Banque Cantonale Vaudoise BCVN SW
February 03, 2008 - 7:59pm EST by
cgnlm995
2008 2009
Price: 451.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,900 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Banque Cantonale Vaudoise – Current Investment Recommendation (451 CHF per Share)

 

Banque Cantonale Vaudoise (“BCVN”) is the leading private bank, asset manager, and retail bank operator in the Canton of Vaud (“Vaud”), a highly affluent, french-speaking region of Swizerland spanning from Geneva to Lausanne. Its private banking franchise manages 85bn CHF in AuM, and contributes roughly 60% of total operating income. It grew north of 10% in 2007, and exhibits low churn statistics of less than 1.5% per annum based BCVN’s tight-knit demographic, and exceedingly high brand equity in its niche region.  The remaining 40% stems from retail banking, and some 10% from trading operations.  BCVN has been building cash for several years, unable to distribute any meaningful amount beyond a paltry 1-2% dividend yield, for political reasons discussed below. Today, BCVN has roughly 60% of its market capitalization in excess capital by Tier 1 and Basel standards.  Management will confirm this fact.  Ex-cash, BCVN trades at 3.4X “earnings power”, which is equivalent to free cash flow, versus its peer-group at 15x (comprised of a 50/50 blend of Swiss Cantonal Banks and Swiss Private Banks and Asset Managers).  BCVN trades at 1.2X Price/Book, penalized by its unimpressive 10.8% ROE, versus a blended peer average of 2.0X Price/Book with an average ROE of 17.3%.  BCVN could reduce its capital by roughly 2.2bn CHF through dividend or share-repurchase, without affecting its core earnings (reasonably, assuming the cash earns 2%, earnings power should be reduced by 44mm per annum, which has been assumed for purposes of this analysis). It is our view that once the capital distribution is communicated/implemented/accomplished, the resulting dramatic improvement in ROE will further underpin a large re-rating based on Price/book multiple convergence, in line with blended peers, given that the present large ROE gap will be entirely closed.[1] 

 

Brief History

BCVN ran into severe financial difficulties in 2001 and 2002 when it was forced to recognize the true value of its loans in its balance sheet. An emergency injection of capital by Vaud in the form of equity and participation certificates (PCs) bolstered the bank’s solvency, and a new management team was appointed, beginning a program to restore the bank’s profitability and lessening the burden of impaired loans. Alexander Zeller, who oversaw a dramatic restructuring at CS Asset Management, triggered our interest in the situation as early as 2004.  As the turnaround plan began to bear fruit in 2003-2005, surplus cash was used, in part, to repurchase Vaud’s entire Particiption Certificates stake. Today, Vaud retains only a 67% interest in BCVN’s common equity, which for nebulous political reasons, has, until now, precluded BCVN from distributing its excess capital.  Given Vaud’s critical role in the rescue of the bank, the company has explained to investors that it had been, until now, respecting its agreement with Vaud, and wait for it to sell its stake down below 50%, in order to commence a cash distribution program.  (Upon information and belief, this “no-distribution” policy was based more upon sovereign commitment and community relations than corporate mandate).  In late 2007, after management and shareholders waited patiently for the conclusion of both Vaud’s strategic review of its stake, the company has begun communicating to investors in the past weeks that they would wait no longer, and the capital distribution policy would be announced at year end results in March 2008, making this an ideal time to examine the investment case.

 

Expected Plan for Capital Distribution

Based on Conversations with management, the plan that seems most likely is a 10-year bullet dividend that will see the cash surplus and an aggressive net income distribution bundled together.  Based on my estimates, dividend yield under this model will be 14% in 2008 trending close to 19% at the end of the 10-year period in 2017 (see below).  The company’s rationale for such a structure, understandably, has been to try to retain stability in the shareholder base, rather than inject a large arbitrage community into its shares.

 

Whether the stock re-rates on a dividend yield, or on a P/E basis ex-excess capital, or a P/E basis ex-present value of excess capital distributions (or similarly, on a P/book basis post balance sheet engineering), the stock appears extraordinarily undervalued, with scope for a medium-term double, if not triple.

 

Lastly, the present value of the dividend stream anticipated attributes negative terminal value to the franchise post 2017, which supports the perspective that the market is valuing BCVN entirely incorrectly.

 

 


 Abbreviated Financial Analysis – Focus on Dividend Distribution

Due to Formatting issues, please see:  http://docs.google.com/Presentation?id=ddj7sb7w_9fmcj6hfj



 

 

 

 

 

 



[1] Note: BCVN has inadequate coverage, and a catalyst for re-rating, beyond capital distribution, would be enhanced liquidity.  The certainty of a liquidity event materializing is lower than a cash distribution, but if it were to occur, would undoubtedly accelerate investor awareness of the investment proposition, placing its  liquidity (today only $700mm USD) closer to that of its larger, more liquid peer group.

Catalyst

Government Placing Q1/Q2
Massive Cash Return
Improved Coverage
Re-rating post cash distribution
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    Description

    Banque Cantonale Vaudoise – Current Investment Recommendation (451 CHF per Share)

     

    Banque Cantonale Vaudoise (“BCVN”) is the leading private bank, asset manager, and retail bank operator in the Canton of Vaud (“Vaud”), a highly affluent, french-speaking region of Swizerland spanning from Geneva to Lausanne. Its private banking franchise manages 85bn CHF in AuM, and contributes roughly 60% of total operating income. It grew north of 10% in 2007, and exhibits low churn statistics of less than 1.5% per annum based BCVN’s tight-knit demographic, and exceedingly high brand equity in its niche region.  The remaining 40% stems from retail banking, and some 10% from trading operations.  BCVN has been building cash for several years, unable to distribute any meaningful amount beyond a paltry 1-2% dividend yield, for political reasons discussed below. Today, BCVN has roughly 60% of its market capitalization in excess capital by Tier 1 and Basel standards.  Management will confirm this fact.  Ex-cash, BCVN trades at 3.4X “earnings power”, which is equivalent to free cash flow, versus its peer-group at 15x (comprised of a 50/50 blend of Swiss Cantonal Banks and Swiss Private Banks and Asset Managers).  BCVN trades at 1.2X Price/Book, penalized by its unimpressive 10.8% ROE, versus a blended peer average of 2.0X Price/Book with an average ROE of 17.3%.  BCVN could reduce its capital by roughly 2.2bn CHF through dividend or share-repurchase, without affecting its core earnings (reasonably, assuming the cash earns 2%, earnings power should be reduced by 44mm per annum, which has been assumed for purposes of this analysis). It is our view that once the capital distribution is communicated/implemented/accomplished, the resulting dramatic improvement in ROE will further underpin a large re-rating based on Price/book multiple convergence, in line with blended peers, given that the present large ROE gap will be entirely closed.[1] 

     

    Brief History

    BCVN ran into severe financial difficulties in 2001 and 2002 when it was forced to recognize the true value of its loans in its balance sheet. An emergency injection of capital by Vaud in the form of equity and participation certificates (PCs) bolstered the bank’s solvency, and a new management team was appointed, beginning a program to restore the bank’s profitability and lessening the burden of impaired loans. Alexander Zeller, who oversaw a dramatic restructuring at CS Asset Management, triggered our interest in the situation as early as 2004.  As the turnaround plan began to bear fruit in 2003-2005, surplus cash was used, in part, to repurchase Vaud’s entire Particiption Certificates stake. Today, Vaud retains only a 67% interest in BCVN’s common equity, which for nebulous political reasons, has, until now, precluded BCVN from distributing its excess capital.  Given Vaud’s critical role in the rescue of the bank, the company has explained to investors that it had been, until now, respecting its agreement with Vaud, and wait for it to sell its stake down below 50%, in order to commence a cash distribution program.  (Upon information and belief, this “no-distribution” policy was based more upon sovereign commitment and community relations than corporate mandate).  In late 2007, after management and shareholders waited patiently for the conclusion of both Vaud’s strategic review of its stake, the company has begun communicating to investors in the past weeks that they would wait no longer, and the capital distribution policy would be announced at year end results in March 2008, making this an ideal time to examine the investment case.

     

    Expected Plan for Capital Distribution

    Based on Conversations with management, the plan that seems most likely is a 10-year bullet dividend that will see the cash surplus and an aggressive net income distribution bundled together.  Based on my estimates, dividend yield under this model will be 14% in 2008 trending close to 19% at the end of the 10-year period in 2017 (see below).  The company’s rationale for such a structure, understandably, has been to try to retain stability in the shareholder base, rather than inject a large arbitrage community into its shares.

     

    Whether the stock re-rates on a dividend yield, or on a P/E basis ex-excess capital, or a P/E basis ex-present value of excess capital distributions (or similarly, on a P/book basis post balance sheet engineering), the stock appears extraordinarily undervalued, with scope for a medium-term double, if not triple.

     

    Lastly, the present value of the dividend stream anticipated attributes negative terminal value to the franchise post 2017, which supports the perspective that the market is valuing BCVN entirely incorrectly.

     

     


     Abbreviated Financial Analysis – Focus on Dividend Distribution

    Due to Formatting issues, please see:  http://docs.google.com/Presentation?id=ddj7sb7w_9fmcj6hfj



     

     

     

     

     

     



    [1] Note: BCVN has inadequate coverage, and a catalyst for re-rating, beyond capital distribution, would be enhanced liquidity.  The certainty of a liquidity event materializing is lower than a cash distribution, but if it were to occur, would undoubtedly accelerate investor awareness of the investment proposition, placing its  liquidity (today only $700mm USD) closer to that of its larger, more liquid peer group.

    Catalyst

    Government Placing Q1/Q2
    Massive Cash Return
    Improved Coverage
    Re-rating post cash distribution

    Messages


    SubjectQuestions
    Entry02/04/2008 10:52 AM
    Memberdavid101
    Cgnlm,

    An interesting idea but the devil is in the details:

    1. Taxes - What tax implications are there for US investors regarding the dividends?

    2. Vaud - Since they control the majority of shares, can they block the dividend plan?

    3. Peers - What industry and companies did you use as comps in compiling the 2.0X price/book and 17.3% ROE statistics?

    4. What is their Tier 1 ratio currently? How much capital do they need to back the asset management business?

    5. Are they structered as a holding company?

    Thanks,

    David

    SubjectRE: Questions
    Entry02/04/2008 07:02 PM
    Membercgnlm995
    Hi David - thanks for your reply and questions
    1. Taxes - What tax implications are there for US investors regarding the dividends?
    This is a question that depends greatly on your dividend recapture program with your prime broker. I am going to give you a long answer, because the structure of the capital return has not been announced, and i do not know exactly how they will cater to their various constituents (i would note that US shareholders are not high on the constituent list).

    In Switzerland there is a 35% witholding tax on dividends and interest income. Under the double tax treaty beween the US and Switzerland, US investors should be able to reclaim 20-25% , with rough taxation of 15%. You would have to check with your lawyers with respect to a offshore fund structure.

    Some prime brokers offer ways around this problem, i.e. selling the shares before the dividend payment and buying a LEPO (Low Exercise Price Option, i.e. with a strike price of CHF 1.00) for a short time period. But i dont know if this is still standard practice.

    Often Swiss companies decide to distribute dividens, typically special dividends, by ways of nominal captial redution instead of paying an ordinary dividend. Nominal reductions are not subject to withholding tax and therefore tax efficient for foreign shareholders. In the case of BCV the nominal value or par value for each BCV share is CHF 62.50. Instead of paying a dividend of CHF 40, they could do a nominal reduction from CHF 62.50 to CHF 22.50. Often companies choose to pay a regular dividend by a normal dividend distribution and distribute the special dividend by nominal reduction. In the case of BCV I would expect this would be the most likely scenario to materialize.


    2. Vaud - Since they control the majority of shares, can they block the dividend plan?
    Realistically, you should expect that Vaud and Management are deciding this in conjunction with one another, and that Vaud is looking to maximize cash distributions. It has 11.5bn CHF of defecit for infrastructure projects, and BCVN sell-down and dividend policy is its only liquid vehicle for making a dent into this defecit. This is an important point.


    3. Peers - What industry and companies did you use as comps in compiling the 2.0X price/book and 17.3% ROE statistics?

    EFG International (SWX:EFGN) 24.00
    Julius Baer Holding AG (VIRTX:BAER) 14.50
    Luzerner Kantonalbank (SWX:LUKN) 18.10
    Partners Group (SWX:PGHN) 94.60
    St. Galler Kantonalbank (SWX:SGKN) 14.60
    Vontobel Holding AG (SWX:VONN) 19.65

    High 94.60
    Low 14.50
    Mean 30.91
    Median 18.88

    Company Name P/TangBV
    Berner Kantonalbank (SWX:BEKN) NM
    EFG International (SWX:EFGN) 4.3x
    Julius Baer Holding AG (VIRTX:BAER) NM
    Luzerner Kantonalbank (SWX:LUKN) 2.0x
    Partners Group (SWX:PGHN) NM
    St. Galler Kantonalbank (SWX:SGKN) 1.7x
    Vontobel Holding AG (SWX:VONN) 2.5x

    High 4.3x
    Low 1.7x
    Mean 2.6x
    Median 2.2x

    4. What is their Tier 1 ratio currently? How much capital do they need to back the asset management business?
    Tier 1 has not been disclosed as of year end, but 20% would be a likely estimate. 9-10% is the capital adequacy requirement in Switzerland, which you'll notice is far more conservative than other W.European countries. I have assumed a 12% threshold is maintained for conservatism.


    5. Are they structered as a holding company?
    No.

    SubjectRE: Vaud
    Entry02/05/2008 09:02 PM
    Membercgnlm995
    very good. this is a very timely idea. i believe they have employed GS and CSFB to advise them on their options. From my perspective, there would be many private institutions that would employ leverage to buy this minority stake given the certainty of the cash flows. However, I hope it is placed in the open market. Speak with the company and try to get a sense for their direction. Calling the banks is another option. I believe the "premium" they could get for their stake is less important to them than making sure they are the most important and reference shareholder. I believe there will be a placement. But, if you or I can buy the stock on leverage for the dividend income, a PE shop could certaintly draw the same conclusion.

    SubjectExc. capital seems overstated
    Entry02/08/2008 01:56 PM
    Memberthistle933
    My conversation with the company also came out with different conclusion as to excess capital than your writeup. They will have roughly 1.7B excess capital at 2008 (not 2.2B, since the relevant thresholds are set by Swiss law, not Basel), but even that amount is not free for distribution. The Swiss regulatory body can be expected to require at least a 20% increment to minimum required level (an extra 360mm by my calculation), with 25-30% out of the question. A 30% premium would reduce excess capital, for practical purposes of distribution, to 1.3B swiss francs. If it takes them 5-10 years to distribute that, the excess capital has an NPV of roughly 60-125 francs per share, leaving a net value on today's stock of around 400 francs. Since you indicate the bank will earn roughly 40-45 francs per share in 09, the earnings yield is not much better than 10%. They make very clear they will pay out significantly less than 95% of their earnings (with current excess capital being additional to that), using the remainder, presumably, to pad an eternally overcapitalized balance sheet. It just seems like yet another Swiss bank run and regulated for purposes of bolstering the Swiss reputation for financial conservatism rather than prudently maximizing shareholder value. For an even more egregious example of this phenomenom, see Hypothekarbank. I don't have a good enough sense of the quality and growth at the underlying bank to say whether 10x earnings is a low enough price to compensate for all the warts here.

    Any thoughts you have on any of the above would be welcome.

    Subjecttypo
    Entry02/08/2008 01:59 PM
    Memberthistle933
    Correction - I said below that the regulators requiring 25-30% premium to minimum capital levels is out of the question; I meant to say that it is not out of the question.

    SubjectRE: typo
    Entry02/09/2008 02:42 PM
    Membercgnlm995
    Yes, I agree on the level of excess capital. I agree, because, I spoke to them last week, and they had changed their tune, which unfortunately is the case with IR there. His commentary is not always consistent with that of management. He is very smart however, but somewhat cagey. They can payout 2.2 without breaking compliance with basel, it sounds like they just will not.
    I was traveling last week but wanted to post an addendum. But with regard to payout ratio, the CEO himself told me 100%, and I modeled 90%. But I disagree with you about your valuation. They will earn conservatively 400mm CHF, earnings growing high single digits, and with the lower payout figure, that leaves the stock at 5X FCF. This company is a private bank and asset manager first, with a retail operation second. The company will be trading on a 12%+ dividend yield if they space the dividend out over 10 years. That will halve, at worst.

    SubjectRE: Comments/ Valuation
    Entry02/10/2008 06:25 PM
    Membermitch395
    it is a little frustrating because investor relations communicates a very different message than senior management. however, to get the benefit of their perspective, a trip to lausanne is necessary. I agree 1.7bn is the number after speaking to the company last week. but the AM division is showing very strong growth, and on my figures will contribute 3/4 of op profit by 2009. This business is a 15 multiple business at least. If you are willing to hold for 2 years, 300mm of AM profitsX15 + 1.7bn excess capital + 3.2bnCHF tangible book value ('07) of retail ops = ~9.4bn CHF or 2.5x upside. Otherwise, on a div yield basis, I get at min a 11-12% div yield growing 5% p.a. This will halve at least rather quickly. 10 years is too long for people not to revalue it on a dividend yield basis. Hope this helps.

    SubjectUpdate
    Entry05/06/2008 11:10 AM
    Membernantembo629
    This seems like a very interesting idea and I would like to dig in more. Any thoughts on the recent earnings announcement and how that changes your view (if at all)

    Thanks in advance
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