Santander Shopping Spree?

Written on the 9th January but I think still relevant:

Europe's largest bank, Banco Santander is making waves this morning with its recommendation to the Board of Directors for a 7.5 billion euros ($8.88 billion) capital raising program. The news is sending the stock price sharply lower, down 9.71 percent at 6.19p in morning trading, which means Santander shares have shed more than 10 percent of their value since the start of the year.

But buoyant profits have been posted at the banking giant. Record profits were generated in 2013 and in Q3 2014, Santander was well in the black, earning EUR 1.6bn in net profit.

So why a run on Santander's stock price?

Raising capital through an accelerated placement of shares at institutions will pull the stock price down.

It’s a supply and demand issue. When more stocks are created and traded on the market, it increases the supply of Santander shares in circulation, which reduces their value.

There are fundamental reasons why a stock price falls in value. For example, when the number of shares in circulation increases, it dilutes the net asset value per share (NAVPS), which is the intrinsic value of the share. It is calculated by dividing the total net asset value of the fund or company by the number of shares outstanding. So if the bank's total net asset value (this figure can be found on the balance sheet) remains the same and more shares are issued, the NAVPS falls.

NAVPS is the old school way of gauging whether the current market value of a share is fair value, oversold or overvalued. When NAVPS falls, more often than not the stock price also falls.

Another fundamental reason why a stock price falls when a company issues more shares is that it dilutes the Earnings Per Share (EPS).

EPS has been defined as the portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability. It is calculated by (Net Income less dividends on Preferred stock) divided by (average outstanding shares). With more shares in circulation, given no change in net income less dividends, the EPS figure falls. If the EPS falls below last year’s figure, it is often interpreted by investors as a negative signal.

Now let's put some flesh on the bones.

CEO Chairman, maybe I should say Chairwoman, Ana Botín, will go to the Board of Directors and ask them to accept the issue of 1,213,592,234 ordinary shares of Banco Santander, which will be placed with institutional investors at a price of 6.18 euros per share. If we do the simple maths, we can work out that the share placement will raise the banking group 7.5 billion euros.

But why does a profitable bank need to raise all that capital, particularly when profits are buoyant?

Moreover, the bank passed the last European Banking Authority (EBA) stress test in October. The idea was to simulate a worst case scenario for the European economy and test whether the banks would be robust enough to withstand the shock. European Banks were tested on their ability to withstand a 5 percent contraction in European Union (EU) Gross Domestic Product (GDP) by 2016 and a sharp rise in EU unemployment which shot up to around 13 percent, from its current level of 10.1 percent. And of course, a bond market crash was thrown into the “doom” equation.

Banco Santander wasn't on the list of the 25 European banks that were deemed to be under-capitalised to withstand a future financial shock.

Three months on and the Euro zone’s economy is looking in a slightly better shape, benefiting from lower input costs, particularly cheaper oil prices.

Nevertheless, Santander's chief, Ana Botín is apparently concerned that the bank's capital cushion is too thin. Ana Botín was appointed to the helm of the bank in September following the death of her father, Emilio Botin, who built the bank into a major international player. Since Ana Botín’s appointment to CEO, she has increased the number of independent directors on the board, shaken up the management team and shored up the lender’s capital base.

“Analysts estimated that the share sale would put Santander’s capital level—under international regulations known as “fully loaded” Basel III criteria—at around 10%, more in line with its European peers. A bank’s capital ratio is the amount of equity it holds in relation to risk-weighted assets on its balance sheet, and it provides a buffer against potential losses,” according to the Wall Street Journal.

“Santander plans to end 2015 with a capital ratio above 10% and maintain its cushion between that figure and 11% in the “medium to long term,” Chief Financial Officer José García Cantera told reporters Thursday.

There are two ways of reading into this.

The bearish view would be that if things are as rosy as they appear in the financial statements, then why is the bank undertaking a massive recapitalisation? Furthermore, why are dividends being cut? The bank is lowering annual dividend to 20 euro cents a share from its previous dividend of 60 cents a share. When there's a bumper harvest there should be a lot more to go around. Might there be an element of Tesco in all this?

Remember, the Tesco scandal, profits overstated by 250 million pounds, dividends cut, then the realisation that the Board was cooking the books, leaving investors with collapsing share price.

Another view is that Ms Botín is just about to embark on a shopping spree, but doesn't want to excite the market with acquisition speculations because it would jack prices upwards. So the strategy might be to let the market believe that the 7.5 billion euros is just a safety cushion, but in reality it is raised capital for acquisitions.

Last year Santander was busy doing deals. They got involved in a joint venture with a payroll-lending company in Brazil. Then there was the purchase of a consumer-finance business that operates in Norway, Sweden and Denmark. Chief Executive José Antonio Álvarez Álvarez said Santander will analyse deals that could bolster the bank’s units in countries where Santander’s presence is weaker.

So it might be about raising 7.5 billion euros to expand the banking empire. Is there a smell of takeover acquisitions in the air?