Deutsche Bank: Eisman versus Braunstein
Steve Eisman, portrayed in the movie "The Big Short" by Steve Carell, did not only predict the financial crisis of 2008. He profited from it. He therefore has a high credibility as a source of financial wisdom. Few people have the courage to bet on a stock that he is actively shorting. Doug Braunstein, the former CFO of JP Morgan, is such a person.
Here an excerpt from an interview with Eisman on October 16th:
Interviewer "For the past couple of years you have been short Deutsche Bank. Are you still short?"
Eisman "Still short Deutsche Bank. Three years and running. The problem Deutsche Bank now suffers from is they're trying to shrink themselves to profitability. And one thing we have learned time and time and time again post-crisis is that's impossible. And so they are going to shrink. And they are going to be less profitable. And then the stock will go even lower, and then we'll see."
Interviewer "Does it go under?"
Eisman "Banks go out of business for funding issues. There is no funding issue at this time of Deutsche Bank. This is really a profitability problem. What a bank does for a living is that it sells you access to its balance sheet for a price. So if you want to calculate what's the absolute return on a bank it's return on assets multiplied by its leverage. That is the return on equity. So the problem with European banks is that they have sold access to their balance sheets too cheaply for decades. And the return on assets has even gone down post-crisis and the leverage has gone down due to regulatory reasons. Deutsche Bank is just the extreme example of what plagues the European banks."
Doug Braunstein has over 30 years of industry experience, held a variety of positions during his tenure at JPMorgan Chase & Co and has worked on over $1 trillion in transactions. Here's what he said in an interview on July, 9th:
Interviewer "You built up a 3.1% position in Deutsche Bank in November 2018. You're the second biggest shareholder right now. You had said earlier that Christian Sewing is the right man for the right job at the right time. How do you grade this restructuring plan announcement?"
Braunstein "I'd actually give it an A because Christian has done more than many had hoped he would do and I am going to break that down into four different components. First is, at its core, this is really not a restructuring. This is a re-positioning of the company and changing the strategic direction and all the other components of this plan are going to flow from that. And what Christian is taking the bank back to is its 150 year old history of being one of the world's best commercial banks. It's consistent, it's stable, it's a little boring. As an investor, that's an exciting place for me to be. And then he's doing three other really important things. First, he's cutting back the investment bank to really focus on its core strengths and the places it has competitive advantages really built around the fixed income businesses, the credit businesses, FX businesses that serve those million corporate clients that are going to be housed in the commercial bank. The second thing he's doing is he's making the bank much more efficient. People are struggling with that. They are saying 'how can I raise revenue 2% while cutting costs at the same time?' And what the market hasn't quite come to understand is that of the 6 billion in restructuring, 5 billion is comprised of businesses they are exiting in this CRU (capital release unit) and 1.4 billion in incremental merger savings from the Postbank Deutsche Bank merger. That's anticipated to be executed on. That is really comparing apples and oranges. So he is digging deep into that efficiency. Third, he is changing the liquidity profile, the leverage ratio and the capital employment of the company and ultimately he is going to be running off 20% of the balance sheet in the next 18 months, liberate capital to make the changes he needs to from a restructuring standpoint and then this company becomes a capital generator that it can return to shareholders. And that's what I am most excited about."
So, who is right? A few days ago, Deutsche Bank provided a financial data supplement for the past few quarters based on its new segment reporting.
Page 7: In 2018, the corporate bank had 1.4 billion EUR of pretax profits on revenues of 5.2 billion, a margin of 26%, with a consistently high return on tangible equity of around 9% (between 6 und 14%).
Page 8: The investment bank made a pretax profit of 872 million EUR on revenues of 7.5 billion (margin of 12%) with a low return on tangible equity of around 2%.
Page 9: The private bank made a pretax profit of 621 million EUR on revenues of 8.7 billion (margin of 7%), a return on tangible equity of around 4%. This number should be increased significantly to >12% if the targeted post-merger synergies can be realized. In the first two quarters of 2019 it was already higher at 5%.
Page 10: Asset Management made a pretax profit of 368 million EUR on revenues of 2.2 billion (a margin of 17%) with a return on tangible equity of 19%.
After reviewing this, if Deutsche Bank manages to wind down its capital release unit (page 13) without loosing additional revenues and realize the targeted synergies, a return on tangible equity in the high single digits looks quite achievable. According to Eisman, that won't be possible. If it is, however, buying a tangible book value per share of 24.5 EUR that earns mid to high single digit returns for a price of a little over 7 EUR looks quite attractive, doesn't it?
Samuel S. Weber, M.A. HSG SIM
SW Kapitalpartner GmbH - Strategisch, Wertorientiert