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In a significant turn of events, recently Hilltop Holdings Inc. (HTH - Analyst Report) announced its plan to purchase US-based financial services company PlainsCapital Corp. for about $536.9 million.

While the deal awaits the approval from the board of both the companies, the transaction is expected to culminate by the end of this year. Accordingly, total cash of $318 million along with 27.5 million Hilltop shares will be disbursed to PlainsCapital upon successful completion of the buyout.

Additionally, each share of PlainsCapital will be valued at a cash of $9 and 0.776 shares of Hilltop. Based on Hilltop's closing price on May 8 of $7.96, the total value stands at $15.18 per PlainsCapital share, thereby summing up to $536.9 million.

Headquartered in Dallas, US, PlainsCapital operates through its subsidiaries –PlainsCapital Bank, PrimeLending, and FirstSouthwest, all of which will be acquired by Hilltop as per the purchase agreement. Consequently, PlainsCapital will become one of the subsidiaries of Hilltop.

Further, Hilltop took the financial advice from Stephen Inc. and legal advice from Wachtell, Lipton, Rosen & Katz. On the other hand, PlainsCapital appointed JPMorgan Securities LLC of JP Morgan Chase & Co. (JPM - Analyst Report) as its financial advisor and Sullivan & Cromwell acted as its legal advisor.

Our Take

We believe that the acquisition complements Hilltop’s inorganic growth strategy very well. Armed with total cash and investments of about $799 million as of March 31, 2012, Hilltop’s balance sheet also remains sufficiently liquid and risk-free to accommodate the purchase.

Moreover, the company had about $528 million in available cash and cash equivalents, at the end of the first quarter of 2012, particularly to fund opportunistic and effective mergers and acquisitions.The statutory surplus and risk-based capital of Hilltop and its subsidiaries exceed the minimum regulatory requirements.

Based on the closing price on May 8, Hilltop had a market capitalization of about $454 million. These aspects further validate Hilltop’s expansion strengths.

Additionally, the proposed acquisition of PlainsCapital underscores Hilltop’s plan to gain from the economies of scale. While Hilltop itself has been taking up effective distribution initiatives across Texas, Oklahoma, Georgia, Tennessee and Arizona, the addition of PlainsCapital will further fortify its market position in these areas.

The Texas-based PlainsCapital operates in 40 locations with over 3,400 employees. Hence, the acquisition should help Hilltop enhance its market share, while also supporting its long-term growth strategy.

Earnings Review

Last week, Hilltop reported its first-quarter 2012 net income of $0.3 million or 1 cent per share against $1.4 million or 2 cents per share in the year-ago period. Earnings also lagged the Zacks Consensus Estimate of 4 cents per share.

Results reflected higher premiums and investment income along with improved net realized gains that drove the top line. However, this growth was substantially offset by higher-than-expected expenses, which in turn hampered the combined ratio and resulted in operating cash outflow and underwriting loss in the reported quarter.

Going ahead, we believe Hilltop’s ongoing business generation initiatives and sustaining a fair capital position should aid the company to benefit from the opportunities that the markets provide on stabilization. However, management requires proactive steps to manage its expense growth as well, in order to maintain its operating and competitive leverage. Hilltops carries a Zacks Rank #3, translating into short term strong Hold rating.

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