How much is Tesla worth?

This is a question which investors and analysts alike have been wrestling with for several years.  Some think Tesla will collapse, others that it is at the build-up stage of a brilliant future.  Its founder just twitted that $420 per share was a price he would “pay” to take it private.  So we’ll take a shot at the question.

At the current stock price of $320, Tesla is worth over $54 billion.  Its enterprise value (market cap. + debt – cash) is around $60 billion, depending on the accounting treatment of certain operating leases.  By comparison, General Motors has a market value of under $51 billion.

Is Tesla really more valuable than GM?  There is no question that Tesla, under the guidance of its CEO and founder Elon Musk, has become synonymous with advanced, stylish and expensive electric cars. Half a century ago, an environmentally driven buyer, wanting to make a small dent into our national thirst for oil, would have bought a small and thrifty Honda Civic.  Today, his wealthier counterpart will buy a Tesla S, park it next to a Mercedes S class, and feel that his car looks and performs better and is more socially responsible.

That Tesla has gained unique brand status, recognized globally, is undisputable.  What’s more, this was achieved by developing new technologies which are often years ahead of competitors like BMW and Chevrolet according to a recent report by UBS.  There is both style and substance behind Tesla’s success.

The problem is that Tesla has not been able to make such technology cheap enough to make a $35,000 car (Tesla 3) profitable; and according to the same UBS analysts, progress towards bringing unit costs further down has been very slow.  Another observer noted that the battery components were expensive, limiting further cost savings, while production volume was much too low to reduce powertrain production costs.

So, what if Tesla were to limit itself to the production of luxury electric cars like its S and X models, selling anywhere between $70,000 and $130,000 a piece?

There is one comparable car company with unique brand name, Ferrari.  Ferrari sells 10,000 cars a year at an average price (to it) of $300,000+.  Its current market value is over $24 billion (and enterprise value around $25 billion).  Today, Tesla sells around 90,000 models S and X per year.  A spectacular Roadster is in the works which will retail at a starting price of $200,000. 

I would think that the luxury car business of Tesla could be worth as much as Ferrari, $24 billion, because both share three unique characteristics: exclusivity, style and performance.

That’s great except that it leaves a $30 billion gap in valuation.  Can this gap be filled?

One logical place where to look would be businesses whose technology is complementary or close to that of the cars.  Actually, Tesla has such businesses: its energy storage and solar energy. 

The solar generation offers integrated generation and storage systems for both residential and commercial customers.  The energy of the sun is captured via low profile panels or roof tiles which look like regular ones.  Batteries are used to store the energy and release it later.  To commercial buyers, Tesla offers batteries to manage loads or turnkey solar panels and batteries to meet communities’ energy needs.

Those businesses generated revenues of $370 million in 2Q18 with a modest gross margin of 11.8%.  How much can they be worth?  The Solar City company which developed most of this technology and which was founded by Musk, was bought by Tesla for $2.6 billion in 2016.  First Solar (FSLR:NASDAQ) sells at 2.5 times revenues.  The energy businesses of Tesla are growing at close to 30% p.a.  Based on that and the Solar City and First Solar valuations, they could be worth $3.5[1]-$4.5 billion.

If Tesla focuses on luxury cars (which is not the case at present) and its energy business grows healthily, Tesla could be worth $28 billion or $164/share.

That still leaves us a gap of some $26 billion.  How can it be filled?  Will Elon Musk suddenly find a way to massively expand his energy business or discover yet another need that Tesla technology can fill?  Call it the Musk factor.  He could add another $4-$5 billion, particularly if the country gets back on the clean energy path.  That would get us in the region of $190/share.

In sum, Tesla seems to be overvalued at current levels by a significant margin.  Then again, nobody expected an individual to start a car company from nothing and build it into the epitome of great electric cars.  It will be a dizzying but fascinating ride.

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[1]  Looking at the trailing last quarters.

Switching to wind and solar, a closer look at policies and costs

Global warming has been a major topic of discussion in recent decades, and it has entered the political debate in a big way, both at the national and international levels.  The 2017 decision by the US to withdraw from the Paris Agreement on Climate Change[1] was perhaps the most visible development.

But France has experienced vigorous debates on climate change: in 2011, candidate Hollande promised that, if elected, his government would reduce the share of nuclear in electricity generation from 75% to 50%, and his successor, Emmanuel Macron, is wrestling with the same goal.  It is worth noting that, given its massive nuclear footprint, France already has perhaps the cleanest electricity generation sector, both in terms of CO2 and other emissions.

As part of the public debate on French energy strategy, the ACSPV, a non-profit organization for the promotion of scientific culture, uniting communes from the Alpine region and members from the prestigious CNRS[2] made a very interesting presentation which I summarize below.

It recalls that France started to articulate a program for CO2 emission control in 2003, mainly by providing energy price subsidies in favor of renewables[3] and securing a share of electricity demand for them.  From 2003 to 2017, these subsidies totaled €28 billion, €5.2 billion for 2017 alone (+10% over 2016).  Given that these agreements have a 15 to 20 year maturity, such a policy is very costly.  Presently, wind and solar, in the aggregate, cost €143 more per MWh than the average.

ACPSV contrasts the French cost of switching to renewables with the cost of CO2 emission.  The latter is as low as €11/ton in the European market and as high as €100/ton in Sweden which set a CO2 tax in that amount.  Yet according to the RTE (government operated electricity grid) the cost of decreasing CO2 emission in France in recent years has been €250/ton!  Furthermore, as fossil-fueled power plants disappear, the CO2 gain from switching to wind and solar diminishes, disappearing totally in 5 year time at the current pace.

ACPSV further criticizes the inefficiency of the “switch to renewable” policy by pointing that, with the same €28 billion spent on subsidies over the 2003-2017 period, France could have subsidized the purchase of  4.5 million electric cars (€6,000 per car) reducing CO2 emission at a lower cost of  €190/ton[4].  Or the money could have gone to upgrade the thermal insulation of 3 million homes; this could have saved 1 MWh from fossil energy origin per home, lowering CO2 emissions by 7.5 million tons/year at a cost of only $100/t[5].

While such alternative policies would be more beneficial than mere subsidies and forced renewable energy purchases, the long term nature of contracts makes it very difficult to change tack: current commitments in favor of wind farms extend until 2036 and total €100 billion.

The criticism of current policies by ACSPV extends to the industrial and economic spheres:  The government effort didn’t result in the creation of viable French manufacturers of wind turbines or photovoltaic panels as these are imported[6]. 

As for the sharing of the subsidies which are financed by a tax on all electricity consumers[7], ACSPV notes that it is socially and economically unfair: only the better offs can afford the initial investment needed for solar panels (and they are later reimbursed via the CSPE, but that CSPE is paid by all customers); with regard to wind, ACSPV regrets that the sector is dominated by the industry union (SER) which carries a lot of weight and influence, yet spends very little on research and development, happy instead to live off guaranteed revenues.

In conclusion, ACSPV recommends to acknowledge the failure of current policies and to abandon subsidies and their unintended adverse consequences.  Instead, it recommends redirecting efforts towards the transportation sector and better home thermal insulation.

France is a special case, in that it already has a very clean electric energy sector, yet the French Green movement has been determined to push for a massive shift towards renewables which, in my opinion and that of ACSPV, makes little sense.  Unfortunately, their votes were needed in the previous socialist government and their advocacy for clean energy as appealing as it sounds, is ineffective and potentially ruinous[8].

Clearly the situation in the US is different, but the basic policy issues are similar.  Unfortunately, the public debate is reduced to a simplistic litmus test:”Do you believe in global warming?  If you do, then money is no object as far as remedies are concerned and wind and solar are the only way out.”

Hopefully, this French debate may spread beyond its national borders.

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[1]  Such withdrawal would take effect in 2020.

[2]  Center for National Scientific Research.

[3]  In this article, renewable will refer to wind and solar.

[4]  Assuming non-electric engine emissions of 150 g/km of CO2 and total car life of 200,000 km (124,000 miles).

[5]  Assuming a 20 year depreciation period.

[6]  Leading French manufacturers having either being rescued by EDF, the dominant electric utility, or a financial buyer.

[7]  CSPE.

[8]  Shifting from 75% to 50% nuclear and having  renewables making up the difference means quadrupling the contribution of renewable, doubling the average French utility bill.  The CSPE would rise to €15 to €20 billion per year, and long term commitments would rise to €400 billion, all that for ever diminishing gains as fossil fuelled power plants would soon no longer exist.

When history may rhyme…in Brazil

If you are in your sixties like me, and particularly if you were born in France, you remember 1968.

How did it start?  Sociologists and politologists have come up with involved theories to explain the so-called “Events of May ‘68”.   Call me a skeptic.  Yes, there had been months of student protests in Nanterre, then the most politically “progressive” campus in Paris, but frankly, that was no news.  The temperature rose when the authorities decided to put an end to the disorders, and student unions called for demonstrations on other campuses and in lyçées (high schools).  But that was hardly earth shattering or critical for what turned out to be the most impactful event in France’s last half century.

From my own perspective, a key factor was that May was the month that preceded life-defining tests for millions of French youths: the dreaded baccalaureat which is the necessary key to enter university, the concours (competitive exams) to enter the top universities (so called grandes écoles), and the year-end university exams.  We were all stressed and apprehensive, and for many, the possibility of postponing these scary trials, even temporarily, AND having fun in doing so, was appealing.

Sure, student protest had gained international visibility, mostly in the US against the Vietnam War, but many American trends and influences came to France without threatening the stability of the country.  

It is also true that the French may have been tired of the quasi-regal leadership of President de Gaulle and at first may not have minded students poking him in the eye so to speak.  The initial government reaction lacked coordination, and the authorities quickly second-guessed themselves, thus increasing confusion.  None of that is very unusual or likely to trigger what turned out to be a quasi coup.

But when the French government started to look and act weak and disheartened, and its leader failed to appear (he even disappeared for a while), then several dissatisfied groups and political opportunists felt emboldened to act: unions called for national strikes and some of them for industrial sabotage[1], opposition parties called for large demonstrations and even tried to force a change in government at the famous Charlety mass meeting.

As we know, all the disorder came to an abrupt end when President de Gaulle reappeared and forcefully declared on TV that he wouldn’t leave power.  Overnight, political and social calm were restored.  But as we also know, de Gaulle resigned the following year and the fallouts of May 68 endure to this day.

In retrospect, I still believe that the huge upheaval of May 1968 didn’t have to happen.  It all started with students defying authority and trying to postpone dreaded exams, and enjoying what at first was frat house partying and horseplay.

History doesn’t always unfold according to vast socio-economic Marxist trends.  More often than not, it does, but now and then major tremors and changes can be traced to the acts of an individual or to an improbable chain reaction.

Which brings us to Brazil.  What is happening in Brazil today is not a repetition of May 68, but as Mark Twain once said, history rhymes. 

The unexpected uncovering of the so-called Lava Jato corruption scandal and its consequences have dealt very severe body blows to Brazilian democracy and I would say it is weaker than it has ever been in the last half-century.  To wit:

-         One president was impeached and forced to resign[2], her successor is currently in jail and the current president is under a corruption cloud and commands a record low 6% approval score;

-         Dozens of congressmen have been indicted and jailed, including both leaders and rank and file, governing coalition and opposition members;

-         While the judiciary branch, in the end, did allow justice to be done, the heavy lifting (investigative work and sentencing) was carried out by the Federal Police and state-level judges, and the highest federal judicial instances vacillated more than once.

The public is rejecting main stream political parties and their leaders, it rejects the president, it is divided about the judiciary system as many either distrust it or positively reject its condemnation of ex-president Lula.

In the middle of this rising chaos and polarization, some actors are starting to test the system.

One is the PT, the party of ex-President Lula.  It is interesting to remember that Lula has often believed that a chaotic situation would help the PT take power.  As Lula still leads all opinion polls by a wide margin, Gleisi Hoffmann, the president of the PT, this week warned that keeping Lula in jail would lead Brazil to chaos.  The PT is also launching a Lula presidential campaign despite him being ineligible.

In doing so, she sets on a direct collision course with General Villas Boas, the Chief-of-Staff of the Brazilian Armed Forces, who twice publicly warned[3] the Supreme Court that the law must be respected and nobody is above the law.  The general’s Twit received the support of several high ranking generals, some in active duty others retired.

Truck drivers have been the second, unexpected, and much more immediately damaging force.  As Petrobras had won the right to set prices daily in accordance with world markets, truck driver unions organized massive road blockages last May to protest diesel price hikes[4].  The government quickly capitulated, forcing a price freeze by Petrobras, then offering gas price cuts to be financed by the government, then backtracked again, then offering truck drivers a pricing table for the freight that they carry.

In the span of a few weeks, the PT and the truck drivers have exposed the extreme weakness of the government, the former by brazenly demanding immunity for its leader, the latter by strong-arming it and hurting the economy.  In the meantime, criminality has surged in Rio de Janeiro and elsewhere, and no high caliber presidential candidate has risen from the field to offer people hope that the turmoil will soon be over.

There might be a respite in the above struggles, but I doubt they will end well.  The pricing table proposed by the government to the truck drivers and the compensation offered to Petrobras (but not to other fuel importers) have little chance to work in a country as vast and an economy as segmented as Brazil.  To make things worse, the drivers threw the first punches and clearly hit their mark.

As to the PT, it has the most popular leader (Lula) and the most effective organization of any Brazilian party.  As I wrote above, I think it is convinced that it will fare better than anyone else should chaos develop; it also sees that the current government can be pushed around with impunity.

Brazilians have a culture of moderation, but events can unwind faster than expected, or take an unexpected direction.  In the current climate, the system offers little in terms of guardrails, so that an unlikely possibility can quickly become reality, a moderate skid can develop into an uncontrollable crash.

History doesn’t repeat itself, but it does rhyme.

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[1]  Interestingly, the communist-affiliated CGT union was proactive in safeguarding equipment and machinery that other unions wanted to damage.

[2]  President Dilma Rousseff was impeached for public accounting faults but she was also widely criticized for the endemic corruption at Petrobras while she presided over its board of directors and afterwards while she headed the government.

[3]  The first warning came on the eve of the Supreme Court’s decision as to whether to incarcerate or not President Lula.

[4]  It is ironic that taxes represent a higher percentage of gas prices than Petrobras’ profit margin.  As such, they were the main factor in pushing gas prices to high levels.

Latin American update

This is an update to the May 4^th post.  I see no reason to change the reservations which I expressed then about the future of the region.

Venezuela

In Venezuela, President Maduro was reelected with no opposition to speak of.  Key political opponents remained in jail or under house arrest.  That this farce received little effective pushback from Latin American leaders is doubly worrying: 1) it shows continuing ambivalence as to how to react to attacks on democracy, and 2) it provides evidence that current leaders are busy with serious troubles right at home.

Venezuela is disintegrating.  Whether accelerating the process would permit an earlier recovery is the question.  At this stage, only the US could trigger such a collapse by barring imports of heavy Venezuelan crude.  But then neighbors like Colombia and Brazil would be hit with the brunt of the fallouts.  It looks like all the parties feel that it is too late to intervene and “own” this crisis and that Venezuela should be left adrift.  Meanwhile, the people suffer.

Colombia

The first round of the Colombian presidential elections took place last weekend.  The results were generally as expected in the latest polls and confirmed the population’s disapproval of the outgoing government. 

Abstentions were an historically low 46%[1].  Center right candidate Ivan Duque led with 39.1%, followed by the populist progressive, Gustavo Petro, with 25.1%, and the left of center former mayor of Medellin, Sergio Fajardo, with 23.7%.  Tellingly, Humberto de la Calle, the outgoing government chief negotiator in the peace process with the FARCs came in fifth with only 2%.

The second round will take place next month and the outcome is not as predictable as one might think.  What is clear is that the two remaining candidates are running on very different platforms and that the middle has been hollowed out; there is not much that Petro and Duque have in common except their passports.

To begin with, while voters rejected the policies of the outgoing government, corruption was the leading complaint, not the peace accord with the FARCs.  Indeed, concerns about quality of life – crime – and economic prospects ranked high.  As in other countries, these concerns often lead voters towards “new faces” rather than established political figures.

Finally, many in the Fajardo coalition are closer to the aspirations and concerns of Gustavo Petro albeit not so much to the candidate himself.  This is the case of Antonio Navarro Wolf, now a senator, and a former #2 of the M-19 to which group Petro also belonged[2]; he has a clean image and is respected.  Antanas Mockus, former dean of the Universidad Nacional, was the most colorful and, in the view of many[3], the best mayor of Bogota in recent memory; he is associated with clean and inclusive government, but he also makes no secret of his support for the peace accord with the FARCs, unlike Ivan Duque.

Will Fajardo, Navarro Wolf and Mockus endorse a candidate?  Will their followers abide by the recommendations or will they simply abstain: rejecting both a right wing candidate and someone who was an ineffective mayor of Bogota and who is viewed as too close to the Bolivarian movement in Venezuela?

As I have written in previous posts, Latin America cries for politicians in the mold of Ricardo Lagos: left of center individuals who are determined to raise the standards of living of the poor, who will do so within the framework of an open economy and who are capable of keeping social cohesion.

Brazil

In Brazil, the situation has not improved although time remains to turn things around.

Pre-candidate Joaquim Barbosa, a former Chief Justice of the Federal Supreme Court, decided not to run.  I think it is a loss for Brazil.  Despite being in jail, former president Lula remains the most popular figure as per these May polls:

       First round voting intentions:

	With Lula	Without Lula*
Lula	32.4%	n/a
Bolsonaro	16.7%	18.3%
Marina Silva	7.6%	11.2%
Ciro Gomes	5.4%	9.0%
Geraldo Alckmin	4.0%	5.3%
Fernando Haddad	n/a	2.3%
Mereilles	0.3%	0.5%
Others	6.9%	7.7%
Invalid/Undecided	26.7%	45.7%

                                                 Source: CNT/MDA

                                             (*) In this scenario, the PT would nominated Fernando Haddad to replace Lula.

In his absence, the field is wide open as close to half of voters haven’t decided or keep voting Lula even though he wouldn’t be on the ballots.  What is clear is that voters are in their majority leaning left but haven’t found a winner there.  Absent Lula, Bolsonaro, a populist from the right, could do well and make it to the second and deciding round.  What is concerning is that voters’ view of politicians is very negative, main streamers and outliers alike (except for J. Barbosa at 12%).

As in Colombia, voters are most concerned about their economic prospects and well-being.  More so than the Colombians, Brazilians expect a lot from their government, often in ways that are incompatible with their ultimate goals:  the country is simply not rich enough to make the massive wealth transfers which they aspire to.  Massive government intervention in the economy has led to massive corruption, inefficiencies and slow growth perpetuating a vicious circle.

Brazil is a huge country and national elections consume vast sums of money (which is partly the reason why Lula’s party tried to divert millions from Petrobras ‘coffers to its own).  Money and organization, in the end, will talk although surprises are possible.  An interesting talk it will be pitting the best organized political party, the PT, without its star candidate (Lula), an Internet-savvy populist from the right (Bolsonaro) and the centrist from the wealthiest state in the country (Alckmin), among others.  Deprived of Lula, the PT is already flexing its muscles through the actions of unions affiliated to it, Petrobras being a prime example.

Historically and culturally, Brazil has not been a country of extremes, and there is no reason to believe this has changed.  But it is going through rough seas without a trusted pilot.

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[1]  Although high by regional standards.

[2]  Reportedly, Navarro broke with Petro when the latter was mayor of Bogota citing his autocratic style.

[3]  Including me.

Barclays Bank, the City shuffle

Barclays Bank’s history goes back three centuries and includes many acquisitions, the latest significant one being the investment banking and trading units of Lehman Brothers in 2008[1].  The 2007-2008 Great Recession left the bank weakened, and while Barclays avoided a government bail-out, it had to conclude several rounds of capital raising which brought it some controversy.

In 2015, it hired a new CEO from JP Morgan, Jes Staley.  Mr. Staley, the former CEO of JP Morgan’s investment bank, set forth a strategy based on a presence in two key markets, the UK and the US and three business activities: retail banking and credit, corporate banking, and investment banking.  In support of this focus, Barclays divested from its African banking operations in 2017 ending its presence on this continent[2].

While its US counterparts have fully recovered from the Great Depression, in large part thanks to massive fresh capital injections, Barclays has languished, tempting hedge funds and activists to build equity stakes.  In 2018, a fund managed by Mr. Bramson disclosed a 5.2% equity position.

Mr. Bramson is less flamboyant that his American peers.  Nevertheless, it is understood that he wants Barclays to phase out its equity, currency and bond trading while keeping its M&A advisory and capital market activities as these are supporting the bank’s corporate banking business.

If true, this recommendation would make sense: trading is risky and uses a lot of capital. It could be painful for more than management’s ego, as in a good year trading can produce good profits.

So it is not surprising that Barclays would explore defensive strategies.  It is however shocking that it would consider merging with the likes of Deutsche Bank or Standard Chartered Bank.  While Barclays denied it had considered a merger, as reported by the Financial Times, there was no denial that Barclays’ chairman had met with director(s) of Standard Chartered.

Full year 2017 results show how passably Barclays performed:

On a GAAP basis, Barclays produced a £1.9 billion net loss vs. a net profit of £1.6 billion in 2016,

It reported an adjusted return on tangible equity[3] of 5.6%[4], which translated into an adjusted return on actual equity of <4.9%,

Cost to income ratio was a high 73%, with Barclays International’s at 89% for 4Q17 vs. a still high 78% ratio for 4Q16 (US Corporate & Investment Banking and US credit cards),

Corporate & Investment Banking used £176.2 billion of risk weighted assets (RWAs) out of a group total of £313 billion, or >58% [Barclays doesn’t break out Corporate and Investment Banking].

By comparison, JP Morgan numbers were as follows:

On a GAAP basis, JPM showed a $25.5 billion net income for 2017 vs. $23.2 billion in 2016,

It reported an adjusted return on tangible equity of 12%, which translated into an adjusted return on actual equity of 10%,

Cost to income ratio was 57%, with Corporate & Investment Banking at 60% in 4Q17,

Corporate and Investment Banking used $826 billion in assets, or 33% of group total and 30% of group common equity.

Clearly, JP Morgan is far more profitable than Barclays, yet follows a much less risky strategy as evidenced by its lower allocation of resources to Investment Banking.  Even then, C&IB at JP Morgan is much more profitable whatever benchmark is used[5].

One intriguing difference between the two banks is the ratio of RWAs to total assets; at Barclays it was 28% at 12/31/2017 vs. 60% at JP Morgan.  While accounting rules are different, Basel III rules apply to both banks, and any resulting difference in risk assessment shouldn’t be in a ratio of 2:1, particularly given the superior risk management displayed by JPM.

In sum, Barclays is faced with major profitability challenges.  For several years, its investment banking unit has struggled, it is clearly undersized yet management seems loath to downsize and refocus it.

Merging with Standard Chartered would compound Barclays problems.  It would also make a mockery of the recent spinoff of Barclays Africa.

Back in July of 2014, when STAN traded at 1,218p/share, I wrote that it should trade in the 878p-912p.  Almost four years later, after a new and well regarded CEO took charge, the stock trades at 754p.

Besides the cultural problems which led the previous management to break US laws and earn the bank heavy fines, STAN faces strategic challenges.  The biggest one is that it operates in 70 markets and derives some 90% of its income from emerging economies in Asia, Africa and the Middle East.

Yes, it operates in regions that will likely enjoy the fastest growth over time, but these will also experience the greatest volatility.  By and large, emerging markets are also characterized by weaker institutional frameworks and less stable political systems.

Crucially, STAN operates as a global bank without having the size to do so successfully.  In its key markets, it faces competitors which are both stronger and more focused.  The result is mediocre profitability.

At the close of 2017, STAN had total assets of $664 billion compared to $1.5 trillion for Barclays.  It earned $1.3 billion after tax (vs. a loss of $191 million in 2016) for a return on average equity of 2.5%.  In 2017, its cost to income ratio was a high 71%.

By comparison, HSBC, the leading British global bank, earned $11.9 billion in 2017 on total assets of $2.5 trillion.  HSBC’s performance was better but still mediocre, with a return on equity of 5.9% and the bank is in the midst of a strategic and operational review.

Combining with STAN would compound and extend Barclays’ problems: a lack of size and a lack of focus, not to mention the challenge of fusing very different corporate cultures.  Barclays should know about the cultural risk as it has had to deal with the Lehman Brothers integration.

One of the most difficult decisions for major corporations to make when facing strategic choices is to accept down-sizing at least temporarily.  Barclays has a great name and tradition as well as expertise in its home market.  Like Deutsche Bank[6], another grandee facing tough choices, it can’t compete globally for investment banking business or sustain a global trading activity.

The hard truth is that, as a result of tough new regulations, banks need to hold more capital than before the 2007-2008 crisis, and even more so to engage in trading.  Lacking size and excess capital, Barclays should listen to Mr. Bramson and refocus its efforts.  PNC and Wells Fargo are successful examples of banks focused on servicing their retail and corporate clients without engaging in global trading.  In Europe, so is BNP.  Deutsche Bank itself has announced large cuts in headcount and a reduction in international investment banking and trading.

The following efficiency and valuation benchmarks offer a simple reality check:

Banks	Total Assets at 12/31/2017	Cost to Income Ratio in 2017	Current Price to Tangible NAV
Barclays	$1.1 trillion	73%	0.8
Standard Chartered	$664 billion	71%	0.8
HSBC	$2.5 trillion	61%	1.4
JM Morgan	$2.5 trillion	57%	2.1
Deutsche Bank	$1.8 trillion	90%	0.4

I think that, in the end, Barclays will be persuaded that Bramson’s recommendations are good for shareholders to whom management is, ultimately, accountable.  I also think that it will be a volatile ride as there will be cultural pushback by Lehman Brothers and JP Morgan alums, and changes at the board and executive levels are likely.

Where could the stock price settle, should Barclays reform itself successfully?  A well run bank should be valued at 1.5 times, or more, its common equity.  Right now, Barclays shares trade at a multiple of 0.67.  The potential is clear and the math is simple.

What is the downside?  At the current share price and with the announced dividend hike raising the yield to 3% p.a., it appears limited barring a major adverse macro-event.  Maybe 10%?

What if Mr. Bramson fails partially or totally?  He may hit a wall, or his campaign may be protracted and end up in failure.  The truth is that major shareholders are unhappy with the stock price; I can’t see management or the board chairman surviving unless the stock price converges towards book value.  That is a 25% to 49% improvement (whether tangible or nominal book value is used).

In the end, I can summarize my views about the possible stock outcomes of the Bramson campaign as follows:

Stock price appreciation	Probability	Expected appreciation
-10%	25%	(2.5%)
+20%	25%	+ 5.0%
+50%	25%	+12.5%
+70%	25%	+17.5%
		+32.5%

Assuming a 2 year horizon, the pre-tax IRR is 18% p.a.  It drops to 13% p.a. if the horizon is extended to 3 years.  I am long the stock.

Mr. Bramson has done the math and we wish him good luck.

May 24, 2018

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[1]  Barclays bought ING Direct UK from the ING Group in 2009 for an undisclosed consideration.

[2]   It retains a 14.7% stake in Barclays Africa Group.

[3]  Since 2008, banks have used tangible equity as a more conservative input to calculate market capitalization to book value ratios, as it excludes such items as goodwill and other intangibles.  It is however NOT conservative to compute return on capital as banks carry such intangibles in their books at a positive value.

[4]  Excluding certain “non-recurring” costs from restructuring and litigation.

[5]  In 2017, JPM’s Investment & Corporate unit earned $10.8 billion after-tax for a 14% GAAP return on equity and 44% of bank total.

[6]  Barclays is luckier than Deutsche Bank in that its home market is more rational.