By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
In retrospect, Barclays’s transformation from a 300-year-old Quaker High Street UK retail and corporate bank into a global capital markets colossus reflected the financial zeitgeist of post-Thatcher Britain in the 1990’s. Mrs. Thatcher had initiated a wave of seminal privatizations, economic reforms and injected a new capitalist ethos in the sceptred isle. This was amplified by Big Bang in 1986, the financial deregulation of the London stock exchange that enabled Barclays to buy stockbroker de Zoete Bevan and gilts jobber Wedd Durlacher. Yet the key moment in Barclays’s transformation was the appointment of ex-Morgan Stanley bond trader Bob Diamond as the chief executive of Barclays Capital, its embryonic investment bank.
Bob Diamond was only the second person in the history of the City of London to build a global investment bank in his own lifetime – after Sir Sigmund Warburg. Diamond made Barclays Capital a market leader in debt underwriting, loan trading and, above all, financial derivatives. In two decades, Barclays Capital contributed over 50% of Group profits and generated a stellar 16% return on capital. Apart from a trading scandal in the Russian rouble crisis of 1998, Diamond’s profit engine catapulted him into the top job at Barclays in 2011.
The Barclays Capital (Barcap) I knew and dealt with in London and Asia before the financial crisis was no stodgy Little England commercial bank but a cosmopolitan outpost of Wall Street in the heart of London. Diamond had built an aggressive risk-taking trading room culture at Barcap that unnerved British regulators, the Bank of England governor Dr. Mervyn King and the politicians in Westminster. In 2008, the subprime crisis gutted the world of finance with a vengeance. Barclays escaped a taxpayer-financed HM Treasury bailout, unlike Lloyds and RBS. Yet Barclays then CEO John Varley raised capital to escape nationalization in the autumn of 2008 with a controversial equity capital injection from GCC sovereign wealth funds, for which he and three colleagues now face a criminal trial.
Diamond bought Lehman Brothers’s equities/corporate finance businesses from the carcass of the failed Wall Street investment bank and sold Barclays Global Investors (BGI), the pioneer of index investing, to Black Rock in June 2009 for a $9 billion profit in order to boost Barclays’s post-crisis capital ratios. Yet a succession of scandals outraged regulators and led Dr. Mervyn King to pressure the bank’s board to fire him as CEO in 2012 after Barclays traders were implicated in the LIBOR manipulation scandal. It did not help his cause that his 2009 bonus was £27 million sterling at a time of financial distress in the UK.
Diamond’s successor Anthony Jenkins, a retail banker, sought to downsize Diamond’s investment bank, firing dozens of Barcap managing directors – some who were my trading counterparties. Jenkins was ousted by the board in 2015 and replaced with ex-JP Morgan investment banker Jes Staley. Staley was mandated to lead a turnaround at Barclays Capital, where profitability had sunk to a dismal 5% ROE. He also sold Barclays’s colonial era banking franchises in Africa (Absa) and the Middle East, in an attempt to refocus the Group on Anglo-American corporate and investment banking plus Barclay card/High Street retail banking.
Activist investor Edward Branson has accumulated a £1 billion stake in the bank in a bid to pressure the board to dramatically downsize Barclays Capital in a quest to boost Barclays’s valuation metrics, a shockingly low 0.6 times tangible book value. Yet Barclays share price has been devastated by boardroom palace coups, botched execution, the prospect of a hard Brexit and the Powell Fed’s U-turn in US monetary policy. It is ominous that Tiger Global, one of Wall Street’s top hedge funds, sold its 2.5% stake in the embattled UK bank. This is hardly a vote of confidence in Jes Staley’s turnaround vision for Barclays. It is sad to see Barclays, once one of the world’s top universal banks, trade at a mere 165 pence on the LSE or a pathetic market cap of £29 billion. Barclays had an annus horribilis in 2018 with a 23% fall in its share price, double the Footsie 100 Index. A 12% fall. The horror of a no deal Brexit haunts the City!
There are some good omens in Barclays at current levels. The dividend yield is a beauty at 4.2%. Pretax profits have begun to rise, albeit only when legal costs are stripped out. The bank comfortably passed the Old Lady of Threadneedle Street’s stress tests.
Barclays trades at a Cinderella valuation of 0.6 times tangible book value. I believe Barclays (and sterling) are grossly undervalued in the soft Brexit scenario I expect. One, Brexit risk is priced into the shares that traded at 240 pence in February 2017. Two, Barclays’s lower cost curves/deferred comps will boost gross profit by at least £500 million in 2019. Three, Basel Tier One will rise to 13.8 by end of 2019. This means the bank will initiate a share buyback program that could well equate to 8% of its current market cap. This means Barclays is a rerating candidate with at least 25% total return upside for me.