In Gap Between Trading and Deal Multiples, a Window for Deals?

One condition that could affect the pace of mergers and acquisitions is the distance between prevailing trading multiples and deal multiples: A large gap might reflect the broad availability of stock currency strong enough to accomplish market-clearing transactions without giving away the farm.

Since the beginning of 2002, the difference between quarterly averages of price-to-tangible-book ratios for the SNL U.S. Bank and Thrift Index and the same ratios in bank deals (also provided by SNL Financial) has ranged from about 45 percentage points to about 180 percentage points (see charts).

The gap in price-to-book multiples has been much narrower, perhaps reflecting a disproportionate fraction of buyout targets that do not carry goodwill. Price-to-earnings multiples have generally been higher in deals, perhaps reflecting poorer profitability at companies that agree to sell.

Across the three measures, recent data has given mixed signals. In the first two months of this year, the difference between price-to-tangible-book trading multiples and deal multiples widened from the fourth quarter but remained relatively small. The gap in price-to-book multiples also widened, but trading-price-to-earnings multiples lost ground to deal valuations.

Of course, trading ratios and deal ratios are conjoined: A strong acquisition price for one company implies that similar bids might be in play for others in equivalent positions, and creates a trading floor for them. Trading values driven by gains in potential sellers could act as a curb on deal activity as they seek even stronger prices.

Indeed, the standard deviation — or the average amount by which values vary from their mean — of price-to-book multiples for names in the Nasdaq OMX ABA Community Bank Index has been extraordinarily tight recently (see bottom chart). Greater differentiation among the strong and the weak could spur deals as investors empower high-performing companies to take over laggards.

Overall, however, dealmaking is idiosyncratic, and it is difficult to trace to anything but the most basic environmental factors — banking stocks have been recovering, and merger volume is climbing nearer to levels that prevailed before the crisis.

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