Barclays is Cheap

After Wells Fargo and Bank of America raised their dividends in early August by 12% and 14%, respectively, we said it was a clear sign to us that they were not in the eye of the storm of the subprime problems, and their stocks were too cheap.


The chart at the right shows that both stocks have recovered smartly over the last two weeks, as it has become clear that, indeed, neither is likely to take big losses. As we write this, however, we believe both stocks may be still as much as 15% undervalued based on the long-term relationships between their dividend growth, interest rates, and their stock prices.



We want to add another stock to the list of banks that we believe has been unfairly punished by the recent liquidity crisis. Barclays Bank is a London-based bank with offices spanning the globe. They have three world-class divisions: banking, capital markets, and asset management (ishares Exchange Traded Funds).

The stock has fallen by nearly 20% over the last 60 days on fears of Barclay's involvement with sub-prime loans, private equity, and hedge funds. There is no way for us to know their precise exposure to these groups, but the company has repeatedly stated that they are not experiencing any large scale losses.


Barclays recently raised their dividend by nearly 18%. A dividend hike of that magnitude is real money since they now yield over 5%.



The chart at the right is Barclay's Dividend Valuation Model. The blue line is the actual annual price over the last 15 years, and the green bars are the model's predicted values. The chart shows a close association between the model and prices over the last 15 years and a predicted 2008 value of just over $55.

From today's price of approximately $49, including the dividend, our model is suggesting that Barclay's may be even more undervalued than BAC or WFC.

Barclays has been in business since 1736. With that kind of longevity, we believe they might know a thing or two about how to navigate financial storms. Their AA bond ratings ensures access to the capital markets and minimizes liquidity issues.

The bank has been in a pitched battle with the Royal Bank of Scotland to acquire ABN Amro, a Dutch banking giant. We believe that the market is worried that Barclays may be dragged into a bidding war. In our minds, Barclays had done a lot of things right over the past 270 years. We're inclined to follow with their judgment with ABN Amro.

A Few Thoughts on the Private Equity Phenomenon

Private Equity is not going away. It will continue to grow and 10 years from now, we will think of it as just being another money management vehicle along side mutual funds, exchange traded funds, managed accounts, etc. Whereas mutual funds began as a way for small investors to improve diversification and have access to professional money managers, private equity funds are a means for institutions and the very wealthy to have access to more of a "hands on" business arrangement with corporate America. It is just another means of owning equity. As I have mentioned previously here, there is a growing feeling that a kind of imperial attitude has sprung up in corporate America. Corporate chieftains have figured out that they answer to everyone, while at the same time, answering to no one, and little by little they have begun to take advantage of their positions in ways that are increasingly unacceptable to many investors. I could not have imagined that this sort of imperial attitude would have become apparent so soon after the Enron fiasco, but $100 million dollar retirement packages for CEOs have become a way of life, with no end is in sight. I have always said that big money thinks and acts differently -- that's how they become "big money." I have a friend who is in this category. When he owns a stock, he will own several million dollars worth. He genuinely thinks that the CEO and the board of directors work for him ( he usually owns more stock than any of them), and if they act in ways that do not suit him, he does not cut bait and try another stock, he will pay the CEO a visit. He does not rant or rave, he just advises the person that he is unhappy, and he expects things to change. He usually has a list of things he does not believe are being handled well, as well as a list of costs that he believes are out of line. He asks for explanations, and if the answers are either not forthcoming or are evasive, he advises the CEO that he will attempt to change the make up of the board. I used to cringe every time he started off on one of his campaigns, but I have come to see things more his way. There are too many boards of directors who are not looking out for the good of the shareholders they are supposed to represent. They are only riding the gravy train just like everybody else. There are too many boards of directors who are not properly supervising their firms' strategies or top managements. They are just honored to be one of the "good old boys or girls" on an important board. My friend says says you can throw a dart at the Wall Street Journal and the odds are whatever company you hit can be run much more efficiently and much more profitably for shareholders if the company were being run by managers who ran the enterprise for the "owners." If my friend is right, and I believe he is, the private equity folks have enough companies to "clean up" to last a lifetime. The mutual fund industry is primarily engaged in the business of investing in stocks. The private equity industry is primarily engaged in investing in companies. There is an absolute world of difference between the two. Too many investors believe that the private equity crowd is bad for the markets and, like the leveraged buyout crowd, are destined to dry up and blow away. They are just as wrong in that assumption as they are in believing that the majority of boards of directors in this country are primarily serving the interests of their shareholders. There are private equity deals being announced every day. There is a simple meaning for their actions: US stocks are cheap, too cheap. With low interest rates and cash flows in good shape, if you throw a dart at the Wall Street Journal, you are likely going to hit a company that can not only be run more efficiently with a "owner" driven CEO, it can be bought with its own net worth. Private equity is just another way to own companies. My guess is that it is in its infancy and that is good news for the stock markets here and around the world. The surest evidence that this is true is that the government is moving to regulate it and tax it. I'm not going to tell you what my friend has to say about the government and taxes.

Pssst, You Wanna Buy a Company?

There are three forces driving the incredible buy-out binge of the private equity firms: 1.) low interest rates, 2.) strong free cash flow growth of corporations, and 3.) the Enron-Sarbanes, Oxley effect. The first two forces are self explanatory and offer the opportunity for the buy-outs. Point three needs some discussion, but at its end, provides the motivation by all parties to do the buy outs. Sarbanes Oxley is the law that, among other things, requires CEOs and CFOs to certify all financial results under threat of criminal penalties. This law was passed by Congress in response to Enron, Worldcom, and the other corporate and accounting scandals that came to light in recent years. In short, Sarbanes -Oxley's only reason to exit is investors' mistrust of accounting and financial reporting in corporate America. Indeed, this mistrust of corporate America, which is both real and growing is the linchpin that holds the private equity juggernaut together. Is it any surprise that the recent explosion in private equity buyouts has coincided with the latest corporate scandals involving the back dating of executive options. The legacy of Enron, et al., means that investors must "discount" all corporate financial reporting for the possibility that what they are seeing "ain't" what they are getting. This discount is imposed on the entire market in a "one-bad-apple" effect and dampens how much investors are willing to pay for earnings. My PE model indicates that the Dow Jones Industrials should be trading at about 17 times earnings. It is now selling at under 15 times 2007 earnings. Now comes the private equity crowd with solutions aplenty. They offer to pay a premium for the "good-apple companies," which pleases the shareholders. (In truth, however, they are really only paying what the market price would have been in ex-Enron days.) "Good apple" corporate managers, who in another day would be fighting the private equity crowd, now become their apologists because they are offered their current jobs and bonuses, and they can leave Sarbanes-Oxley behind because its onerous rules do not apply to private companies. Finally, the private equity firms make their investors happy because they are buying companies on the cheap, and in 3-5 years, they will be able to resell the same companies back to the same shareholders for a 100-200% profit. Einstein is reported to have said that the greatest invention of all time was compound interest. He obviously had never heard about these private equity deals. I make the private equity crowd out to be sharks. They are not. They are just shrewd capitalists taking advantage of the fears and doubts of post Enron investors. But there is a sign that the perfect storm that the private equity firms have been riding is coming to an end. Blackstone, one of the largest private equity firms is going public. Let me say that another way: Blackstone, one of the smartest outfits on the planet is now willing to sell a piece of itself to the public and thus, become a public company, governed by Sarbanes-Oxley. I wish Mark Twain were alive today to give us a pithy quote.

A Few Thoughts About Private Equity

As I write this I am admiring the Cascade Mountains of Oregon. It is 17 degrees outside. It was 80 when I left Indiana. Gee, you mean you can't believe the Weather.com's predictions for Oregon's mountain country? With all this time on my hands that was supposed to be dedicated to learning to fly fish, I find myself just staring at these magnificent mountains while random thoughts flow through my mind. The thought that keeps appearing most often is,"What do all of the private equity deals mean?" Are they a good thing, or a bad thing. Are they an indication of just how cheap the market is, or are they just one more Wall Street gimmick that is going to crash and burn one day? Obviously, our firm has been collectively thinking about this for a long time. But in recent weeks, the buyouts have reached the point where Kohlberg Kravis Roberts, Blackrock, and Texas Pacific seem to be buying a company a day. These are high risk players, but they are obviously not fools. If you would have told me a year ago that companies as diverse as Biomet, TXU, The Tribune Companies, First Data, and Equity Office Properties would all be bought out by private equity firms in the span of six months, I would have told you that the Dow Jones Industrials would be over 14,000, maybe pushing 15,000. Something just does not add up about the rampant, almost frantic, pace of the buyouts and stock market's apathetic attitude towards it. Let me see, last month the markets sold off 5.5% in about a week. At the very same time, large buyouts were being announced almost everyday. Don't investors realize that the private equity money is only buying companies where cash flows over the next 5-10 years are expected to produce an annual rate of return of 15%-20%. Don't investors realize that this onslaught of private equity buyouts is going to keep rolling until prices of US stocks are much higher, and thus, puts a floor under any big market correction? But, as I sit here pondering the disconnect between big money buying everything in sight and the stock markets trading at PE multiples about the same as they were at the bottom of the bear market in 2002, I catch a beauty of a thought. If it's correct it might answer both behaviors. Let me sleep on it and I'll see if it still makes sense tomorrow. My wife just came in with snow shoes and a hiking map. She says we are adapting.