendeck (1988).
50
This point is made in Madura and Wiant (1994 p 1148).

18

that overall, the market perceived the merger as a value-adding investment (ie the value of
the single post-merger firm exceeds that of the sum of the two individual pre-merger firms),
even in the face of uncertainty regarding approval of the bid. Together with the positive
CAR earned by both parties over the longer event horizon the evidence implies a general
market-based opinion of real potential gains from the merger.

5.

CONCLUSION

It was found that regardless of the valuation model used to measure the pre-offer value of
Bank of Melbourne shares a significant premium was implicit in the offer made by Westpac.
Whilst the evidence on the wealth effects for shareholders in the acquirer (Westpac), and in
the target (Bank of Melbourne) is ambiguous, the value-weighted consolidated CAR is
positive over all event horizons.

19

REFERENCES
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Merger, Journal of Financial Economics, Vol 11, 121-139.
Bank of Melbourne Information Memorandum, 1997.
Berger, A.N., Demsetz, R.S. and P.E. Strahan, 1999, The Consolidation of the Financial
Services Industry: Casues, Consequences, and Implications for the Future, Journal
of Banking and Finance, Vol 23, Nos 2-3, April, pp. 135-194.
Berger, A., and D. Humphrey, 1992, Megamergers in Banking and the Use of Cost as an
Antitrust Defence, Antitrust Bulletin, Vol 37, pp.541-600.
Bishop, S., P. Dodd and R.R. Officer, Australian Takeovers: The Evidence, The Centre for
Independent Studies, 1987.
Brown P., and R. da Silva Rosa, 1997, Takeovers: Who Wins?, JASSA, v1997, issue 4,
pp.2-5.
Calomiris, C. and J. Karenski, (1996), The Bank Merger Wave of the 1990s: Nine Case
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20

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21

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22

APPENDICES
Appendix One: -Valuations
Dividend Discount Model
In 1995 the Bank of Melbourne paid out $0.42 per share in dividends, and $0.47 per share in
1996. Prior to the merger announcement, it was forecast by BARCEP the bank would pay
out approximately $0.50 per share in 1997. The actual payout was only $0.23; the final
dividend was not paid, due to the payment of a special dividend of $0.90 to shareholders
under the terms of the merger agreement. Forecasts made at the end of 1997 by BARCEP
suggested dividends of $0.48 in 1998 and $0.52 in 1999. This implies a constant annual
growth rate of approximately 5.5% since 1995. However, assuming an annual dividend
growth rate of 5.5% may be unrealistic: the average growth rate since 1996 is only 3.4%. A
further restriction is that it is unknown whether this growth is permanent or transitory, which
will also affect the valuation. As is well known, the assumption made regarding the annual
growth rate plays a vital part in the valuation, as shown below.
The discount rate used as the required cost of capital is taken from the Independent Experts
Report p163. It is calculated based on the CAPM, and is in the range of 11%-12%.
Assuming a constant dividend growth rate of 5.5%, and using 11% as the discount rate, the
1997 price is approximately $8.24, calculated as: $0.48/1.11 + [$0.52/ (0.110.055]/ (1.11)2.
Using 12% as the discount rate, the implied price through finding the present value of
dividends is $6.81.
However, where the annual growth rate is assumed to remain constant at 3.4%, the
valuation range changes dramatically. For an 11% discount rate, the implied price is $5.99.
For a 12% discount rate, the price is $5.25.

23

Method of comparable multiples


The Independent Experts Report (p.5) provided by Grant Samuel suggests that the
historic/current P/E multiple for major banks at 24 July 1997 was 12.5, and could
prospectively move to 12.0, while for regional banks it was 15.2, prospectively falling to
14.1. In 1996, the Bank of Melbourne reported a net operating profit after tax of $91.2
million. The valuation using the regional banks multiple of 15.2 and 1996 after tax operating
income is $1386.24 million. The purchase price over value premium here is only $43
million, or approximately 3%. The multiple for major banks of 12.5 implies a value of $1140
million, in which case the offer would represent a 25.4% premium.

Residual Income Model


For the residual income valuation, 1997 book value per share (BPS) is $5.37, calculated as
average shareholders equity, divided by average number of shares on issue. Earnings per
share (EPS) were $0.609, while dividends per share (DPS) were $0.23. Forecasts for 1998
suggested EPS of $0.6158 and DPS of $0.4867, while for 1999 forecasts were EPS of
$0.6687 and DPS of $0.52. The cost of capital is again in the range of 11% to 12%, again
obtained from the Independent Experts Report.
Assuming income is comprehensive, 1998 book value per share should be $5.749 (based on
the stocks and flows equation), while 1999 book value should be $5.8977.
Using 11% as the discount rate, the 1998 and 1999 residual incomes are:
$0.6158 0.11*$5.37 = $0.0251 and $0.6687 0.11*$5.749 = $0.03631. This is an
insufficient time span to accurately obtain a growth rate of residual income. The 1996 BPS
is $5.22. Thus 1997 residual income (RE) is $0.609 0.11*$5.22 = $0.035. The most
obvious assumption is that residual income will be constant at around $0.035 per year
beyond the horizon. This suggests a value of:
$5.37 + $0.0251/1.11 + $0.03631/(1.11)2 +$ (0.035/0.11)/1.112 = $5.67
The value implied assuming a growth rate in residual income of approximately 2% (derived
from the growth in residual income from 1997 to 1999) is:

24

$5.37 + $0.0251/1.11 + $0.03631/(1.11)2 + [($0.03631(1.02)]/0.11-0.02)/(1.11)2=$5.75.


In this instance, the growth rate clearly does not make a material difference to the valuation,
so the valuations produced using a constant RE of $0.035 are reported.

For a discount rate of 12%, the residual incomes are $0.6158 0.12*$5.37 = $-0.0286. For
1999, the RE would be $0.6687-0.12*$5.749 = $-0.02118. This implies that the firm would
be selling at a discount to book value, which is clearly not optimal. This indicates that there
are problems in using this model, which may be induced by the short time frame of the
valuation. Ideally, valuations performed using the residual income model make use of at
least five years of earnings and dividend data, and preferably ten, whereas here, only two
years of forecasts were used.

25

Appendix Two: - Event Study Results


Monthly analysis
Target E(r) over (-3, 3)
31/01/97
28/02/97
27/03/97
30/04/97
30/05/97
30/06/97
31/07/97
Total
CAR (-3,3) 0.001498

0.009968
0.020129
0.005033
0.030708
0.045448
0.044388
0.012281
0.167955

Actual
Return
0.037874
-0.05911
0.012225
0.120978
0.005385
0.015676
0.036428
0.169454

Bidder Expected Return (-3,3)

Actual Return

31/01/97
28/02/97
27/03/97
30/04/97
30/05/97
30/06/97
31/07/97
Total
CAR
(-3,3)

0.046406
-0.02706
0.013607
-0.06849
0.031305
0.134968
0.092214
0.222945

0.001157
0.018401
-0.00722
0.036353
0.061368
0.059569
0.005082
0.174713
0.048231

Consolidated Expected Return (-3,3)


31/01/97
28/02/97
27/03/97
30/04/97
30/05/97
30/06/97
31/07/97
Total
CAR (-3,3)

0.005933
0.019338
-0.00058
0.033293
0.052739
0.051341
0.008984
0.17105

Actual
Return
0.041782
-0.04443
0.012858
0.0342
0.017257
0.070312
0.061978
0.193952

Abnormal
Return
0.027906
-0.07924
0.007192
0.09027
-0.04006
-0.02871
0.024148
0.001498

Abnormal
Return
0.045249
-0.04546
0.020824
-0.10485
-0.03006
0.075399
0.087132
0.048231

Abnormal
Return
0.035849
-0.06377
0.013435
0.000907
-0.03548
0.018971
0.052995
0.022902

0.022902

26

Daily Analysis
Target Expected Returns
20-Mar-97 0.001901
21-Mar-97 -0.00051
24-Mar-97 0.004156
25-Mar-97 0.001171
26-Mar-97 0.000711
27-Mar-97 0.004654
28-Mar-97 0.000484
31-Mar-97 0.000484
1-Apr-97 -0.01573
2-Apr-97 0.001394
3-Apr-97 0.002103
4-Apr-97 0.002553
7-Apr-97 -0.00027
8-Apr-97 0.001438
9-Apr-97 0.005382
10-Apr-97 0.001406
11-Apr-97 -0.00239
14-Apr-97 -0.0029
15-Apr-97 0.004132
16-Apr-97 0.006254
17-Apr-97 0.002055
Cumulative Abnormal Return
Bidder Expected Returns
20-Mar-97 0.0032574
21-Mar-97 -0.0017682
24-Mar-97 0.00796
25-Mar-97 0.0017352
26-Mar-97 0.0007756
27-Mar-97 0.0089981
28-Mar-97 0.0003021
31-Mar-97 0.0003021
1-Apr-97 -0.0335096
2-Apr-97 0.0022
3-Apr-97 0.0036776
4-Apr-97 0.004616
7-Apr-97 -0.0012669
8-Apr-97 0.0022922
9-Apr-97 0.0105151
10-Apr-97 0.0022252
11-Apr-97 -0.0056978
14-Apr-97 -0.0067468
15-Apr-97 0.0079094
16-Apr-97 0.0123344

Actual Return
-0.00495
0.007417
0.009804
0.003652
-0.00122
0.00243
0
0
-0.01098
0.076734
0.07654
-0.00316
-0.00955
-0.00213
0.010627
0
-0.01277
-0.00752
0.003231
0.005362
0
0.125031
Actual Return
0.002833
0.02927
0.028438
-0.00401
-0.00943
0.001352
0
0
-0.03998
-0.0339
0.001018
-0.00729
-0.00147
0.007305
-0.02954
-0.0015
-0.01665
0.003049
0.007582
0.013504

Abnormal Return
-0.00685
0.007925
0.005648
0.002481
-0.00193
-0.00222
-0.00048
-0.00048
0.004748
0.07534
0.074437
-0.00572
-0.00928
-0.00357
0.005245
-0.00141
-0.01037
-0.00463
-0.0009
-0.00089
-0.00205
Abnormal Return
-0.00042
0.031039
0.020478
-0.00575
-0.0102
-0.00765
-0.0003
-0.0003
-0.00647
-0.0361
-0.00266
-0.01191
-0.0002
0.005012
-0.04006
-0.00373
-0.01096
0.009796
-0.00033
0.001169

27

17-Apr-97 0.0035778
Cumulative Abnormal Return
Consolidated Expected
Returns
20-Mar-97 0.002534912
21-Mar-97 -0.001097264
24-Mar-97 0.005933592
25-Mar-97 0.001434772
26-Mar-97 0.000741187
27-Mar-97 0.006683904
28-Mar-97 0.000398992
31-Mar-97 0.000398992
1-Apr-97 -0.024037897
2-Apr-97 0.001770663
3-Apr-97 0.002838609
4-Apr-97 0.003516819
7-Apr-97 -0.000734965
8-Apr-97 0.001837334
9-Apr-97 0.007780305
10-Apr-97 0.001788874
11-Apr-97 -0.003937325
14-Apr-97 -0.004695525
15-Apr-97 0.005897051
16-Apr-97 0.009095158
17-Apr-97 0.002766457
Cumulative Abnormal Return

-0.00149
-0.07461

-0.00507

Actual Return

Abnormal Return

-0.00131
0.017628
0.018511
7E-05
-0.00505
0.001926
0
0
-0.02453
0.025035
0.041249
-0.00509
-0.00577
0.002276
-0.00814
-0.0007
-0.01458
-0.00258
0.005264
0.009166
-0.0007

-0.00385
0.018726
0.012577
-0.00136
-0.00579
-0.00476
-0.0004
-0.0004
-0.00049
0.023264
0.03841
-0.00861
-0.00504
0.000439
-0.01592
-0.00249
-0.01065
0.002113
-0.00063
7.11E-05
-0.00346
0.03174

28