UBS - UBS Just Got A Monster Bargain - And Investors Can Too

2023-03-20 10:55:03 ET

Summary

• UBS Group AG made an exceptional deal buying Credit Suisse Group AG for about $3.25 billion.
• In order to support the deal, Swiss authorities orchestrated exceptional support, providing financing of up to CHF 100 billion and risk protection of CHF 25 billion.
• Following the UBS / Credit Suisse merger, UBS' CEO Ralph Hamers vowed that the bank's strategy will remain unchanged -- but scaled.
• UBS management expects that the deal will materialize a 74% increase in UBS' tangible book value per share at Day-1.
• While it is too early for me to assign a new target price to UBS stock, I am confident to already argue that the new TP will be higher than $34.46 estimated previously.

UBS Group AG ( UBS ) made an exceptional deal buying Credit Suisse Group AG ( CS ) for about $3.25 billion - valuing the Swiss banking giant CS at only a fraction of the Friday close market cap of about $8 billion. Although UBS investors' initial reaction to the deal is negative, with UBS shares being down as much as 15% on the open (SIX exchange trading reference), I argue that the selloff is a mistake.

The eventual value this acquisition is likely to bring to UBS over the long term is hard to express in numbers (for now). But investors should consider that after the CS acquisition, UBS will be the Swiss' last global banking giant, a jewel that Swiss authorities will likely protect and support. Or in other words, if the Swiss authorities expand such effort to save the country's #2 bank, how aggressively will they intervene to protect the combined entity of #1 and #2? The implications for UBS cost of equity/ risk should be obvious...

Reflecting on the combined strength of UBS/ Credit Suisse, paired with risk-protection of up to CHF 25 billion, it hard to argue that UBS didn't make a monster bargain. And if UBS can make such a bargain, UBS investors can, too -- by buying UBS stock.

UBS Swallows Credit Suisse On Attractive Terms

After months of stress for Credit Suisse, which culminated in a heated negotiation over the past weekend, UBS has agreed to acquire Credit Suisse at a value of approximately 3 billion Swiss francs--a discount of close to 70% as compared to Credit Suisse's market value as of Friday, 17th March. Given that the deal is transacted through equity exchange, UBS intends to buy Credit Suisse offering 0.76 of its shares for each CS share.

In order to support the deal, Swiss authorities orchestrated exceptional support: The Swiss National Bank committed up to CHF 100 billion in financing, while the Swiss financial regulator Finma pushed measures to facilitate the quick execution of the deal, including ((A)) the elimination of the need for UBS to obtain shareholder approval for the deal, ((B)) the wiping out of Credit Suisse AT1 bonds, and ((C)) the overlooking of monopoly concerns in the Swiss banking market.

Expanding on the "wiping out of Credit Suisse AT1 bonds," which eases UBS' financial burden by about CHF 15.8 billion, I would also like to point out that the Swiss authorities have further agreed to cover losses for CS non-core assets by up to CHF 9 billion, if losses exceed an initial CHF 5 billion that will be borne by UBS. This brings UBS cumulative downside protection to about CHF 25 billion, which is close to 50% of UBS current market cap!

UBS Strategy Unchanged, But Scaled

Following the UBS / Credit Suisse merger, UBS' CEO Ralph Hamers vowed that the bank's strategy will remain unchanged -- the Swiss giant will continue to operate with a focus on the low-risk and asset-light Wealth and Asset Management. But by adding about CHF 1.6 trillion of Credit Suisse' assets under management ("AUM"), the strategy has immediately accumulated scale.

Adding Scale to GWM and AM

With an estimated CHF 5 trillion of invested assets for the pro-forma entity, UBS is projected to become the world's second-largest wealth manager, just behind Morgan Stanley. And with regards to asset management, UBS is projected to claim the #3 in Europe and the #11 globally.

Shrinking CS' Investment Bank

Keeping UBS' strategy unchanged also means that UBS will shrink CS' legacy investment bank. At a press conference announcing the deal, UBS chairman Kelleher commented :

Let me be very specific on this: UBS intends to downsize Credit Suisse’s investment banking business and align it with our conservative risk culture,

... We will be de-risking a lot of the tricky businesses that we are inheriting.

While markets are still waiting for more guidance, according to further comments by Kellner, the combined investment banks of UBS and Credit Suisse won’t claim more than 25% of the new entity's risk-weighted assets.

At this point, no information was given to what is expected to happen to the CS First Boston spin-out. But I personally continue to expect a liquidity event ((IPO)).

Talking Leadership In Swiss Retail Banking

With specific focus on Switzerland, which is undoubtedly an attractive market for banking, the combined entity of UBS and Credit Suisse is modelled to account for about CHF 333 billion of customer deposits and CHF 307 billion of loans. As compared to the second largest institution, Raiffeisen, both metrics top the competitors' size by about 50%.

As a side note, analysts at JPMorgan Chase (JPM) have previously valued the Swiss retail banking unit at a minimum of CHF 10 billion Swiss francs, which is about triple the purchase price of the entire CS group!

Financial Implications

Putting everything into numbers, UBS management expects that the deal will materialize a 74% increase in UBS' tangible book value per share at Day-1. And regarding profitability, the deal could potentially unlock annual cost reduction of more than CHF 8 billion by 2027--the year when the deal is projected to be EPS accreditive. Admittedly, waiting 5 years for a deal to be EPS accreditive is not very exciting. But I understand that a merger of such scale is likely take a lot of time.

Conclusion

Before the CS deal, I assigned a "Buy" recommendation to UBS stock, arguing that the market is likely undervaluing UBS' exceptional position as a wealth and asset manager. Now, after UBS has bought its key domestic rival Credit Suisse for close to nothing, I am even more confident in my long-term UBS thesis -- the stock can trade much higher.

While it is too early for me to assign a new share price to UBS (I would wait for further disclosures and management estimates/ guidance), I am confident to already argue that the new target price will be higher than the $34.46 estimated previously .

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