By Vitaliy Katsenelson, CFA
- Lloyds provides a clean exposure to the U.K. market. It’s a very well-managed company and provides quick entry into the European Union’s best economy.
- The Lloyds brand is valuable. As one of the highest-rated banks in the world, Lloyds TSB carries a very old and well-respected brand. Wells Fargo (NYSE: WFC) is the only other non-government-sponsored bank rated AAA by Moody’s.
- The acquirer will be able to leverage Lloyds’ AAA-rated balance sheet. I’ve seen this happen before when Lincoln National (NYSE: LNC) bought Jefferson-Pilot (NYSE: JP). Lincoln Financial’s debt rating was several notches below the very highly rated Jefferson Pilot’s. By bringing Jefferson Pilot’s debt rating to Lincoln Financial’s level, it was able to extract several hundred million from Jefferson Pilot’s equity, thus reducing the ultimate cost of the acquisition.
- Say goodbye to the high dividend. Lloyds has one of the highest dividend yields in its industry, 6.6%. The acquirer will be able to cut the dividend, bringing it to the industry’s level and freeing up additional cash.
- Lloyds is still a bargain, trading at about 12 times 2006 estimates. Banks usually trade at lower P/Es to the market, due to the limited growth opportunities in this mature industry. Thus, at current valuation, Lloyds does not appear to be a bargain-basement stock. However, after leveraging Lloyds’ balance sheet, the company may, in fact, be a bargain.
Despite its 80% dividend payout ratio, Lloyds is growing earnings by mid-to-high single digits. Since the company has plenty of room left for organic growth, it’s not building a war chest to make acquisitions.
Foolish bottom lineI have to confess, I don’t want Lloyds TSB to be acquired. Yes, I could make a couple more dollars in the short run, but I’m loath to part with Lloyds for several reasons. First, management showed that it is very shareholder-friendly by paying a superb dividend. Second, the company doesn’t have any plans to do something foolish, like buy a minority interest in a risky foreign bank that will turn into a liability in a few years. (Remember Argentina?) Lastly, Lloyds doesn’t have trading operations that help it meet quarterly earnings — until it loses billions of dollars on a good trade gone bad. You can pass this stock along to your grandkids, secure in the knowledge that it’ll still be around in 30 years.