The last time I covered the Metro Bank (LSE: MTRO) share price, I concluded the risk/reward ratio of investing in the stock wasn’t attractive enough, and investors might be better off searching elsewhere for profits.
Since then, its shares have surged off the back of speculation the UK’s largest mortgage lender, Lloyds Banking Group, is weighing up a bid for the challenger bank to take advantage of its depressed share price.
The Evening Standard was the first to report the merger speculation last Friday. Citing an unnamed source, the paper reported Lloyds would look to make an offer in the New Year as it attempts to take advantage of Metro’s recent problems.
With a market capitalisation of £405m (compared to Lloyds’ £41bn), it could certainly afford its smaller peer, and a deal would likely be encouraged by regulators. The additional capital backing of Lloyds’ balance sheet would remove all concerns about Metro’s financial position.
Metro’s board is also likely to welcome an offer. The lender recently had to offer investors an interest rate of 9.5% to take a £300m bond, which was required to help shore up its balance sheet. When a bank is having to pay nearly 10% to borrow money, but only earning 4.25% from its customers (the rate for a five-year fixed mortgage), it’s a big red flag.
By merging with Lloyds, Metro should be able to lower its costs of capital which should improve profitability.
Will a deal go ahead?
At the time of writing, there’s no certainty any offer will be made for Metro, but if one doesn’t merge, how much would the company be worth? Well, currently, shares in Metro trade at a price to book ratio of 0.2. So, if Lloyds offered book value, the stock could jump three-fold.
However, I think it’s unlikely Lloyds will want to pay full price. It will have to pump new capital into the business, and there’ll be extra costs associated with the merger as well. On this basis, I think the bank will want a substantial discount for the assets of its smaller peer.
There’s also been some speculation Metro’s founder Vernon Hill could come back to instigate a management buyout of the business, and this could upset Lloyds’ plans.
Time to buy
So, with two potential suitors eyeing up Metro, is it worth piling into the stock ahead of a bidding war? The answer to this question depends on your risk tolerance. The merger and buyout rumours are currently just that, rumours, and there’s no certainty any offer will be made, or deal agreed.
On this basis, I think it’s best to assume no offer will emerge and evaluate Metro on its own merits. If you feel the bank looks attractive as a stand-alone investment, it might be worth buying. If not, it might be better to stay away.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.