Mkt Price: GBP 3.75p
Mkt Cap: GBP 66.2 mio
Equity/Total Assets Ratio: 69.2%
P/B Ratio: 0.46 (adjusted)
Price/Cash Ratio: 0.61 (adjusted)
Congrats if you guessed I was referring to the European Islamic Investment Bank in my last post! EIIB’s the first independent Sharia’a compliant Islamic bank authorized by the FSA. Headquartered in London, EIIB offers Sharia’a compliant treasury, investment, private equity and investment banking services. Established in early 2005, their FSA authorization process took a little over a year to complete. The bank then immediately opened up for business, following up with an IPO a month later. Fortunately, these were the boom times (aah, remember those days..?!) and they raised an impressive GBP 183 mio of Equity from a private placing and their IPO.
Using this Equity base, Total Assets were slowly ramped up to reach a peak of GBP 347 mio in June 2008. The intention was to invest primarily in Sharia’a compliant lending and Sukuk. Fortunately, the bulk of the B/S remained invested in inter-bank lending. With the market deep in the throes of the credit crunch at the time, it would be kind to presume this was a deliberate investment policy. Considering some of the bank’s other stop/start initiatives, the more likely reality was that the bank was slow to get their business and personnel up and running – so funds were placed on inter-bank deposit by default. Whatever the strategy was, it was overtaken by events and Assets have been gradually run down to GBP 218 mio since. Fortunately, this lack of leverage and exposure saved shareholders from some of the worst ravages of the crunch, leaving Equity standing at GBP 151.1 mio today.
Needless to say, the poor roll-out of the business, poor news flow, loan/Sukuk writedowns and underlying operational losses since 2008 have cratered the share price and valuation. In the past year, EIIB’s closing share price has oscillated between GBP 2.4p and 4.0p, so looking at today’s share price we have to ask if a potential break higher is on the cards soon? But first, let’s focus on the current strength and valuation of the business:
EIIB’s certainly the best capitalized bank I’ve ever come across, I challenge you to find a stronger bank globally! And, please, let’s not discuss monkey business like Tier 1 Capital, you’ll just scare the horses… Why, you may ask? Well, years ago I naively thought that a bank’s Tier 1 Capital Ratio pretty much boiled down to Equity divided by Total Assets, with some minor tweaks. Nope, not at all, it’s actually defined as Core Capital divided by Total Risk-Weighted Assets. This turns out to be a very different beast. Core Capital generally used to correspond to Equity (Ordinary plus Preferred Share Capital), but became horribly corrupted in the past decade with all kinds of contingent/subordinated debt instruments masquerading as Equity. Risk-Weighted Assets is even worse – you apply a risk weighting to each Asset depending on its risk level. So, for example, the more risk-free Assets you hold the lower the Total Assets figure in the equation…well, that is until the risk-free Assets are no longer risk-free… And this is exactly how banks could boast of, say, a perfectly acceptable 9% Tier 1 Ratio, only to end up crushed under the weight of 30-40 times leverage and begging for a bail-out. Shame on me, personally it took me a very long time to finally reconcile one stat. to the other.
Call me simple, but whenever I analyze a bank’s financials now (never more than once a year, doctor!) I have a very simple approach. Skip all that glossy text and pictures in the annual report, skip straight to the B/S and calculate the one really important ratio: Equity/Total Assets. I think it’s acceptable to include Preferred Equity but nothing else, and I want to see at least a 7% Ratio. Goldman Sachs (GS:US), for example, currently has a 7.4% Equity/Total Assets Ratio – for a bank of their calibre, I can live with that. EIIB, on the other hand, has a ratio of GBP 151.1 mio Equity / GBP 218.4 mio Total Assets = 69.2%.
It’s also incredibly liquid (I think it’s safe to presume inter-bank deposits are short term, 3 mths or less). I calculate Net Cash on the following basis:
GBP 17.441 mio Cash + 91.811 Due from Institutions – 40.352 Due to Institutions + 29.600 TriTech Proceeds – 0.923 DiamondCorp Placing + 13.600 Turath Fund Closing Proceeds – 2.787 Estimated Restructuring & Operational Losses since Interims = GBP 108.4 mio Net Cash
This gives us a Price/Cash Ratio of 0.61. For Price/Book, I’ll make two small adjustments to Equity : First, a mark-to-mark valuation of their 23.0% holding in DiamondCorp (DCP:LN). This stake is composed of 55.761 mio shares valued/purchased @ GBP 13p, vs. a current GBP 5.75p share price. Second, an allowance for one year of estimated operational losses. These will be reduced by the recently announced restructuring (at a cost of GBP 0.75 mio) which halves headcount and will produce annualized cost savings of 40%. I would therefore calculate Current Adjusted Book to be:
GBP 151.148 mio Equity – (55.761 mio Shares * GBP 7.25p Loss) – (4.266 Restructuring/Operational Losses) = GBP 142.839 mio Book / 1,765. 659 mio Shares Outstanding = GBP 8.09p per share
Therefore, P/B currently stands at 0.46. Hopefully we’ll finally see some improvement in Revenues, plus some further cost control, but if not I calculate that annual operational losses will now only amount to about 1.6% of current adjusted Book. This is acceptable. So, we clearly have a very attractive Margin of Safety, as measured from a number of perspectives. What does this mean in terms of Fair Value? Considering the writedowns to date, the operational losses and the unlisted investments, one can certainly argue for a discount to Book Value, but before homing in on a final number I’ll cover some further qualitative analysis in my next post.