When Stockholders Meet Stakeholders: Inside the Novo Banco Sale Terms

In 2014, Portugal, having just emerged from the European Sovereign Debt Crisis, was rocked by another disaster, this time in its banking sector. Banco Espírito Santo, one of the country’s largest private financial institutions by net assets and a market share of over 20%, was in dire straits. By early August, the Portuguese central bank, Banco de Portugal, was forced to provide a 4.4 billion euro bailout. Under the terms of this bailout, the former giant was restructured into two entities to be held by the Portuguese government: the original bank, BES, which kept so-called “toxic assets”, while healthier assets were transferred to a new bank called Novo Banco. Two and a half years later, the Portuguese government is unwinding 75% of Novo Banco to private equity firm Lone Star. While a government selling a bailed-out firm to private investors in and of itself is a fairly uncommon situation, the terms of this deal appear to be very unique and non-traditional. 

It’s worth noting that banking is a very important sector in any domestic market, affecting nearly everyone in a country in some way. Working people use it for the safe storage of their money, while businesses make use of the banking sector for loans and the processing of payments – the sector hits nearly every facet of modern life. As a result, many countries are somewhat reticent to have foreign controlling interests in their domestic banks, as they can be seen as disconnected from day-to-day life within the country’s borders and may not appreciate all the stakeholders within the community in which they operate.

Strange Bedfellows…

The idea that the Portuguese government is willing to sell to a foreign company, then, raises a key point about this deal, as it affirms that the special relationship between the US and the EU is still strong. More importantly, with all the concerns recently about President Trump’s comments on trade and nationalistic movements gaining momentum on both sides of the Atlantic, the fact that the Portuguese government is doing this deal with an American firm implies that the relationship between the two is expected to continue to be strong and is an important signal to the business community at large.

The selection of Lone Star as the partner also implies that the private equity firm has struck what’s considered to be a great deal on both sides of the negotiation table. Being the preferred bidder after a lengthy process – Banco de Portugal had originally set its own sale deadline of August 2015 – means that they beat out not only other foreign investors, but also groups based within the European Union (which is considered “domestic enough” for the case of an EU member state).

… And Stranger Terms

Perhaps most interesting, however, is the sale price at which this deal will close. Most transactions like this are fairly straight forward from a bird’s-eye view of pricing: the Buyer pays the Seller some agreed upon amount for the business’s equity. And, at first glance, the headline number of 1 billion euros is fairly mundane, until you dig into the details. As it turns out, Lone Star isn’t “buying” the shares from the government, per se; instead, they are agreeing to a 1 billion euro capital injection into the bank itself. In return, Lone Star will receive a 75% stake in the company’s equity, while Portugal’s Bank Resolution Fund will be the sole other shareholder until such a time that they decide to divest.

From Lone Star’s point of view, this is a drastic reduction in the cost of acquiring the equity. If they had simply bought the shares in a traditional manner for 1 billion euros, that money is gone and can’t be put towards the bank’s business. By agreeing to invest the capital in lieu of a direct payment, they are able to make use of it in ways that will help to grow the bank’s operations and profitability.  Since they are getting 75% of Novo Banco’s shares for their investment, in a manner of speaking, the cost of the equity to Lone Star for this transaction has been reduced in price by three quarters!

How It Came to Be

All of these points relate to the selling party being a very non-traditional deal partner, as the government of Portugal and its Bank Resolution Fund have strikingly different interests than most sellers. While most entities that are looking to divest their ownership stake in a company, be they individuals, businesses, or investment funds, are looking primarily to get the best price they can, a government bailout fund has many other considerations. Obviously, the Portuguese government would want to recoup as much of the cost of the bailout as possible, they are also keenly aware of other stakeholders in the transaction, instead of simply just stockholders and, being considerably less bound by the fiduciary duty of maximizing shareholder returns, they can act more readily on the wants and needs of these oft overlooked groups.

The Portuguese government has a clear and vested interest in ensuring the success of its banking sector, as it provides not only high paying jobs for its society, but also helps to act as the grease for the wheels on its economic engine. A well-functioning, stable and competitive financial industry provides loans to businesses to help them grow and retail banking services to the public at large to ensure they can meet their financial goals at the lowest costs possible, in turn acting as a rock-solid base upon which a country’s economy can grow. In turn, this encourages businesses, both foreign and domestic, to invest in the country, driving economic growth and providing jobs and wealth for its citizens. The importance of the financial sector’s well-being far outstrips the extra billion euros that would be in the federal coffers from a more vanilla-type sale, which explains why the Portuguese government would be willing to even consider this deal in the first place. That’s not to knock the price – it’s certainly not chump change – but the long-term value of the social benefit to the entire country is considerably higher.

Seeing the Whole Picture

As we all know, no two deals are created equal, but some are considerably more unique than others. The distinctive structuring of this transaction really drives home the point of how important it is that dealmakers know what the parties involved are looking for, not only from a valuation perspective, but also from a more holistic point of view, one that incorporates both stockholders and stakeholders. With these things in mind, the “valuation gap” between buyers and sellers can be overcome in creative ways that, while unorthodox, satisfy everyone’s requirements in a mutually beneficial manner.

Kevan Hartford

Kevan Hartford is a Toronto-based finance professional working in asset management.