Easy Merger Math for Prosperity and Privileged Peers

With the trading multiples on Prosperity Bancshares Inc.’s stock as rich as they are, engineering accretion in the company’s deal for American State Financial Corp. this week was a cakewalk.

The value of Prosperity’s shares puts the Houston company in an exclusive club, however. Few peers are empowered with currency so potent, and implicit green lights from investors to go out and do deals.

The chart here shows institutions with strong price to tangible book per-share multiples in the KBW bank index, a large capitalization group, and the Nasdaq OMX ABA community bank index, a group of about 100 actively traded names with a median $4 billion of assets.

Only about five or six trade at levels near or above the median 220% of tangible book that has prevailed in deals valued at more than $50 million over the past two and a half years, according to data compiled by KBW Inc.’s Keefe Bruyette & Woods Inc. (The figure reflects acquisition multiples after marking target loan portfolios to market.)

Tangible book value ratios can be a clearer gauge of investor sentiment with earnings still being knocked around in the wash of the financial crisis. Nonetheless, net income is, of course, the bottom line. If the earnings stream fused on to an acquirer divided by the shares issued to sellers in a merger is higher than the buyer’s earnings per share, the transaction is accretive to earnings per share. In stock-for-stock deals, if the buyer’s shares trade at a higher multiple to earnings than the pricing for the acquisition, there is earnings accretion: Each new share issued represents a claim on a greater share of earnings than at the buyer on its own.

Prosperity forecast that the American State acquisition would increase its earnings per share by 8% over what would otherwise have been the case.

Prosperity’s shares closed at 13.6 times the consensus analyst estimate for its earnings per share in 2012 the trading day before announcement, or level with the multiple represented by the purchase price and Prosperity’s projection for American State’s net income this year.

Prosperity’s accretion estimate also included the assumption that it will be able to eliminate 20% of American State’s expenses because of overlap between the two companies (meaning it would acquire a larger earnings stream), and it has actually agreed to pay for a third of the deal in cash, reducing the number of shares it would otherwise have to issue.

Meanwhile, the gap between the 313% price to tangible book multiple on Prosperity shares before announcement and the 206% multiple for the deal was large enough to leave plenty of room for accretion to tangible book value per share despite the cash payout.

High trading multiples can also imply that investors expect the companies to accept generous buyout offers, but a number of the companies in the chart are frequent acquirers and explicitly on the prowl. Banks with currencies like these are likely to be active on the takeover circuit.