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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a founding partner of Veritum Partners
The Scottish writer and poet Robert Louis Stevenson once wrote that “to travel hopefully is a better thing than to arrive”. While Stevenson was referring to the hunt for El Dorado, he could easily have been reflecting on 21st-century investing in the European bank sector.
For much of the decade up to 2022, the standard playbook for a European bank presenting its strategy to its investors was some version of “our current levels of profitability are rubbish, but over the next few years it will improve and so will our valuation”.
Today, management has delivered. The key profit metric — return on equity — has almost doubled from about 7 per cent in the decade to 2022, to nearer 13 per cent. This is thanks to the ending of the zero interest rate era, continued good asset quality and decent cost control despite high inflation.
Yet while the banks have honoured their promises, the equity market hasn’t delivered on its side of the bargain. Share prices of banks have increased, yet in most cases by much less than the upgrade to their profits. Put another way, the valuation has got cheaper, which is not what management might have reasonably expected when it made its commitments. Today, banks in Europe are trading on 6x price earnings multiple, compared with a two-decade average of nearer 10x.
This is of course deeply frustrating for banks. It is also disappointing for any investors who bought into the promised improvement. But perhaps it could prove the catalyst for something more dramatic.
The European bank sector has long looked like fertile terrain for activist shareholders. Many banks are in effect conglomerates, owning businesses across loosely connected parts of financial services and often in disparate countries. They have high cost bases, fragmented market shares and low valuations. Most so-called “sum of the parts” valuation measures conclude that a division or two of the bank is in effect available “for free”.
So where are the activists? There have been occasional flickers of interest. In the mid-2000s, Knight Vinke tried to force HSBC to exit its US business, but had to retire defeated. More recently, the global private equity firm Cerberus tried to force the merger of two German banks that it owned — Deutsche Bank and Commerzbank. Again, that proved unsuccessful. Among the factors holding back activists in the past were low levels of profitability.
But in a world of higher profits and consistently low valuations, 2024 might be ripe for a fresh wave of bank activism. Indeed, the conditions for activists might even improve further. With most analysts expecting bank returns on equity to modestly decline as rates start to fall, investors might get scared off, leaving valuations looking even more enticing.
In late December 2023, Cevian — a more behind-the-scenes activist — disclosed a €1.2bn stake in UBS. Publicly it remains supportive of UBS management as the bank integrates Credit Suisse, but it has clearly seen something that it finds attractive.
However, it’s not just rubbish returns that have put activists off. Regulators must approve anyone who seeks “control” of a bank — typically interpreted as owning 10 per cent or more — and historically regulators have been nervous of activists. The fact that these investors often agitate for large corporate change can be seen by regulators as introducing unwelcome instability.
But that attitude may be changing, as regulators appear increasingly open to the role such activists might play. This is evidenced in part by their apparent willingness to allow such investors to start joining the shareholder register of banks and their recognition that better-run banks are healthier for the economy.
With the treacherous journey to higher profits now complete, and valuations still depressed, 2024 may be the year that activists may finally drive the European bank sector out of its slumber.
