Are RBS shares on a dotcom!!! valuation?

Are RBS shares on a dotcom!!! valuation?

28 Feb 2014

You might have heard that The Royal Bank of Scotland (RBS) delivered some disappointing results yesterday. Underlying operating profit fell by 15% to £2.5 billion and the shares fell by 8%. But you might be surprised that it made a profit at all, given that the reporting of the figures and the interviewing of the latest CEO were generally hostile. Well, here’s a point. The net result, discouragingly referred to as “attributable to ordinary shareholders” was rather a long way shy of the £2.5 billion underlying operating profit – it was in fact a loss of £9 billion. If you want to know how these figures are related, the earnings release has 225 pages to help you get up to speed.

But before you do that, I would like to draw your attention to the report for 2008. Over a mere 99 pages, a modest underlying operating profit of £80 million somehow delivered a loss of £24 billion to those very ordinary shareholders.

If you are wondering what damaged that hapless underlying profit so badly, it included:

“Credit market write-downs and one-off items, purchased intangibles amortisation, write-down of goodwill and other intangible assets, integration costs, restructuring costs and share of shared assets”.

Stuff, essentially.

In case you think that the bank is putting a deceptive spin on its results, it explains itself as follows.

“The financial information on pages 23 to 81, prepared using the Group’s accounting policies, shows the underlying performance of the Group on a managed basis which excludes certain one-off and other items. Information is provided in this form to give a better understanding of the results of the Group’s operations.”

In other words, if you think that the bank made £2.5 billion rather than lost £9 billion, you will be understanding it better. You will be better informed than the FT (“Royal Bank of Scotland slides to £9bn loss for 2013”) and the BBC (“RBS shares fall after biggest loss since financial crisis”).

The dictionary definition of “underlying” is interesting.

1. Lying under or beneath something: underlying strata.

2. Basic; fundamental.

3. Present but not obvious; implicit: an underlying meaning.

4. Taking precedence; prior: an underlying financial claim.

I think we can all agree with definition 3, that if RBS’s profitability was present, it was not obvious. Certainly RBS’ largest shareholder, the UK government (82%), will appreciate the irony of definition 4: “an underlying financial claim”. You can say that again.

In 2001, RBS was transformed by the takeover of the much larger NatWest (and Fred Goodwin took over as CEO). That was when RBS became the international bank that it is now. Over the subsequent 13 years, the aggregate result attributable to ordinary shareholders is a loss of £17 billion. (If anyone wants to point out that these were accounting losses they can go and boil their head – these were write-downs of acquisitions bought for cash).

I am a novice in banking analysis but I feel justified in stating my suspicion that RBS is a failed experiment. I am somewhat mystified by the lingering belief that, if we wait patiently enough, it will succeed. But why else would it still command a market capitalisation of £40 billion?

There is plenty of talk around now of the return of stupid technology valuations. , Twitter and Blinkx spring to mind (I have no strong view on any of these stocks other than the knowledge that I don’t want to own them at the moment). But I have never seen a technology company commanding a £40 billion valuation as a reward for losing £17 billion over 13 years.

The view that huge banks can deliver regular annual returns on capital of more than 10% appears to have been an illusion. Profitable years that subsequently get adjusted away were never profitable years. Banking was once supposed to be dull and low margin. Bankers were supposed to be able to sleep at night. Do we not all profoundly wish to return to this business model? Well, nearly all of us. If you work for UK Financial Investments Ltd, managing the government’s stakes in RBS and Lloyds, you might take a different view.

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