TheChek News Flow

UBS Chief: We Deserve a Higher Stock Price

The Swiss bank’s booming wealth management group merits a valuation closer to peers like BlackRock.

If you are an institutional investor or a rich individual, Sergio Ermotti wants your money.

After overhauling UBS Group’s (ticker: UBS) battered franchise and turning it into a wealth management powerhouse, the CEO is hunting for a higher market valuation and more high-net-worth clients for his roughly 7,000 U.S. financial advisors.

Neither will be easy, as Ermotti acknowledged in a recent interview in Zurich.

“The priorities are twofold: One is to look and feel boring. You can continue to show the value of the transformation…so you can repeat the success. Nothing wrong with that: It’s like winning the [soccer] Champions League every year,” says the 57-year-old Ermotti, who is an ardent supporter of Italy’s AC Milan. “The second one is, how do you get fit and prepare for the changing environment?”

In the market’s eyes, UBS is caught between two stools. Since taking over in 2011, Ermotti shrank the investment bank and its balance sheet to refocus on UBS’ golden goose of wealth management—a legacy of its Swiss heritage and the (troubled) buy of U.S. brokerage PaineWebber in 2000.

The strategy, while mostly successful, has made the firm a strange beast in the financial-services jungle. UBS is the world’s largest wealth manager, with about $2 trillion in assets, but its investment bank still contributes more than a quarter of operating income (through the first quarter).

How to value such a hybrid? The market’s response has been: as an investment bank, beset by concerns over regulation, litigation, and profitability. That’s why, despite a 50% rise in the shares since 2012, the bank’s valuation is still in the middle of the industry pack, at around 1.2 times book value.

Investors’ refusal to embrace the new, improved UBS is vexing for its CEO. “At the end of the day, what we are isn’t the most expensive…investment bank. We are the cheapest asset-gatherer in the world,” he says, casting a beady eye on the richer valuations of U.S. money manager BlackRock (BLK), with a price-to-book value of 2.4 times, and Julius Baer Group (JBAXY), the Swiss private bank that trades at 2.1 times.

But those firms don’t have an investment bank that, although much lauded for its narrow focus and monklike attention to costs, still carries the remnants of a troubled past. Ermotti sees litigation costs and regulation as the two biggest hurdles to a rerating of UBS shares.

On the first issue, he reels off numbers like a man who has been spending a long time thinking about this problem. “Since I started…we put aside money for provisions of nine billion Swiss francs ($9.3 billion). We had CHF4 billion in legal costs, litigation costs, regulatory remediation.” That’s a cool CHF13 billion-worth, as Ermotti points out, three Swiss francs per share. Reducing these costs to a normalized level could add CHF2 billion back into earnings, giving the shares, now around CHF16, a slight boost.

On regulation, Ermotti bemoans the chilling effect that uncertainty—from the much-delayed Basel III capital buffers to the U.S.’ tough treatment of foreign banks—is having on his ability to deploy cash. “Nobody in the world believes we need more capital. Now the question is: ‘Guys, how much of this capital can be returned to shareholders?’ ” he says. “Until you unlock some of these issues, you don’t get a rerating.”

But Ermotti remains optimistic the market will eventually agree with his sum-of-the-parts valuation for UBS (a higher multiple for its wealth management business, blended with a lower valuation for its investment banking). “It isn’t a matter of years, it’s a matter of quarters,” he says.

CRUCIAL TO THIS STRATEGY is the firm’s U.S. wealth management unit, which accounts for more than half of its total assets. UBS has focused on the fastest-growing segments of high-net-worth individuals (with investible assets of between CHF2 million and CHF50 million) and ultra-high-net-worth individuals (above CHF50 million). “We went upmarket,” Ermotti says. “We don’t play for size. We play for quality.”

It’s a far cry from the dog days of the financial crisis of 2008, when UBS’ previous management repeatedly tried (and failed) to sell the loss-making unit to rivals. Ermotti stated his commitment to U.S. wealth management and saw the red ink replaced by an annual profit of CHF1.1 billion.

UBS is also starting to get a grip on compensation costs—the traditional bugbear of an industry where the big producers tend to jump ship when they get a better offer. UBS was “an unlikely trendsetter,” as the CEO puts it, in January when it overhauled its compensation structure in an effort to reward retention and reduce attrition.

“The previous system was no longer sustainable in the long term and not in the best interest of our clients and our stakeholders,” Ermotti explains. “We pay advisors a higher commission base, based on employment tenure, growth, and productivity.” He professed himself pleased with the early results, but it will take years to truly test the new system.

As a committed soccer fan, Ermotti knows that it is not easy, or likely, to win the Champions League every year.

ECB Taper Talk Puts Spotlight on Italy

Any sharp rise in borrowing costs risks reviving questions over the sustainability of Italian debt.

The recent volatility in bond markets has stirred up old fears in Europe. Investors have long been concerned about the possible impact of the end of the European Central Bank’s quantitative easing program on the eurozone’s periphery, not least Italy—the country long-regarded as too big to save. Now with markets abuzz with talk of central bank monetary policy “normalization,” those concerns are once again front of mind: Without the fire blanket of ECB government bond-buying, will Italian borrowing costs soar once again, plunging the eurozone back into crisis?

For the moment, there is no sign of any panic—or any immediate cause for alarm. Italian 10-year government bond yields have risen sharply in the past two weeks to just over 2.2% in tandem with other eurozone government bond markets. But the spread between German and Italian bond yields—a measure of the perceived riskiness of Italian bonds—has widened only modestly to 1.7 percentage points, well below the recent peak of 2.2 percentage points ahead of May’s French presidential election though still above the 1.3 percentage points a year ago before fears about Italian political risks started rising in the run-up to a November constitutional referendum.

Nonetheless, investors are wary because at some point rising Italian government bond yields run the risk of creating negative feedback loops into the real economy via higher domestic borrowing costs. With the trifecta of Italian government debt equivalent to 132% of gross domestic product, growth not expected to exceed 1.4% this year, and inflation still below 1%, any sharp rise in borrowing costs risks reviving questions over the sustainability of Italian debt. Italy can cope with bond yields rising above 2%, but what if they rise above 3% or 4%? asks Marchel Alexandrovich, European economist at Jefferies International.

These concerns are shared by policy makers, though ECB officials say they won’t allow this to influence its decision-making: the ECB’s task is to set monetary policy conditions for the whole eurozone, not an individual country. Besides, there is no reason why any ECB decision to taper its purchases of government bonds should trigger a crisis. After all, the Italian government benefits from a deep and liquid domestic market for its bonds: the Italian household sector holds €3 trillion worth of liquid assets and is currently adding to those savings at an annualized rate equivalent to more than 8% of GDP.

At the same time, the government is running a primary budget surplus which means that Rome only needs to issue new debt to roll over existing debt and cover its interest expense—a task made easier by the Treasury’s efforts to lock in current low-interest rates and extend the maturity profile of its debts. Policy makers also note that a rise in interest rates may not be as damaging as investors fear since higher household investment income could boost spending and growth.

The real short-term risk is that ECB tapering might crystallize existing fears about Italian political risks ahead of the general election that must be held by the end of February. If the outcome was a populist 5 Star Movement committed to taking Italy out of the euro, the eurozone would be plunged into crisis from which there is no obvious escape. Under such circumstances, Rome is unlikely to request the kind of bailout program needed to unlock further ECB assistance.

Yet even if the eurozone survives this test—continuing this year’s pattern of market-friendly political surprises—policy makers fear that long-term political risks will continue to hang over the government debt market. True, Italy is currently enjoying a cyclical upswing, helped by a buoyant global economy. It should also reap some benefits from the recent, belated efforts finally to clean up its banking system and tackle the legacy of bad debts. Other recent overhauls should also contribute to stronger growth including reforms of the labor market, judiciary and new incentives to encourage equity investment which should help unlock access to capital markets.

But these reforms are unlikely to lift Italy’s long-term growth prospects to levels that would remove concerns about its long-term debt sustainability. In a recent speech, ECB executive director Benoît Coeuré drew attention to the striking correlation between the quality of a country’s institutions as measured by the World Bank’s Worldwide Governance Index and its GDP/capita. Italy’s position at the bottom of the eurozone governance league, ahead of only Greece, may partly explain why Italy’s GDP/capita growth performance has also languished at the bottom of the European league, having remained stagnant for the best part of two decades.

This suggests that the key to sustainably boosting Italy’s long-term performance lies in deeper institutional overhauls that will speed up the reallocation of resources to the most productive sectors of the economy and discourage the kind of rent-seeking that continues to drag on productivity and GDP/capita. For that, Italy needs a stable government committed to delivering reforms. Until it finds one, the specter of crisis will continue to stalk Italy—and the eurozone.

... or if the M&A talks leaked to the press.

Amazon has long had a reputation as a hard-ball negotiator. It turns out its negotiations with Whole Foods leading up to its $13.7 billion acquisition agreement were no different, according to an SEC filing outlining a timeline of the talks between the two companies.

On May 23, Amazon made a written offer to acquire Whole Foods for $41 a share, less than a month after the first meeting between senior executives of the companies, the filing said.

Whole Foods came back with a counterproposal of $45 a share, which got Amazon to increase its offer to $42. But Amazon’s bankers from Goldman Sachs then “stressed several times” that the increase to $42 represented Amazon’s “best and final offer.”

Amazon’s bankers “also made it clear again ... that Amazon.com would disengage from its efforts to acquire the Company and pursue other alternatives and initiatives if the $42.00 per share price were not accepted,” the filing said, “and that Amazon.com expected that the Company would not approach other potential bidders while the Company was negotiating with Amazon.com.”

Amazon also threatened it would walk away if the talks leaked to the press, which they did not.

Translation: $42 or nada.

According to the filing, Whole Foods’ board of directors believed that the hard line Amazon outlined was “highly credible” and also believed that Amazon “would likely have sought to acquire another industry participant” if Whole Foods declined the offer or sought other bids. The board also said the best bet to “obtaining a superior transaction would be to enter into the attractive Amazon.com transaction to which any potential third party bidders could then react.”

As a result, Whole Foods never went back to another unnamed suitor — referred to as “Company X” — that had presented Whole Foods with a merger idea that would work out to $35 to $40 a share for Whole Foods shareholders. (If you have an idea of who this suitor is, I’d be interested in hearing it.)

Whole Foods also did not engage with four private equity firms that had expressed initial separate interest in a potential leveraged buyout of the grocer. The Whole Foods board, according to the filing, was concerned that the talks might leak and also did not think the PE firms would be able to beat Amazon’s offer.

In the end, the $42-a-share offer represented a 27 percent premium to Whole Foods’ closing stock price on the day before the deal was announced.

Other bidders can still bring offers to Whole Foods between now and when the company’s shareholders vote on the deal. If that happens and Whole Foods accepts another offer, the grocer would have to pay Amazon a $400 million breakup fee.

Estimates show that nearly as many U.S. households subscribe to Prime as to pay TV.

Someday soon, more U.S. households will be subscribers of Amazon Prime than cable or satellite TV, according to recent estimates of Amazon’s popular shipping and entertainment service.

According to estimates from Morningstar, nearly 79 million U.S. households now have an Amazon Prime membership*, up from around 66 million at the end of last year.

That compares to a projected 90 million U.S. households that will pay for cable or satellite TV this year, according to S&P Global.

According to these estimates, more U.S. households may have an Amazon Prime subscription than a pay TV subscription as soon as next year.

The implication here is not that Amazon’s Prime Video service is more popular than TV; the main reason most people subscribe to Amazon Prime is still the fast delivery of products.

But it is an indication that Prime is moving toward becoming a “no-brainer” for more than just wealthy Americans. To that end, Amazon has been courting lower-income American households with discounts for those on government assistance, as well as a monthly payment option for those who don’t want to cough up $99 for an annual subscription.

These growth tactics are important, since more than 80 percent of America’s wealthiest households already pay for Prime. And Amazon knows that Prime is the core of its retail business: Prime members spend more in a year than non-Prime members do, shop more frequently than others, and price-compare less, according to studies.

* Amazon doesn’t disclose Prime member numbers, so Morningstar’s estimates are based on an analysis of Amazon’s cash-flow statement. There are survey-based Prime membership estimates from other companies that range as high as 85 million U.S. members and as low as 60 million.

Macro :

- ECB’s Coeure Says Euro Zone Needs to Be Ready for Next Crisis

- France Ready to Fend Off Hostile Predators of Big Cos.: Le Maire

- Google, Amazon, Facebook Must Pay EU taxes, French Minister Says

- Cariparma in Talks to Buy 3 Italian Banks for EU1: Messaggero

- Buffett Plans Further Investments in Germany, Advisor Tells BAMS

Keep an eye on :

- A2A iM : A2A Gets Non-Binding Offers for Montenegro EPCG Stake: Radiocor

- ADP FP : Caisse Des Depots May Consider Aeroports de Paris Stake: Reuters

- AMZN VX : Amazon Prime On Pace to Have More Subscribers Than Cable: Recode

- AAPL US : ITunes Store’s Share of Movies Market Falls to 25%-30%: WSJ

- AV/ LN : Schneider Electric Is Said to Mull New Bid for Aveva: S. Times

- GBF GY : Bilfinger CFO Patzak Says Restructuring Still at Early Stage: BZ

- BT/ LN : BT Group to Conduct a Review of Its Businesses: Telegraph

- DC/ LN : Dixons Carphone CEO Is Said to Have Been Approached for ITV: Sky

- EDF FP : EDF May Not Be Part of France State-Asset Sale: Reuters

- HEN3 GY : Henkel Plans Additional Acquisitions, Mega Deals Unlikely: RP

- NETS DC : Nets shareholders could unlock value via sale after disappointing post-IPO run - MergerMarket

- OCLR US : Oclaro PT Raised at Stifel; Seen as Logical M&A Target

- ROG VX : Shire Gets Injunction Against Roche on Emicizumab

- SU FP : Schneider Electric Is Said to Mull New Bid for Aveva: S. Times

- SHP VX : Shire Gets Injunction Against Roche on Emicizumab

- FP FP : Total-Led Group Saw Return of Iran Sanctions as Unlikely: Shana

- VIV FP : Vivendi asks Telecom Italia boss to cool broadband row with Rome - http://reut.rs/2u75fFx

- VOW3 GY : VW Official Said to Have Estimated ~$19b Fines in Aug. ’15: BamS

Deal would create stronger Asian competitor to Maersk and Mediterranean Shipping

China Cosco Shipping has sealed a deal to buy Orient Overseas International of Hong Kong for $6.3bn in cash, in the latest wave of M&A in container shipping, as the battered industry navigates its way to sustainable profitability.

The takeover, announced on Sunday, between two members of the Ocean Alliance grouping of container lines, creates a potentially stronger Asian competitor to the P2 Alliance of Denmark’s Maersk Line and Switzerland’s Mediterranean Shipping Company, operators of the two largest container fleets.

The HK$78.67 offer is at a 31 per cent premium to Orient Overseas’ closing price on Friday and has already been accepted by the controlling shareholder, CC Tung, whose family owns a 68.7 per cent stake.

If the deal obtains regulatory approval, China Cosco will hold 90.1 per cent of the enlarged group, while its partner in the offer, Shanghai International Port Group, will hold the remainder.

The combined group will operate more than 400 vessels and operate the world’s third largest container ship fleet according to Alphaliner, the shipping data provider.

There have been eight M&A deals in the industry in the last four years, with the market now bifurcated between big players going aggressively after market share in the premier routes and companies falling into a second-tier level, such as Orient Overseas, according to Basil Karatzas, chief executive of Karatzas Marine Advisors.

“The acquisition of Orient Overseas further strengthens Cosco’s market position and gives it the critical mass to compete with the very top players in every respect,” he said, adding that “there is little doubt that Cosco likely will not be done and is likely to go after more targets in the near future.”

China Cosco was formed at the end of 2015 out a merger between China’s two biggest state-owned shipping lines, Cosco and China Shipping.

Orient Overseas was established in 1950 by Mr Tung’s father, CY Tung, after fleeing from communism in mainland China. Once one of the sector’s most profitable operators, it has struggled to recover fully from the sharp downturn that hit the industry in the global recession of 2008.

Energy, heavy machinery and steel focus of drive to scale up state-owned enterprises

China is preparing a fresh round of megamergers between state-owned behemoths in the energy, heavy machinery and steel sectors, as hopes fade for a more fundamental overhaul of the state sector. 

State-owned enterprises account for more than a third of total investment and receive almost 30 per cent of bank loans but generate less than a tenth of total gross domestic product, according to Gavekal-Dragonomics, a Beijing-based research provider. 

In a landmark economic reform blueprint approved in late 2013, top Communist party leaders pledged to “raise corporate efficiency” at SOEs while also ensuring that they “undertake social responsibility”. Analysts say the inherent tension between these two goals has never been resolved. 

Since then, government-orchestrated mergers have emerged as the primary focus of SOE reform, while progress has been slow in implementing other changes that could boost efficiency, including privatisation and increased competition. 

“The ongoing wave of megamergers has both domestic and international aims,” says Wendy Leutert, a PhD candidate in government at Cornell University who is completing a dissertation on SOE reform. “At home, the Xi administration hopes mergers will enable state firms to co-ordinate excess capacity cuts and boost pricing power. Abroad, the goal is to increase national champions’ market share, eliminate price wars, and integrate upstream and downstream industries.” 

The official Xinhua news agency reported last month that the government’s focus for SOE mergers is coal and electricity, heavy machinery and steel.

Coal producer Shenhua Group is reportedly in merger talks with China Guodian Corp, part of a broader effort to consolidate the power sector. If approved, the combined group would have $262bn in assets. In March, the listed arms of China National Nuclear Corp and China Nuclear Engineering & Construction Corp said their unlisted parent companies would merge, creating an $80bn group. 

China National Machinery Industry Corp won approval last month to absorb textile machinery producer China Hi-Tech Group, a combination worth $52bn in assets. China National Machinery acquired another central government-owned machinery group, China National Erzhong, in 2013. 

Following the tie-up of Shanghai Baosteel with Wuhan Iron & Steel last year, which created the world’s second-largest producer, local media is rife with rumours about the next steel merger. 

Some experts believe the ultimate goal is for the enlarged Baosteel to form the core of a “southern steel” conglomerate, while Beijing-based Shougang Group will merge with other rivals to form “northern steel”. 

“Some of the mergers are mostly about combining similar companies to generate scale and reduce competition. Others are intended to integrate upstream and downstream portions of the industry value chain,” says Li Jin, chief researcher with the China Enterprise Research Institute. 

Mr Li also notes that some recent tie-ups are intended to prepare SOEs to win projects related to President Xi Jinping’s Belt and Road initiative, which is focused on infrastructure investment in developing companies. These mergers include the combination in late 2014 of the country’s two main train producers and last year’s merger between its two biggest shipping groups. 

ChemChina and Sinochem are planning a merger next year, the Financial Times reported in May. Bankers say the deal is intended to boost ChemChina’s financial strength so it can successfully absorb Swiss agrochemicals group Syngenta. 

Defenders of the government reject the claim that mergers are the only tool the leadership is willing to deploy. 

“Mergers are just the most visible actions, so people say it’s the only thing happening. This is wrong,” says a recently retired executive at a large state group. “Mergers create the foundation. Once you have created the groups you want, then you can move on to other reforms.”

In fact, the mergers have been a key feature of SOE reform efforts for more than a decade. The central government owns 101 groups, down from 189 when Sasac was set up in 2003. Such continuity is why many critics doubt that mergers can address the root problems that have plagued SOEs for years.

They say the SOEs need to be subjected to more competition by reducing barriers to entry in sectors such as energy, telecommunications and heavy machinery that are largely closed to private firms. They also argue that SOEs’ preferential access to bank credit and the expectation of government bailouts make SOEs complacent about week profitability or even outright losses. 

“Rather than allowing the market to enforce survival of the fittest, the government-guided mergers typically force stronger SOEs to absorb their weaker rivals,” says Yanmei Xie, an analyst at Gavekal Dragonomics. 

Many experts say the goal of SOE reform has never been clearly defined. For some, the campaign means pushing state groups to act more like private companies. For others, it’s mostly about strengthening the Communist party’s grip on SOEs, in part by enforcing greater political discipline. 

The latter approach seems to be winning out. In an article in a Communist party newspaper last month, Sasac chairman Xiao Yaqing emphasised the importance of SOEs as a tool for the government to guide the economy and achieve political objectives. 

“We must resolutely resist ‘privatisation’, ‘de-state-ification,’ ‘de-main guidance-ication’,” he wrote.

- Enormous divisions in the Labour and the Tory parties and a "deteriorating" economy will make people think again.

- Note that Sir Vince Cable is likely the next Lib Dem leader