Press and investor commentary concerning the Heine Securities investment in Chase Manhattan Corp. indicates that this deal is poorly understood.
It is very hard for old prejudices to die, and for investors to grasp new ways of thinking about an industry. This is apparent in the analysis of the Heine investment.
Commentators are arguing that Heine will not succeed in either taking over or breaking up Chase. In addition, the commentary still focuses upon earnings issues, as opposed to value issues. Finally, it is reported that there are only a small number of potential buyers for Chase, because it is such a huge banking organization.
For some months now, our firm has been focusing upon the fact that bank stocks trade as bond surrogates. Further, the only analysis done of banking companies is an attempt to determine how bad their earnings may be in the next down cycle.
The result of this analysis is to value banking companies at unusually low multiples relative to earnings, dividends, and book values. Moreover, since the only bull case to be made on banks is a takeover story, the smallest, most efficient, and most cyclical one-product companies in the industry sell at high multiples, while the most efficient, largest, and most attractive, product-creating companies sell at the lowest multiples.
To put it another way, the more efficient and larger a bank gets, the lower its multiple drops. The used-car syndrome may be perfectly applied to large bank companies - that is, that the parts are worth more than the whole, or the carburetor is worth more than the car.
Heine Securities clearly understands this dichotomy. It realizes:
*That a bank can be sliced into tiny pieces;
*That there are multiple buyers for these little pieces.
*Most importantly, that the tiny pieces are worth perhaps 100% to 150% more than the whole.
This is why Heine will succeed. There is a staggering amount of money to be made in breaking up banking companies.
In the April 7 issue of The New York Times, an attempt was made to value some of the larger pieces of Chase Manhattan Bank. Even this primitive analysis, which failed to understand how many pieces of Chase can be sold and dramatically understated their value, concluded that Chase broken up is worth more than Chase put together.
As analysis of banking companies becomes more sophisticated, it will be understood that a big bank like Chase can be broken into dozens of businesses, and that each can be sold at a price substantially higher than indicated in the New York Times' valuation.
If one thinks of the individual products being sold by a bank, one can come up with a series of salable businesses:
Real estate. Included in this sector would be residential mortgage origination, mortgage servicing, commercial mortgage origination, special workout servicing, and REITs composed of increasingly valuable repossessed real estate.
Consumer. Here one finds credit card lending, auto lending, home equity lending, and general personal finance for both standard and substandard borrowers.
Commercial. In this sector there is asset-based lending, factoring, specialized real estate lending (working-capital loans), and a variety of leveraged-buyout lending schemes.
Capital markets. This segment includes municipal underwriting, limited corporate underwriting, foreign exchange trading, bond trading, and a variety of derivative products.
Trust operations. This may be personal trust, corporate trust, or a variety of derivative products.
Data processing. In this segment there are a surprisingly large number of businesses, including payroll processing, merchant processing, cash management, a series of trust operations, and correspondent services.
This very limited review of salable banking products does not even scratch the surface. (Consider such subset products such as mortgage processing.) It also fails to recognize the value of bank real estate holdings, excess reserves on the bank balance sheet, and the premium available from owning low cost consumer deposits.
A bank is a veritable cornucopia of values. The market refuses to recognize the existence of these values. Heine Securities understands value and will therefore succeed in forcing the breakup of Chase Manhattan Bank.
It is likely that as value analysis replaces whatever now serves as analysis of banking, other predators will be attracted to the business, trying to maximize stockholder returns.
Ultimately bank managements, which generally do not control bank stocks, will be forced to turn from building financial empires to building shareholder value. This means that banks will themselves accelerate the breakup process, spinning off ownership of a variety of their more attractive businesses to stockholders.
It should clearly be understood that there are literally thousands of buyers for the pieces these banks can sell or spin off. There is no reason to assume that there is a very small number of one-time, "big-gulp" buyers. The market for these sliced-and-diced banks is virtually infinite.
The United States government's principal interest in banks is that they create no losses for taxpayers. That banks stimulate economic growth is only a secondary matter.
Banks are now using FDIC-insured funds to buy back their stock and fund high-risk trading activities such as derivatives operations. If the banking companies were stripped down to individual product lines, they could do nothing with FDIC funds but stimulate local economic growth. Moreover, they would not be financing risky activities with insured funds.
In essence, stripping the banks would reduce risk to taxpayers and increase the funds available for stimulating local economic growth. That's win-win for everyone.
Michael Price of Heine Securities is to be complimented for starting the process. Let the games begin.
Mr. Bove is an analyst with Raymond James & Associates Inc., an investment firm in St. Petersburg, Fla.