The bargain-basement price tags attached to the franchises of many major banks could soon trigger an outbreak of mergers and acquisitions, according to Michael L. Mayo of Lehman Brothers.
"Virtually any bank, except for the very largest, is vulnerable to being taken over if its stock is selling at a big discount to its authentic franchise value," Mr. Mayo said last week in an interview.
He rates Mellon Bank Corp. of Pittsburgh, First Chicago Corp., and First Commerce Corp. of New Orleans as leading merger targets among major banks because of their deeply depressed values on this basis.
Mr. Mayo devised the alternative system because he felt traditional ways to measure banks' worth are both inadequate and misleading, and likely to become more so as banks move into other business lines.
"Twenty years ago banks were very much alike, almost from a cookie cutter," he said. "Today, banks are in mutual funds, data processing, mortgages, and credit cards to varying degrees.
"They are getting more involved in consumer finance and will be moving into areas like annuities," he said. "A lot of these businesses require different valuation techniques."
Using his own method, Mr. Mayo found that actual franchise values exceed stated book values by an average of 70% among the 57 banking companies tracked by his firm.
The analyst adjusts banks' equity for unrecognized items in 13 categories, such as overfunded pensions and unrealized derivatives losses. The sum of these adjustments is a bank's "hidden book value" and is added to reported book value to reveal true franchise value.
Lehman used his model last fall to help select 20 banks for a basket of likely acquisition targets and to create its own "bank takeover index" for use in selling investment products. The basket's value is up 7% so far this year.
In the analyst's recent calculations, Mellon's franchise was the most ignored by the stock market. At yearend, its adjusted value of $8.3 billion was an extraordinary 80% higher than its $4.6 billion of market capitalization.
Among other things, adjustments for Mellon's $200 billion of money management assets, including $70 billion from its acquisition of Dreyfus Corp., is reflected in its franchise value but not elsewhere, Mr. Mayo said.
"Mellon is the second-largest money manager in the country, behind Fidelity (Investments)," Mr. Mayo noted, "yet that is not reflected in their book value."
A buyer willing to pay $6 billion for Mellon would be a offering a premium to book value while effectively getting a bargain, the analyst noted. But he acknowledged that only the nation's five biggest banking companies could entertain a deal that large.
Meanwhile, a bank in Lehman's takeover index was part of a deal this week.
Michigan National Corp. will be acquired by National Australia Banks Ltd. for $1.56 billion, or $110 a share. Mr. Mayo estimated Michigan National's true franchise value at $83.03 a share.
Other banks in the takeover basket include CoreStates Financial Corp., whose franchise value is boosted by a large adjustment of $4.52 a share for cash management and data-processing activities. First Chicago gets a big $14.52 a share upward adjustment as credit for its well-regarded credit card operations.
Mr. Mayo thinks the franchise value model can be useful for predicting consolidation activity, because "it's a proxy for the break-up value of banking companies."
Recent dealmaking shows that banks with stock trading under 75% of true franchise value are the most tempting targets for acquirers. "Looking back at 10 banks recently acquired, the average price-to-franchise value ratio was 71%," Mr. Mayo said.
The buyout prices themselves averaged 11% higher than franchise value. Mr. Mayo said that is because franchise value cannot account for the value of synergies in a deal as two banks fit themselves together.
