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Should I buy shares in Virgin Money Holdings, up 8% today on takeover offer?

UK-based challenger bank Virgin Money Holdings (UK) (LSE: VM) has looked like a good value stock for some time and today it’s clear that such attractions have been noticed by other firms in the sector. The share price is up around 8% today as I write on the news that London-listed would-be consolidator in the industry CYBG (LSE: CYBG) has pitched a preliminary and conditional offer to acquire the entire issued and to be issued share capital of Virgin Money.

Attractive-looking valuation

CYBG proposes that Virgin Money shareholders will receive 1.1297  CYBG shares for each Virgin Money share they hold if the deal goes through, which will leave them owning around 36.5% of the combined company. According to the rules of The City Code on Takeovers and Mergers, CYBG now has until 5 pm on 4 June to announce whether it will or will not make a firm offer for the business. In the meantime, Virgin Money’s directors are considering the proposal and have advised shareholders to take no action for the time being. Indeed, it could all come to nothing, or CYBG may have to put in a higher offer before Virgin’s directors are happy to recommend the proposals.

Even after today’s rise in the share price, it’s hard to make a case for Virgin Money being over-valued. At 338p, the forward price-to-earnings rating for 2019 sits at 9.7 and the forward dividend yield is around 2% with anticipated forward earnings likely to cover the payment a healthy-looking five times. The price-to-book ratio is close to 0.76. Ignoring cyclical uncertainties for a moment, Virgin Money’s valuation seems undemanding from several angles.

A good deal or assets plundered?

CYBG thinks the proposed deal will be good for Virgin Money shareholders, giving them an “attractive” premium at the beginning and the opportunity to participate in the continuing progress of the combined group.” CYBG’s directors talk about potential synergy benefits from combining the two firms but the real prize seems to be what they call the “strength and appeal” of the Virgin Money brand, which would “play a significant role in the combined group.”

Maybe from a business perspective, this is a good idea. CYBG reckons the enlarged company would create the UK’s “leading” challenger bank offering full-service banking to 6 million personal and business customers. An organisation that size could go on to gain yet more traction in the market, winning business from the old dinosaur institutions such as Lloyds, Barclays, Royal Bank of Scotland and HSBC in Britain.

From an investing perspective, I think the situation is tricky. In the longer term, an enlarged company could do well and an investment in Virgin Money could work out well too. However, there is no certainty that any deal will go through and if it fails, the shares could slip back down again from today’s elevated level. Another possibility is that a higher offer materialises, either from CYBG or from another company, which could drive the share price even higher in the short term. Overlaying it all is the cyclicality of the banking sector, which I see as a good reason for low valuations right now. On balance, I’m cautious and would not bet the farm on Virgin Money now.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.