Thursday, July 12, 2007

'Sell' Signal Favors RBS


Royal Bank of Scotland so far has benefited from activist investors targeting other banks involved in the battle for ABN Amro. But maybe the Scottish bank itself should be the focus of shareholders. RBS chief Fred Goodwin could increase the bank's stock market value more by selling Citizens Financial -- its retail banking franchise based in Providence, R.I. -- than by buying another rival.

RBS potentially is in a position to carve up Amsterdam's ABN because hedge funds agitated for the bank to be broken up. Meanwhile, its main rival as a suitor for ABN, the United Kingdom's Barclays, has been told by another activist that it shouldn't bid because to do so would hurt its shareholders. But RBS hasn't made a watertight case that its shareholders will benefit from its own bid for parts of ABN, including its Chicago-based LaSalle.

Citizens should earn about £1.1 billion ($2.2 billion) next year, less than 15% of the bank's total, according to J.P. Morgan. But assume it could be sold for the same 19 times 2008 earnings that Bank of America -- another bank involved in the complex battle over ABN -- has offered for LaSalle.

On that basis, Citizens would fetch nearly £21 billion. That would amount to a third of RBS's £60 billion market cap. If Mr. Goodwin handed that to shareholders, the remainder of RBS (mainly British retail and corporate banking and insurance) would be worth £39 billion -- or only about six times earnings.

That's cheap. Investors would be more likely to value those earnings on a multiple of some 8.9 times, in line with U.K. peers. That would value the business at about £57 billion -- or an extra £18 billion -- equal to 30% of the group's current market value.

Sure, there would be some negative consequences. Selling Citizens might trigger a capital-gains tax bill. RBS's strategy of building a trans-Atlantic business would be in tatters. Finally, Citizens is particularly well capitalized, so some of the sale proceeds might be needed to shore up the rest of the group's capital.

Even so, the value creation would still be substantial. Hedge funds searching for another target for bank activism might want to turn their attention to Edinburgh.

BRICs of Steel

Why do steel producers in the so-called BRIC countries (Brazil, Russia, India and China) seem to go crazy when shopping abroad? Gerdau, a Brazilian steelmaker, joins India's Tata Steel and Hindalco and Russia's Evraz, in forking over big bucks for a developed-world rival. It is paying $4.22 billion to acquire Chaparral Steel.

As with Hindalco's takeover of Canada's Novelis earlier this year, or indeed Tata Steel's takeover of Britain's Corus, the strategy looks sensible enough. With Chaparral, Gerdau vaults to the fourth-largest U.S. steel player, by tonnage, from No. 5. It also diversifies away from its South American base.

And the deal confers more than bragging rights. Gerdau hopes to squeeze $55 million of costs from Chaparral, based in Midlothian, Texas. Unfortunately for Gerdau shareholders, just like Tata and Hindalco before it, the finances of the transaction don't stack up.

Consider the value of the synergies today to shareholders of Gerdau Ameristeel, the U.S. listed subsidiary making the purchase. After taxes -- and once discounted back to reflect that the cost savings won't arrive until 2008 -- they are probably worth about $350 million to shareholders. The trouble is that Gerdau is paying about $1.04 billion more than Chaparral was valued at before it put itself up for sale in April.

Subtract from that premium the implied worth of the promised cost cuts and it looks like Ameristeel has overpaid to the tune of a whopping $700 million. Lucky for Gerdau, its investors have not punished the company so viciously. They generously marked down Ameristeel's market capitalization by only about $360 million, or 7.5%.

--Mike Verdin and Rob Cox (Wall Street Journal)

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