With the opening up of the Financial Markets in the aftermath of the admission of China into WTO, there were increased cases in merger and acquisition in the Banking Sector either in Hong Kong and China which poised opportunities to the investors. The valuation methods used for Banks are based on market price against book value ratio (Price/Book) rather than using Price against Earning (P/E) ratio, why is it and what is the rationale behind it?
First of all, what is meant by book value. Book value is equal to total assets minus total liabilities. Since most of the assets and liabilities items on the balance sheet of a bank are monetary items which are highly liquid that can be converted easily into cash if to sell them in the Capital Markets. The market value of these items can be easily identified either by mark to market or mark to model. That is why the Price Book valuation is more appropriate for valuing a Bank than Corporations in other industries. Theoretically, a bank can sell all the assets and paid all the liabilities at market value. The balance of such is equal to the net worth of a bank. So, if there is an acquisition, the minimum price to pay must be at least equal to the net worth of the Bank, otherwise the acquired Bank would prefer to break up the balance sheet and sell them on a piecemeal basis that could ultimately give better value to the existing shareholders rather to sell it to the acquirer.
Hence, in order for an acquirer to succeed the deal, minimum price to pay must be at least equal to the net worth of the acquired bank. How much to pay above the net worth will depend on how much synergies that can be created from the combined Bank. Of course, there are other factors need to be considered such as competitive bids and the level of premium to tempt the shareholders to sell it to the acquirer.
If we take Wing Lung Bank as an example, the 2.9 price book ratio seems quite high but for the acquirer China Merchant Bank (CMB), it may be another story. The price paid by CMB might take into account of growth, synergies and other strategies that the outsiders might not be easily quantified. On the the hand, for the late privatization of CITIC International Financial Holdings (CIFH) , you might be surprised why the price book is 1.6 only if to compare 2.9 above. It does not mean the price is wrong instead it tells us another story. Since the control has been in the hands of Citic Group before the privatization, there is no need for Citic to pay too much premiums for the balance of the purchase. Whether 1.6 is fair will depend on the whole structure of deal such as exchange of shares etc.
As there are many different types of business combinations, it is natural the price book ratio for each deal transaction could be quite different from one another.
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