Australia | Jul 20 2007
By Greg Peel
And the Academy award goes to…Alan Moss. Again.
So entrenched has the Macquarie Bank charade of understating guidance become, that profit upgrades are starting to be anticipated with about as much excitement as another instalment of Big Brother. There wasn’t an analyst in town who hadn’t already set its first quarter result forecast some significant level above Macquarie Bank (MBL) management’s year-end (March) guidance, and Alan Moss didn’t disappoint.
Well bugger me if first quarter profit wasn’t “substantially up” on the previous corresponding period. And who’d have believed Nick “Much” Moore’s Investment Banking Group would have pitched in with 62% of the booty? It only looks after such things as specialist funds, M&A and IPOs. However, there was an element of surprise from analysts as to just how broad based the bank’s result proved to be. It seems even the mailroom is firing on all cylinders.
Despite analysts having played the second guessing game, earnings upgrades have still followed, mostly in the single digits. It’s a bit hard not to pay attention to the sort of figures being achieved in assets sales, the extraordinary flows in funds under management (as a result of new super laws), the performance fees being extracted from the multitude of specialist funds, and the performance of stockbroking.
Damn the torpedoes, full steam ahead.
But, indeed, there have been torpedoes fired. Back in May, when the stock price was roughly where it is now, legendary US analyst Jim Chanos called the Macquarie model into question. As a successful “short seller”, Chanos suggested that Macquarie “relies heavily on off-balance sheet financing and related party transactions”. People listen to Chanos, because he was the only player on Wall Street to pick Enron for the house of cards it was.
This was not the first time Macquarie has been compared to Enron. The problem is that the bank has developed businesses and new ways of making money that the average punter just doesn’t understand. The Enron name was brought up back in 2005 when the bank’s shares fell 20% to about $62 as the world was turning against infrastructure funds and the Sydney Cross City Tunnel figuratively collapsed. At the time, the bank’s supposedly excessive debt was cited as a major concern in an environment where interest rates were on the rise.
Suffice to say, that was 50% ago.
The story hasn’t changed however, and the latest debt concerns revolve around the current US subprime mortgage crisis. Alan Moss was asked at the pre-AGM media briefing yesterday what the sum total of the bank’s debt actually was. He couldn’t answer. He was also asked what the bank’s exposure to subprime mortgages might be. He couldn’t answer that either, but suggested it would be insignificant.
That the CEO did not have these figures immediately to hand may seem disconcerting, but one has to know Alan Moss. While Enron disappeared up its own backside of creative accounting, Moss cut his teeth as the head of Treasury for the bank in a time of excessive market volatility that culminated in, among other things, the stock market crash of 1987. And his field of expertise was risk management. Macquarie Bank wrote the book on sensitivity analyses and tough trading limits, to the exaltation of its competitors.
On the night of October 20, 1987, Macquarie’s SPI options proprietary book was inside its limit extremes, which included a limit for the stock market gapping down 10% in a day. The next day the book was looking at losses of $12 million – a rather extraordinary amount in those days – but by week’s end had pulled the loss back to only $1 million. While Macquarie stood unscathed amongst the carcasses of other proprietary traders, the experience nevertheless rattled Alan Moss, and he immediately imposed limits that would take into account an overnight gap of 40%. As the current CEO, there is nothing to suggest Moss’s strict conservatism has changed.
But the market doesn’t necessarily see it that way, and nor does Jim Chanos. While every broker in the FNArena database has set a share price target in excess of $100, they do not all have Buy ratings. One of Macquarie Bank’s biggest problems is market perception. It is not just the overpaid executives chestnut (although that doesn’t help), it’s the sheer disbelief in the bank’s world-conquering innovation. There just must be something fishy going on.
To some extent, Macquarie is almost a victim of its own success.
Management is quick to point out that Macquarie’s ongoing upside profit surprises are born of an unprecedented financial market environment that cannot last forever. Analysts further acknowledge that were the market to turn a bit sour, the party will be over. Not that Macquarie would suddenly suffer losses, but the market would run for the exits. There are a lot of one-off income items that rely on asset sales, performance fees, enterprise capital management and market turnover.
Respected left-of-field (and ex-Macquarie cadet) bank analyst Brian Johnson, of JP Morgan, lists his first “risk to price target” of $106.94 as “perceptions of arrogance”. Only then does he add the more tangible risks of rising real interest rates, seed asset valuation risk, and conglomerate management risk (Macquarie has now grown bigger offshore than it is on).
Nevertheless, Johnson rates Macquarie as Overweight. He has also, for some time now, maintained a split valuation model. Johnson considers Macquarie to be only 60% an investment bank and 40% a fund manager. His “unstressed” forecasts provide the target of $106.94, but his “upwardly stressed” forecasts provide a figure of $120.93. Take your pick.
Of the ten brokers and consultants in the FNArena database, two rate Macquarie as Hold. If you remove Macquarie itself from the group (it’s not allowed to put a recommendation on itself) and Credit Suisse, who is currently involved in something that means it’s restricted, then 2 in 8 or 25% of the database does not want to buy Macquarie Bank here.
Merrill Lynch (who only sets targets on Buy ratings) notes that Macquarie’s attempt to restructure into an internationally recognised Non-Operating Holding Company (a move that would reduce capital adequacy requirements and allow the exploitation of greater debt) is “on track” but that management noted “changes are very difficult to forecast and could be materially negative in respect to regulatory capital ratios in some circumstances”.
To that end the Merrills’ analysts have suggested “We believe the rising capital intensity of Macquarie’s model pushing against an increasingly geared bank has been an issue for some time and these statements add a note of concern.”
GSJB Were (who normally doesn’t set targets, but has in this case) shares a similar concern over “riskier” earnings streams. The analysts suggest the stock price might look cheap when comparing to the long term historical average PE of 17.5x, but the analysts prefer to apply 10x to the asset sales business and 17x to the rest. The brings us to 15.3x, and implies that Macquarie “is currently trading on a full multiple”.
Amongst the more positive reviewers, Deutsche Bank makes note of the capital adequacy uncertainty but suggests an adverse impact on Macquarie’s regulatory capital position would be only a “worst case scenario” at this point. At the current share price, says Deutsche, Macquarie represents “an excellent buying opportunity”.
UBS, on the other hand, found little to be concerned about and shot its target up from $110 to $114.
This leaves the B/H/S ratio at 6/2/0. The average target is $109.23, some 21% above the 1pm trading price of $90.40 (the stock is off 1.4% today). Targets range from $100.29 (Weres) to $114.14 (Citi).
Neither Citi, ABN Amro or Aspect Huntley have reported this morning, but I’m sure we’ll learn their thoughts in due course.