United Overseas Bank Ltd’s Latest Acquisition May Be Both a Bargain and a Great Investing Lesson

United Overseas Bank Ltd (SGX: U11) announced earlier this week that it is planning to buy up the rest of Far Eastern Bank Limited that it does not already yet own.

As of the time of the offer-announcement on 24 March 2015, UOB owns 78.88% of Far Eastern Bank, a stake it had acquired all the way back in 1984.

Buying at a premium at face value

From the official announcement, UOB will be offering a total of S$74.15 million in cash for the remaining 21.12% of Far Eastern Bank. That purchase price values Far Eastern Bank at an 80% premium over its last reported net asset value.

At first glance, UOB seems to be overpaying, especially when considering that the bank is trading at only 1.27 times its own book value at its current share price of S$22.93.

But if we dig deeper, UOB’s latest acquisition actually reveals an important investing lesson regarding the value of legacy assets.

When a premium becomes a bargain

Legacy assets are by definition assets that have been around for a very long time. As nearly all assets would have to undergo accounting depreciation, it’s often the case where legacy assets would see nearly all of their accounting value be chipped away after many years.

However in reality, some legacy assets which have undergone significant accounting-depreciation are far from worthless. On the contrary, assets like free-hold land and buildings generally increase in value over time.

The acts of 1) depreciating a legacy real estate asset, and 2) economic reality’s invisible hand pulling the value of said asset up with the passage of time, can create a significant mismatch between the accounting value of a company’s assets and what economic reality actually dictates.

This is exactly what is happening in UOB’s latest deal.

Far Eastern Bank actually owns the Far Eastern Bank Building, a property whose accounting value on Far Eastern Bank’s balance sheet at end-2014 was only S$3.72 million. In reality though, Far Eastern Bank Building had been pegged to be worth some S$167 million in a valuation exercise done on 13 January 2015.

On that basis, UOB’s seemingly expensive purchase price of 1.8 times Far Eastern Bank’s accounting book value may just end up being a bargain instead.

Foolish Summary

This deal may not have any significant positive impacts for UOB given that the bank has total assets of some S$307 billion at end-2014, a figure which dwarfs the sums associated with the Far Eastern Bank acquisition.

But, it does highlight an important thing for investors to note when looking at legacy assets: At times, the accounting value of assets on a company’s balance sheet can be very different from their true economic worth.

As Warren Buffett once said, “Managers and investors alike must understand that accounting numbers is the beginning, not the end, of business valuation.”

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any companies mentioned above.