Pacific Century strategy pays off

By Frank Cho
Advertiser Staff Writer

Wall Street reacted positively last week when Michael O'Neill, the new chairman of Pacific Century Financial Corp., announced the company would reverse years of expansion and sell its underperforming operations to free up $400 million in capital by year-end.

Michael O'Neill is using Bank of America model in raising shareholder value at Pacific Century Financial. Advertiser library photo

After just four months of study, the plan unveiled by O'Neill last Monday calls for Pacific Century to shave $5 billion in assets and 1,000 jobs to create a leaner, more streamlined operation.

And if it seems like O'Neill knows what he is doing, it might be because he's done it before.

"The playbook he is using is very similar to the one he used at the old Bank of America and Continental Bank," said David Winton, a New York-based banking analyst with Keefe Bruyette & Woods Inc.

At Continental Bank Corp., O'Neill unloaded nonperforming assets before he finally sold the whole bank to BankAmerica Corp. in 1994.

As vice chairman and chief financial officer at Bank of America a few years later, he used the same strategy again to weed out underperforming operations, including those in Hawai'i, before merging that company into NationsBank in 1998.

In the wake of last week's announcement, banking industry experts are divided on whether O'Neill is now setting up Bank of Hawaii for a sale or a merger. But what they do agree on is that a simpler, smaller Bank of Hawaii — with smaller asset problems — would be an easier sell.

"It's certainly not my intention to do that. But any CEO that says his company will never be sold is simply being irresponsible," O'Neill said.

A sale could mean huge profits for shareholders depending on the premium offered for the company, which most analysts say is still undervalued as of Friday's closing price of $22.40 a share.

Those who would stand to benefit the most include O'Neill, who spent $10 million last year to buy Pacific Century stock that was trading at $10 below current prices.

O'Neill describes his strategy as maximizing shareholder value — in basic terms that means doing most anything to raise the stock price for investors.

He says it's the same strategy that helped the $400-billion Bank of America nearly quadruple its share price over a three-year period.

"If you want to call this the same playbook, it is, and hopefully has the same results," O'Neill said.

Pacific Century has been gradually divesting itself of assets almost since the day the new chairman took the job Nov. 3. Even before last week's announcement, the bank had sold its Arizona branch network and its credit card portfolio.

But this week's announcement left no doubt that the bank is divesting not only its assets, but its entire Pacific Rim strategy.

"The two words in my judgement that are overrated are diversification and growth. We can grow very badly and destroy shareholder value, and we can diversify and destroy value and I will tell you we are guilty of both," O'Neill said.

And O'Neill is wasting little time trying to correct that. The day after he announced the new strategy, the bank announced the sale of its 17 percent stake in an Australian regional bank.

Nearly everything else is also either already on the market or being prepared for sale.

O'Neill said his plan will trim the company's assets from $13.9 billion to $8 billion by 2003. The return on equity will improve from a dismal 8 percent to a respectable 17 percent and return on average assets will increase from 1 percent to 1.5 percent.

For sale are the company's Asia, South Pacific and California banks. The company is keeping a representative office in Tokyo, and branches in Guam and American Samoa.

Erick Eisenstein, an analyst with Standard & Poor's, said Zions Bancorp. is a potential buyer for the company's 19 branch, Encino, Calif.-based subsidiary, Pacific Century Bank. Other analysts have also mentioned BancWest Corp., the parent company of First Hawaiian Bank as another potential suitor.

"I would not be surprised, but they would need to go through the process," O'Neill said.

Joe Morford, an analyst with Dain Rauscher Wessels in San Francisco, said the California bank could fetch $175 million or more, but was less sure of how much the South Pacific operations were worth because of the lack of U.S. players in that market.

"Certainly, Los Angeles is an attractive deposit market," Eisenstein said.

Pacific Century has hired Credit Suisse First Boston to help sell the businesses. Advisors will begin marketing Pacific Century Bank next week and the South Pacific banks in about two weeks. O'Neill said interest in the California bank has been high, but declined to disclose details.

What the company plans to do with the freed capital from the sale of assets is still not clear, O'Neill said.

O'Neill said the company will invest some in its businesses, expanding profitable operations; capital not used will be returned to shareholders through a stock buyback program awaiting regulatory approval.

If successful, many expect the bank will emerge an even stronger competitor in the Hawai'i market.

"I think what O'Neill is trying to do is bring focus to Bank of Hawaii," said David McClain, dean of the College of Business Administration at the University of Hawai'i. "Any good manager these days is into focusing, and certainly a less-complicated bank is going to be easier to sell."

But analysts who applauded the company's expansion into Asia and the South Pacific at the time — only to eventually be disappointed by sagging profits — now are more cautious about the company's newest shift in strategy.

"I understand why they got involved in that strategy, and at least on paper it made a lot of sense at the time," Winton said. "On balance, investors I talked to don't find this an incredibly attractive franchise at the end of the day because it will be a one-state bank."

Ultimately, the list of companies that could be interested in a purchase or merger with Pacific Century may be short, but analysts say it also is well-known.

"One of the names most talked about is Wells Fargo," Winton said.

Several veterans of the California bank, which merged with First Interstate nearly a decade ago, now work for Pacific Century, analysts said. That familiar relationship and Wells Fargo's desire to expand has stirred a lot of speculation.

While Winton said he is not sure what O'Neill's long-term plans for the company are, he said it may take another year or two before the bank's operations are completely refocused and made ready for a sale.

But the longer a potential suitor waits, the more it likely will have to pay.

Pacific Century's share price, as of Friday's close, already has risen 65 percent since O'Neill took over, and many analysts say itlikely will go higher before the year is out.

It should not come as a surprise the importance O'Neill has placed on the company's stock price. He owns thousands of shares himself, and believes that is the best report card he can get on how he is doing as CEO.

On Friday at the bank's annual shareholder meeting, O'Neill helped pass amendments to the company's stock plan requiring senior executives to buy more company stock themselves.

"What you see is what you get. I am an advocate of shareholder value," O'Neill said. "The only difference between this and BofA is the scale."

Frank Cho can be reached by phone at 525-8088, or by e-mail at fcho@honoluluadvertiser.com.