Tags
activist investors, DiamondCorp, EIIB, Equity/Total Assets, HBG Holdings, Margin of Safety, Sharia'a, sukuk, value investing
European Islamic Investment Bank (EIIB:LN)
Mkt Price: GBP 3.625p
Mkt Cap: GBP 64.0 mio
Equity/Total Assets Ratio: 69.2%
P/B Ratio: 0.45 (adjusted)
P/C Ratio: 0.59 (adjusted)
Fair Value: GBP 8.09p
Upside Potential: 123%
Continuing from my previous EIIB post: Let’s not forget that EIIB is a bank. Why am I re-stating the obvious? Well, I know it seems like banks are ten a penny (actually true in the US, with a recent count of 6,500 banks, if you can believe it!), but a new banking licence in the UK is a pretty rare thing. Especially an Islamic banking licence. I’ve no real idea of how much that’s worth, but it’s certainly a valuable intangible that isn’t listed anywhere on the B/S. EIIB presents a cheap entry to any financial institution who’s contemplating entering (or bulking up) in the UK and/or the Islamic finance market. When you consider the strength of EIIB’s B/S, the FSA licence (which would otherwise take at least a year to obtain) and the potential business contacts/opportunities gained, why not pay a premium to Book in a takeover situation? One should also consider the leverage potential implied – EIIB could almost quadruple its B/S, still be considered a very safe bank (with a near 20% Equity/Total Assets Ratio) and presumably achieve a radical transformation of its P&L and Return on Equity. Nobody’s cup of tea right now, and not a strategy that is being signaled by the company, but still something to consider…
In reality, with EIIB appearing to now give up on being an asset manager, the company seems to be focusing on in-house private equity investment. This may not be such a surprise, particularly when one notes the arrival of HBG Holdings on the share register earlier this year with a 15.6% stake. HBG’s a private equity fund management business, which serves private and institutional Gulf clients. Commenting on the acquisition, Michael Toxvaerd, Chief Investment Officer of HBG said, “The strategic stake in EIIB is in keeping with our objective of investing in undervalued AIM listed companies. We believe there is significant upside potential in this business and we hope to play an active role in unlocking value”. Shortly thereafter, Toxvaerd and HBG’s CEO joined EIIB’s board as directors.
OK, so perhaps we’re really dealing a private equity fund? One that should now have a reasonable annual expense ratio of 1.6%. How can we judge their record on this basis? Well, we don’t have that much to go on. DiamondCorp (DCP:LN) is still a fairly early stage investment, and they’ve made what appear to be some other small but smart purchases…but based on the very successful divestment of TriTech (at an IRR of 35%+) and hands-on guidance from HBG, I’m prepared to give them the benefit of the doubt.
Let’s put all this together: We have an attractive investment thesis – Islamic finance is one of the most direct conduits to current and future oil wealth, but it’s still a relatively niche area in the Western world. EIIB is a Sharia’a compliant bank/investment manager, located in London with a valuable FSA licence. It has minimized leverage in response to the current market environment, its B/S has been marked down for loan/Sukuk losses, and it’s now minimizing its annual expenses. It has an additional Margin of Safety in its cheap P/C and P/B Ratios. It now appears to be making private equity a primary focus, coupled with an activist private equity investor with a significant stake, a stated agenda and meaningful board representation. Its share price chart suggests a potentially significant move higher if the current trading range is broken. Taking all this together, I’d assign a Fair Value equal to the current Adjusted Book Value of GBP 8.09p per share, offering a 123% Upside Potential. I already mentioned in my previous post that EIIB is now my second largest portfolio holding at 5.8%.
ps Two other positive factors to mention: First, a little snippet buried in EIIB’s June announcement of the TriTech divestment: “…The result of this transaction is expected to potentially put EIIB in a position to pay a dividend in respect of 2011…”. A dividend will simply reduce Book and Fair Value, of course, but I haven’t seen any mention of dividend anywhere else since then, so any confirmation may prove a pleasant surprise and hopefully attract some fresh attention and investors… Second was EIIB’s retirement of 3.3% of its Shares in Nov 2009 through a tender offer at GBP 7p, a premium of 141% to the market price at the time!
History doesn’t necessarily repeat itself, but there was another very interesting wrinkle in the tender offer…tender applications were only accepted for up to 500,000 shares per Qualifying Shareholders. A happy accident for some shareholders if they had a larger shareholding built up across more than one broker, and/or had other family members holding shares also..! And, of course, I should mention that you need to be very wary of nominee shareholdings if a similar tender offer were to reoccur. If your broker happens to have more than one client in the stock, they need to make absolutely sure that the tender agent accepts/recognizes a separate tender application for each client (even though there is only one nominee shareholder, the broker). I can’t stress this enough – in the event, jump in your car and drive all the way to your broker to discuss in person, if necessary! It’s worth it, no point in hearing happy news of a tender and then finding out some/all of your shares weren’t accepted because of some back office temp muppet getting it wrong… But anyway, that’s all potential icing on the cake – regardless, EIIB is an interesting niche business, and a safe and cheap stock with a potential activist catalyst!
Wexboy 
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Hi Wexboy. Interesting post. I used to run a banks fund in a previous life, so I sympathise with your views on Tier 1 calculations. IMHO, the risk weighting of assets has been the single greatest reason as to why we are in an ongoing banking, liquidity and credit. It allowed banks and regulators to believe their assets were smaller than in reality. Unfortunately for them and the taxpayer, liabillities (ie funding) cannot be risk weighted. Ths the only way these huge balance sheets could be funded was through the shadow banking system. That as we know is history.
This leads me to Assets/Equity. One would think that it should be followed as an appropriate yardstick for leverage and thus safety. But that does not lead one to necessarily interesting investments in the banking universe.
For example, Svenska Handelsbanken and DNBNOR have equity to assets ratios of 3.7% and 5% respectively. In both cases the loan/deposit ratios are amongst the highest in Europe. Yet both banks have fared incredibly well during the past three years (one is +50% and the other is +150% – nice money if you can get it). The key for both I think is that they remained profitable and provisions remained low.
At the other end of the spectrum, several Italian banks entered the crises with very low leverage and reasonable funding metrics. For example UBI Banca in the wealthy Lombardy region of Italy has an equity/assets ratio of 8.3% and a loan to deposit ratio of 98%. Meanwhile the stock has cratered and will be forced to raise equity.
The key in all of this is that it has a low level of profitability, and while it did not make risky loans in the fashion of Irish, UK or Spanish banks, its funding cost is linked to the price of Italian debt and it holds Italian debt. These will erode capital.
Capital cannot be divorced from profitability. Thus in the case of EIIB, while the bank looks to be very robust and is trading on a very low book multiple, this is not helped by the investor having no idea as to will they every earn a profit, and if so what size will this profit be versus the equity it holds. I guess what I am saying is that I would be wary of saying that holding a lot of equity makes a bank safe. It depends on what type of assets that equity is supporting, and what is the carrying cost of liabillities. To buy banks purely on the basis of equity and funding should be intuitive, but sometimes it is anything but.
My interest is piqued by EIIB, so I will add it to my list and see how it fares – thank you for that.
John