2023-07-06 11:36:30 ET
Summary
- While analysts favor Credit Suisse as a compelling deal for UBS Group AG, we believe significant challenges lie ahead.
- We do not support a regional IPO on the Credit Suisse local retail banking activities.
- Here at the Lab, we see cheaper EU bank opportunities elsewhere. We believe that Wall Street is not pricing higher execution risks linked to Credit Suisse' acquisition.
Here in the Seeking Alpha community, we were among the few analysts covering both Credit Suisse and UBS Group AG (UBS). Our readers know that we have always been cautious of Credit Suisse , while since April 2022, we have supported UBS Group AG . Given our recent analysis of CS called " It Is Over ," we decided to move on with UBS. Our latest UBS publication was pre-CS acquisition and our target price was set at CHF 22 per share. Since then, UBS's stock price has declined by 3.15%, significantly underperforming the S&P 500 (SP500) return.
Mare past analysis - pre-CS deal
There is a lot of news to price in and many assumptions to make. Let's analyze what we believe is worth consideration:
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In early June 2023, the Swiss finance ministry agreed with UBS to cover the potential loss of up to CHF 9 billion, which is approximately $10.01 billion. This government downside protection will come into action only if losses exceed CHF 5 billion and are, in any case, limited to a maximum of CHF 9 billion;
- Regarding asset liquidation, UBS is seeking a buyer for Credit Suisse Chinese JV. Under Chinese law, a single player cannot hold two banking licenses with a majority stake, and UBS already has a 67% stake in its Beijing-based bank. As a reminder, UBS established its Chinese presence more than a decade ago and was the first foreign financial company to hold a majority stake in a banking unit;
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UBS could split Credit Suisse's Swiss division and separately list the company on the Zurich Stock Exchange. This could be the plan reported by the Zurich newspaper Inside Paradeplatz . This potential IPO would allow UBS to dilute its exposure while maintaining a majority stake. Here at the Lab, we are not forecasting this scenario, but this could not be supportive. In detail, we are more inclined in case the business is retained. UBS might advance a restructuring plan with higher synergies to boost profitability metrics;
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According to UBS, the company will report a gain of almost $34.8 billion and a negative impact of $17 billion. UBS estimates a negative impact of $13 billion attributable to fair value adjustments in assets and liabilities. UBS also calculates litigation costs and higher regulatory expenses for a total of $4 billion this year (and could top $28 billion over the next five-year period). These figures are currently based on the bank's latest estimates, and as further analysis is performed, these figures are likely to change. There is also a goodwill gain in the bank estimates, but UBS will also make various changes to its accounts as it needs to incorporate the latest CS fair value. The bank will likely write down $10 billion in assets and an ongoing deposit decrease. In Q1, Credit Suisse's outflow was $75 billion , and looking at the recent quarterly evolution (Fig 1), we believe a similar number will also be recorded in Q2. Thanks to the latest Bloomberg news, the bank outflows are continuing . Indeed, UBS-CS rivals can benefit from this moment of weakness and feast on CS's client spoils . As reported by Reuters, major CS clients are going to Deutsche Bank Aktiengesellschaft , Julius Baer, and Morgan Stanley;
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After bailing out Credit Suisse, UBS is now moving on to restructuring. The Swiss bank plans to cut more than half of the 45,000 employees of the acquired group starting in July. Almost all banking divisions should be affected. Staff have been told to expect three rounds of layoffs in 2023, with the first predicted by the end of July and two more rounds tentatively expected in September and October. Three months after UBS agreed to take over Credit Suisse in a government-brokered bailout, the extent of the restructuring is starting to become clear. UBS, whose combined workforce jumped to about 120,000 when the bailout closed, has said publicly it plans to save about $6 billion in payroll costs over the next few years. The group intends to cut the total workforce by about 30%, or 35,000 people;
- The UBS CEO also plans a " massive downsizing " of Credit Suisse's investment banking division.
Source: Bloomberg (Fig 1).
Valuation
Looking at the aggregate level, the new entity will control $5 trillion assets and be one of the world's largest asset managers. At first sight, UBS made a compelling deal, and the bank increased its Net Asset Value by 70% in a single acquisition.
However, UBS is now trading at 0.9x its tangible book value with a RoTE of 5.8%. If we incorporate $10.5 billion in cost reductions thanks to a good restructuring plan and almost $14 billion in restructuring charges, we arrive at a RoTE of approximately 11% only in 2025. On a pre-acquisition basis, UBS Group AG traded at a premium price on its tangible book value at 1.3x with a RoTE of approximately 15%.
Comparing our European Bank's coverage at the aggregate level, today, the tangible book value is 0.8x with a RoTE of 11.5%. UBS CET1 ratio is also weaker than peers, with a ratio of 14% versus peers' average at approximately 14.5%. Before the CS acquisition, the UBS CET1 ratio reached 14.2% ; but we should also incorporate Credit Suisse related risk-weighted assets now . However, this deal has many risks, and our approach is more cautious regarding transaction dynamics and money flows. UBS Group AG just got the keys to Credit Suisse, and we will have a clear picture in the Q2 financial figures.
UBS now has lower capital return prospects with a lower distribution. Here at the Lab, we forecast a DPS per share of $0.65 and $0.70 in 2024 and 2025, yielding 3.3% and 3.6%, respectively. This is much lower than our EU best-pick champions that we highlight below.
Valuing the company in line with EU peers using a tangible book value, we derive a target price of CHF 21 from 22 per share, and we are downgrading the stock with a neutral rating, given the acquisition complexity and higher litigation costs expected. The rating agency Standard & Poor's is also cautious, confirming UBS' A- rating but revising the outlook downwards from stable to negative following higher " execution risks " linked to CS's acquisition.
Conclusion
Here at the Lab, we see cheaper opportunities than UBS Group AG elsewhere, with other EU banks valuations more attractive. We reconfirm our positive views on ISP , UniCredit , CASA , and BNP Paribas .
For further details see:
UBS Group: Resume With An Equal-Weight Valuation