A couple of weeks back I thought to myself; what if I change my screener from searching for net-nets to instead look for really low P/B stocks. I set my screener for P/B < 0,35x (and some other quantitative measures, such as P/E < 5 and P/E10 < 5) and Voilà! there they were, French banks all over the screener!
Well this is odd I thought. I know the banking sector in Europe is not the most exciting or expensive sector (the Deutsche Bank case was at this point in time a hot news topic), but from the valuation multiples I’m seeing there must be something more to the picture. So what do you do when something looks too good to be true? You google it.
From the google search I managed to find a brilliant blogpost from a French value investor that made the whole case a lot clearer and also more interesting. The blog is called Value investing France and you should definitely check it out. Before moving on with my analysis I just want to stress that I couldn’t have managed putting all the pieces together without his blogpost and further help via email. I would also like to stress that I don’t speak French and that I have used Google translate for most of my research. It is therefore possible that I have misunderstood parts of the information that this analysis relies on.
An unconventional ownership structure
Before diving into the more interesting parts of this analysis we have to start off with the ownership structure and some related details of the French regional banks analysed in this post. You will soon understand why.
For those of you that have been to France or know anything about their banking sector, you will probably recognise the name Crédit Agricole. Crédit Agricole or more correct Crédit Agricole group is a network of cooperative and regional banks. In total there are 39 regional banks in the Crédit Agricole group. The holding company of the Crédit Agricole group is listed on the Paris stock exchange under the ticker “ACA”. The 39 regional banks together own 57 % of ACA shares outstanding via a company called SAS Rue la Boétie (SAS). Until lately, ACA in return owned about 25 % in each regional bank. The structure of the Crédit Agricole group looked like this:
In this analysis I will mainly focus on the regional banks but because of the structure of the group and recent developments ACA will also be mentioned numerous times.
So what about the regional banks of Crédit Agricole group then? Well, as you probably can guess they are involved in basic and traditional local retail banking in different parts of France (se map below). In other words, their focus is on household, local SME businesses and farmers. In contrast, the business model of ACA is a more complex. They engage in International banking, Financial services such as asset management and securities, insurance, consumer finance, private banking and also Corporate and Investment Banking such as offering brokerage, investment banking, structured finance and commercial banking services.
As stated earlier and showed in the picture above, there are in total 39 regional banks spread across the country. Of the total 39 banks 13 are publicly traded on the Paris stock exchange. The history behind this goes back to the early 1990’s when the banks were in need of capital and new laws made it possible for them to acquire the capital without diluting the control of the banks. It was made possible for the banks to issue two new types of shares:
- Cooperative investment certificates (CCI’s) (Certificat coopératif d’investissement)
- Cooperative member certificates (CCA’s) (Certificat coopératif d’associé).
The CCI’s and CCA’s differ from the regular definition of an ownership in a company (a share) on the fact that they don’t give the owner a right to vote. They do however give the holder the right to a dividend and to the net assets of the bank (shareholders’ equity). The difference between CCI’s and CCA’s is that the CCI’s are publicly traded, the CCA’ are not. Also, CCAs can only be bought and held by members of the issuing Crédit Agricole Regional Bank and its affiliated Local Banks.
A third class of ownership exist in the structure of the regional banks. This class is known as the Part Sociales (PA) and is owned by the local banks of the region but also clients of the bank. The PA is the only ownership type that gives the owner a right to vote. However, the PA is not publicly traded and has a fixed nominal value. The holders of the PA gets a small interest every year that is decided on the general annual meeting.
Here is an example of the ownership structure of one of the regional banks (Nord de France “CNF”) as of June 2016:
Here is also an example, from the same regional bank, on how the dividend/interest is divided between the different shares:
As I now continue with this analysis I will be talking about the CCI’s if not otherwise stated.
Recent changes in the ownership structure
When the laws for CCI’s and CCA’s was implemented in 1987 and 1992 the anticipated outcome was that these shares were mainly going to be bought by customers of the banks. What instead happened in the Crédit Agricole case was that ACA acquired a big portion. As noted earlier and observed in the ownership structure for the example of CNF above, ACA owned about 25 % in each regional bank. From this ownership ACA could consolidate a quarter of the regional banks profit into their statements at the same time take advantage of the dividend received in the development of other business lines. It also had the effect of even out the power relationship between the different parties as the regional banks owned about 57 % of ACA.
In mid-February 2016 things drastically changed for the Crédit Agricole group when operations “Eurêka” was presented. ACA announced that it was going to sell back the 25 % ownership in each regional bank to the regional banks.  The logic behind this transaction was said to strengthen the capital structure of ACA but also to simplify the structure of the whole Crédit Agricole group. The regional banks would together create a new holding company called SACAM Mutualisation (SACAM) and buy ACA ownership in each regional bank for a total price of 18 B€. The new structure would look like this:
The price of 18 B€ would be financed with a 11 B€ loan from ACA at a fixed rate of 2,15 % maturing in 10 years with an option for early repayment after four years. Another 5 B€ would be financed with the cancelation of what earlier was known as the “Switch guarantee” (see picture of earlier group structure). The Switch guarantee was a 5 B€ warranty under which the regional banks charged a 9.34% interest on 5 B€ deposited with ACA since the crisis of 2008. The remaining 2 B€ would be a pure cash payment from the regional banks. It can here be noted that the equity stake in the regional banks was valued at €16.8bn in ACA’s balance sheet at the end of 2014. 
The new structure
So now we know the price paid by the regional banks and how the deal was structured, but what about the implications and the value of the transaction?
Implications of the transaction
Depending on what perspective you take on the transaction there will be different conclusions drawn over its implications, good and bad. Because this analysis takes a CCI owners viewpoint that is also how I will frame it.
- Because of the new ownership structure of the SACAM, it will not be possible for the regional banks to consolidate the earnings into their accounts (as was the case for ACA). Reason being that 39 banks will now split the ownership of those earnings. The exact details and outcome of the SACAM for each regional bank I don’t know jet.
- With the closing of the Switch guarantee it will have a negative effect on the income for the regional banks. It has earlier been a large source of income, about 460 M€ in total.
- The loan of 11 €B will give rise to a new interest expense (236,5 M€ in total). The 2,15 % fixed rate in relation to today’s interest environment and the fact that it relates to inter banking lending is in my opinion a bit high.
- As noted earlier, the regional banks own 57 % of ACA via SAS. A financially strengthened ACA will of course be of importance for the regional banks in the long run. At the moment this is most evident in the form of an increased dividend from ACA as a result of the simplification transaction.
Value of the transaction
One thing that stays constant and will not depend on the perspective of the transaction is the price paid in relation to the value of the regional banks. With the price of 18 B€ in relation to the net asset value of the regional banks gives us a P/B-multiple of ~1,05x paid by the regional banks.  Most of you I guess would think this sounds like a fair multiple to pay, me included. However, what I and many others don’t think is fair is how this deal excluded minority CCI-holders from taking advantage of the same offer made to ACA. In this context it is worth noting that the thirteen publicly traded regional banks are selling for an average P/B-multiple of 0,31x on the market (see table below).
The defence association of minority shareholders (ADAM) was alerted regarding the matter and about one month later the ADAM addressed the issue to the French financial market regulator Autorité des marchés financiers (AMF). The ADAM stressed in two letters to the AMF the point of equal treatment of shareholders and that a transaction involving all the CCI’s at the same price paid for ACA ownership would be less than 5 €B. It took about one month for the AMF to respond and the outcome was not positive for the minority CCI holders. The AMF concluded that there was no need to implement a public take-over bid to the benefit of the minority shareholders. The AMF response (Google translated from the AMF- statement):
“The AMF noted that while stock market law is structured by the principle of equality between the holders of a category of title, this principle could not, in the current state of the texts and case law, be regarded as having a General and absolute scope which would make it possible to apply it in the absence of explicit provisions. Thus, if such provisions exist with regard to public offerings and capital reductions, the proposed transaction does not involve a mandatory public offering or cancellation of the CCI’s or the CCA’s. Moreover, CCI’s are not financial instruments subject to these provisions, but non-voting securities.”
The AMF also adressed a number of the implications that i earlier mentioned:
“Concerning the consequences of the transaction for the holders of CCIs, the AMF noted that the transaction will have no impact on (i) the liquidity of the CCIs, Sacam Mutualisation intending to hold long-term CCis acquired from Casa, (ii) the commitment made by the Regional Banks when listing Casa to distribute at least 30% of their result, this commitment being maintained by the said Caisses, and (iii) the remuneration of the CCIs, the Caisses Regional authorities have indicated that the remuneration for 2016 will be at least equal to that for 2015 and that their results should be increased by 2019.”
Casa = ACA
Caisses = regional banks
Last but not least the AMF concluded in their last section that:
“Finally, with regard to the prohibition of perpetual commitments, it is not for the AMF to decide on this point, as well as on the conditions under which holders of CCIs could apply for redemption of their securities under articles L. 231-1 et seq. Of the French Commercial Code and 19 sexies et se of the Law of 10 September 1947.”
In regards to the last statement by the AMF, ADAM is now in the process of seeking redemption for the minority CCI’s at the same level as ACA is getting paid. This was first done in a written formal request sent to each CEO of the regional banks. I haven’t managed to find any formal statements regarding the outcome, but from the information at a France investing forum this first step was declined. The next step for the ADAM is legal action by taking it to the courts.  Again, I have found no formal news but according to the same investing forum this process has just started. As I understand it, this is a process where the ADAM is helping individual CCI-owners to sue the banks. I have earlier today emailed the ADAM regarding where they stand on the matter and hopefully I will get a response that I can present in the next part of this analysis.
The French regional banks – a risk arbitrage case
There is nothing today that indicates that things are about to change (in a positive way) for the minority CCI-owners in regards to a buyout. If the legal actions don’t pay off I see no reason for the management of the regional banks to change their minds in the short term. However, if the legal actions do pay off I think there is a quite high possibility that we will see some buyout action of minority CCI’s. As noted earlier, all the public CCI’s would at the same P/B-multiple as the ACA buyout (1,05x) cost the regional banks 5 B€ on top of the 18 B€ already paid to ACA. As laid out in an article by a French investor, this would be financially possible and also quite profitable for the regional banks.
In the context of framing this as a risk arbitrage situation there is also two interesting historic events. In 2009 two former publicly traded regional banks decided that they didn’t want to be public anymore. They bought back all of the certificates at P/B-multiple of 0,8x.  The reason why I present these events is to demonstrate that there has been public buyout of CCI’s and that this, especially when recent developments are taken into account, could happen again. With the new SACAM structure I think there is an increased possibility and opportunity for the regional banks to do this, as they now can finance such transaction in collaboration.
If we take the 13 publicly traded regional banks and their average P/B-multiple of 0,31x (see table below) this can be translated into the two possible risk arbitrage outcomes:
- The CCI’s are bought out at the same P/B-multiple (1,05x) as the ACA buyout = a possible return of 239 %.
- The CCI’s are bought out at the same P/B-multiple (0,8x) as the 2009 buyouts = a possible return of 158 %.
Wrapping up part one
My goal with this first part of the French regional bank analysis was to set the stage for the risk arbitrage case. I think it is obvious that we have strong but highly unlikely buyout catalyst in the short to medium term horizon. However, with a longer time frame I think this probability is quite high. As will be outlined in part two of the analysis, the risk arbitrage case is only one side of the coin. Next time I will present the other side and when put together with the risk arbitrage side I think a basket of French regional banks make a perfect Dhandho investment – heads I win tails I don’t lose much. So stay tuned!
Disclosure: The author is long all thirteen regional banks mentioned when this analysis is published.