Well it was certainly a week to forget for shareholders in beleaguered “challenger” bank – Metro Bank. From scratching near 320p a week ago Friday the stock, incredibly, fell by over 50% from this level by mid last week to just 155p at its low point – a decimation in market capitalisation of near £300m. The reason is well known now and does not need re-hashing here – essentially it was the company’s own pulling of a so called “MREL” bond due to a shortfall of the target sum of £200m at a pretty punchy interest of 7.5% that caused a crisis of confidence in management.
With the stock being heavily shorted by some of the big name hedge funds such as Marshall Wace and ”Mr Brexit” Crispin Odey, these big guns did what they do best – pile pressure on when management least needed it. Hence the dramatic drop. We also hear that there were quite a number of heavily leveraged large private investor positions that were forced out as the stock fell precipitously throughout Tuesday into Wednesday. Indeed, we note that margin levels here are now very punitive both on the long and short side – an indicator of the perceived risk in the stock. Of course, the fundamental law of investment ref the correlation between risk and reward remains true.
So, the million dollar question – what plays out now? Honest answer is we do not know, nor indeed does anybody else aside from management and their close advisers. All we can do (as with any investment) is to take the known facts and apply to the current valuation to establish whether we believe the stock to be bought, sold, held or avoided. Upfront – we remain long and indeed added on the weakness last Tuesday – the position in Metro now in our Top 5 holdings. We laid out the primary reasons HERE in early Aug. Thus far out of those 5 picks Metro has, it is fair to say, not played out as we expected.
Facts as we see it however now are that the bank is either forced into being acquired by one of many other potential parties from the big beasts in banking in the UK such as Barclays, any one of a number of overseas entities looking for a footprint in the UK with Capitec’s name being put in the frame through to a US player with even Goldman Sachs being touted as a potential acquirer. There was extensive commentary on this front last week in the press that investment bankers were actively hawking the proposition around. Events could move at a pace here in the days and weeks ahead.
The enviable shareholder base including the Toll brothers, Steve Cohen, Michael Bloomberg etc remains intact and they are all well under water. Should management request another equity check we would be amazed at this valuation if they did not step up. To us an equity raise looks extremely unlikely however as the irony of this situation is that the balance sheet is not actually stressed as the results on the 24th July made abundantly clear. The issue is one of opposing forces – hedge funds that are short trying to accelerate the current situation into a real crisis for the bank and management hoping to hold out for the 3Q results and key EU departure date (as intended!) of 31 October in order to reach calmer waters to retap the markets.
To conclude, this is a binary trade at this point – either a takeover/under (depending on price) is forced on the bank by the regulators a la the situation during the banking crisis of 2008/09 and matters are effectively taken out of managements hands or, fundamental reality asserts and the BoE provides them the breathing room to re-tap the markets for the MREL funding requirement due by 1 Jan 2020. It is intriguing that the Sunday Times are reporting a source “close to the BoE” this weekend that this “could” be granted. That tells me that the monetary authorities do not want to exacerbate the situation at this point. If the company is granted the breathing room to raise the MREL bonds and the 3Q results prove assuaging to investors there is every likelihood we see the shares trade closer to £4 or £5 than the current £2. It is worth re-iterating once again that at this price the stock is currently priced at less than 20% of book value, a near 10% discount discount to the last net cash amount raised of just under £375m and just a quarter of tangible book value. On any valuation measure the stock is extremely cheap. If the bank does continue as an independent entity, to make sense of the current valuation you either have to anticipate a run on the bank’s deposits that puts them out of business or a depletion of the loan book by way of NPLs (Non Performing Loans) of near 7% of the loan advanced base – an unheard of figure in the most vicious of historic recessions.
We also doubt that the FCA would hit the bank with a punitive and damaging fine in regards to the loan misclassification issue earlier this year. The MREL prospectus disclosures that many jumped on a couple of weeks ago was standard legal verbose that needs to be included – always paint the blackest picture is the mantra here. In fact, resolution of this issue would, on balance we believe, provide for a further relief rally event,
The absence of further commentary by management towards the end of last week as the stock seemed to be sinking into the abyss did surprise us aswell as many others. Some felt it was a dereliction of their duty to shareholders but, on reflection, whenever banks have historically told parties not to panic, they usually do precisely the opposite! What is abundantly clear is that they were not sat on their laurels. Further commentary this weekend in the press that Chairman Vernon Hill has been looking for support for the equity and the TR1 by 683 Capital Management on Friday coming on the heels of the Davis Selected Advisers where the 2 US funds now hold approaching near 9% of the float illustrates that other deep pocketed players see value here. By our calculations both these two new investors paid between 250 & 350p for their holdings. In short everyone is underwater on the long side here and a heavily dilutive secondary equity raise is most certainly not what any of these parties want.
As we saw with Kier that was shorted to a similar degree going into the summer and that rose from @ 60p to near 150p inside of several days, should short covering begin in earnest if momentum builds to the upside and the move north could be very sharp. The shares are quite “gappy” in their trading and as per the moves in late May this year, there is no reason to believe that we could not see a doubling and some on the stock in short order should any one of the catalysts above come to fruition.
To conclude, on pure valuation fundamentals the price makes no sense. Indeed it makes no sense sub £5 or £6 hence the big fund buying into the shares in recent weeks and the heavy support at the £5 raise level in mid May. We suspect Craig Donaldson will fall on his sword shortly and a big name CEO be brought on board to reinstall confidence. Speculation this weekend in the press of interest by activist investor Elliot Management run by Paul Singer should make clear to “Big V” that his unchallenged stewardship is coming to a close too. What is for sure is that the current status quo will not remain as such – 3Q results are to be revealed shortly and may be brought forward ref their disclosure, all but certain management changes and possible further new investor additions to the balance sheet etc could all prompt a sentiment change and ignite a return to realistic value. The stock is dramatically oversold. A move back towards 240/270p in short order looks to be on the cards to us just to correct the extreme negative sentiment.We remain long.
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