RAIFF - Raiffeisen Bank International AG: Good Reason For The Low Valuation And Still It Could Get Much Worse

2023-06-07 10:35:58 ET

Summary

• Raiffeisen Bank International (RBI) faces significant risks due to its large Russian business and exposure to Signa Group.
• RBI's Russian profits are stuck in Russia due to Western sanctions and Russian counter-measures. At the same time, there are compliance and reputational risks.
• The Russian business could be essentially worthless to shareholders.
• The Signa exposure could lead to major problems at home, too.

Raiffeisen Bank International AG ( RAIFF ; RAIFY ) (RBI.VI) appears to be a bargain on paper. I will refer to the company as “RBI” in the interest of brevity. Austria’s second largest bank is highly profitable and trades at a P/E-ratio well below 2. There are, however, very good reason for this valuation. In fact, I believe that given its risk profile, the stock is overvalued even now. Below, I will explain my thesis with a particular focus on RBI’s oversized Russian business and its exposure to Signa Group.

The Russia Problem

RBI’s Eastern Europe segment (Russia, Ukraine and Belarus) accounts for about half of its profits ( Q1 : €359 million compared to €738 million in overall profits; full FY2022 : €2.2 billion of €3.8 billion – notably including a gain of €453 million from the sale of the Bulgarian unit). Russia represents the lion’s share (about 80 percent as of Q1). Russia’s central bank regards RBI as one of thirteen systemically important financial institutions. RBI is the largest foreign bank in the country. The business is exceptionally profitable (at least for the time being), but RBI cannot get the profits out of Russia due to Western sanctions and Russian counter-measures. Hence, I would argue that the true value of Russian profits is far below the nominal amount.

Somewhat ironically, the sanctions against the Russian banking sector have made the business even more profitable, as RBI is one of the last remaining Western banking channels. But inevitably, being among the last major Western banks active in Russia comes with significant risks. RBI is under OFAC investigation regarding its compliance (or lack thereof) with American sanctions. While that does not necessarily lead to penalties, it underlines the existence of a problem. Regulators are concerned as well. The ECB is pushing for a disposal of the business. There are reputational concerns to be considered as well. I do not imagine the average customer to be particularly happy about their bank being associated with Russia and possible sanctions breaches.

To make matters worse, management displays a worrying attitude towards the whole situation. For example, chairman Erwin Hameseder accused critics of “black and white morals” at the March general meeting. The latest quarterly report waxes at length about responsibility for Russian customers and employees and even emphasizes its commitment to maintaining the necessary operations to meet the conditions of a Russian banking license. I cannot help but get the impression, that RBI’s higher-ups still hope to get away with sticking to Russia in the long run. RBI meanwhile is even exploring asset swap plans involving Sberbank ( AKSJF ), a state controlled Russian entity sanctioned by the EU, the US and Britain among others. Dealing with Sberbank would likely create a compliance minefield.

At least, RBI is exploring a sale or spin-off (cf. p. 4 of the latest quarterly report ) of its Russian and Belarusian activities. However, a spin-off could quickly prove to effectively be worthless, I believe. First of all, the spun-off business would be a Russian bank. That would put it under the de-facto control of the Russian regime (which is fairly unlikely to prioritize Western shareholders).

A spun-off Russia business would also be easier for the governments of the free world to target with sanctions without unpleasant side effects for Western economies.

A sale meanwhile would likely be closer to a write-off in practice, based on the sale of other bank and non-bank businesses’ Russian activities following the Russian attack – Societe Generale’s ( SCGLF ) exit in particular. Additionally, RBI would, again, face the problem of not being able to remove any proceeds from Russia.

Risky Signa Exposure

The non-Russian business is not problem free, either. RBI has significant exposure of at least €320 million (though likely higher) to privately held Signa Group and its founder, Rene Benko. Signa, in turn, is facing its own set of troubles. First, its retail arm is struggling. Its German retail subsidiary, Galeria Karstadt Kaufhof, just finished the second bankruptcy proceedings within the span of 3 years. Signa had to agree to contributions of at least €200 million as part of the bankruptcy plan. Galeria Karstadt Kaufhof is also a core tenant of several objects owned by Signa’s commercial real estate division. The rents paid to the sister company are considered to be on the higher end compared to market rates for similar properties, thus crucial in order to justify the valuation of said properties on Signa’s balance sheet (and the aggressive annual adjustments thereof in recent years). Meanwhile, the company is selling its Austrian retail subsidiary Kika/Leiner for a symbolic sum of €1 and had to agree to making further financial contributions in excess of €100 million.

At the same time, Signa’s real estate and development business is facing the same problems the whole sector is with rising rates and high inflation. The company had to sell several properties at a lower than expected price. According to insiders quoted by Der Standard a portfolio of some fifty objects sold for slightly below €400 million rather than €500 million previously expected.

Furthermore, Signa is under Federal investigation for corruption in Austria, which might make further financing harder due to reputational concerns. Notably, Italy’s Supreme Court of Cassation found Mr. Benko guilty of corruption charges in an unrelated matter in 2014.

Public markets are already taking the risks rather seriously: Signa bonds due 2026 (coupon rate: 5.5 percent) trade about 40 percent below par value. There appears to be concern among equity investors, as well. Klaus Michael Kühne, who owns 10 percent of real estate division Signa Prime Select, publicly indicated his intention to exit within around two years.

Even the ECB has already inquired about several banks’ exposure to the embattled group.

A sample of seven of Signa’s properties cited in an Austrian parliamentary inquiry shows at least €320.7 million secured debt Signa owes to RBI as of early March. Notably, this sample consists of a mere 7 properties. Given the historically close relationship – among other things, RBI co-invested with Signa in the past on several occasions and former RBI CEO Dr. Karl Sevelda is a board member – the exposure might be considerably higher. Other banks have already cut back on their exposure to Signa. Deutsche Bank AG ( DB ) cut ties earlier this year, according to reporting by the Financial Times . Credit Suisse ( CS ), too, reduced its exposure from 2021.

Conclusion

RBI’s Russian business is much less valuable in reality than it appears to be on paper. While no profits or proceeds from any sale can be removed from Russia, the activities can lead to tangible legal consequences elsewhere and are detrimental to the bank’s brand and reputation at home. Its Russian assets, meanwhile, are ultimately at the mercy of the Russian regime. In the long run, I view the Eastern Europe segment to be potentially almost worthless.

Outside of Russia, there are looming risks, too. The exposure to Signa in particular may cost the bank dearly. Given that all those problems cumulate at the same time, Raiffeisen could even end up in a similar situation as Credit Suisse with the Austrian government forced to step in to prevent a financial chain reaction. After all, not only is RBI Austria’s second largest bank. Its collapse would also have major impact on its majority shareholders, the domestic Raiffeisen co-operative banks. Such a scenario could potentially all but wipe out shareholders.

With all that in mind, I consider the stock to be uninvestable, unless and until there is more transparency regarding the total extent of the Signa exposure and a clear path to a solution for the Russian business. I suppose there is a fair value of more than zero (but probably far below the current price) for the stock, but in order to calculate it, the aforementioned information is crucial. As is, one has to treat it as potentially (close to) zero, to be on the safe side.

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