More on Toronto Dominion Bank(TD-NYSE) and Waterhouse/Green Line IPO
Stock symbol: TD-NYSE
(Source:From Toronto Globe & Mail Newspaper)
Thursday, January 28, 1999
ERIC REGULY
Toronto-Dominion Bank's (TD-NYSE)tentative plan to spin off its discount brokerage operations is an indictment of the entire Canadian banking system. It confirms that the banks are low-value conglomerates holding high-value businesses. In other words, they don't work. If you believe this theory, then you should be asking why the banks were -- and, for the most part, still are -- eager to merge when doing the opposite, breaking themselves apart, seems to make more sense.
TD(NYSE) did the math and was impressed by the numbers: Its wealth management division, dominated by two top discount brokerage companies, Green Line in Canada and Waterhouse in the United States, might be worth $2-billion as wholly owned subsidiaries. But break them out and apply the same stock multiple -- more than 60 time earnings -- enjoyed by Charles Schwab, the leading player in the discount brokerage game, and the value of the Green Line-Waterhouse combo soars to about $8-billion, or almost half of TD's total market value. Schwab, happily caught up in the hype surrounding Internet and electronic commerce stocks, is trading at gravity-defying multiples. TD simply wants a piece of the action.
Canadian banks have always traded at low multiples compared with their U.S. counterparts. This is partly because the Canadian financial services market is more heavily regulated, grows at a slower pace and presents fewer opportunities for cost reduction because mergers are taboo. The low multiples could also be the unfortunate byproduct of decades of singularly meek and insulated management, but this is another story.
When the banks delved headlong into higher-multiple businesses -- wealth management, discount brokerage, electronic banking and credit cards, among others -- with no meaningful improvement to the stocks' price-to-earnings ratios, they knew something was wrong. They were stuck. The obviously rising value of Green Line and Waterhouse was not reflected in TD's stock price. Similarly, Bank of Montreal's stock price was ignoring the value of Harris Bank, its Chicago subsidiary. Hence the possibility of TD severing the discount brokerages from the inert whole and putting them into a separate publicly traded company. The shares could then be used as an acquisition "currency."
A heartless corporate raider like Carl Icahn would waste no time in blowing up the Big Five Canadian banks on the assumption the parts are worth more than the whole. But Icahn-like figures are gone and it wouldn't matter one iota if they were still here. Canada's banks are takeover-proof, thanks to the 10-per-cent ownership rule that the banks and the government want to keep in place. This means it is up to them to create shareholder value by shedding the undervalued bits and giving them their own stock market listings. Don't get your hopes up. While TD has seen the light, there is a good chance its rivals will try to buy, instead of sell, their way out of the box. The banks have always worked on the big-is-best principle -- Royal Bank's strategy is to dominate any business it's in -- and there is little reason to think the approach will change any time soon in spite of talk about the newfound desire to concentrate on top-performing businesses and abandon the rest.
The gobble-your-way-to-success scenario could backfire. Acquisitions could be extremely costly. The banks would have to use cash to fund their buying sprees in the United States because Canada's accounting rules for pooling of interest deals work against them. Even if they could use their shares as currency, they wouldn't want to because the share multiples are too low. The smart buyers use high-multiple shares to buy low-multiple shares, as Merrill Lynch did last year when it snagged Midland Walwyn.
The other reason is that acquisitions of wealth management companies and the like may not be their best use of capital. Companies that concentrate on one product line are rising to the top and putting the squeeze on the traditional financial conglomerates -- the banks -- that have to spread their capital over a variety of operations. Single-minded dedication has made Charles Schwab the leader in discount brokerage, Fidelity in mutual funds and GE Capital in commercial lending.
The modern economy is telling the banks that they're in danger of becoming dinosaurs. Customers no longer need to put their spare pennies in bank savings accounts; they put them in mutual funds, most of which are not controlled by banks. Businesses are no longer prisoners of the banks either. Small companies can now get loans over the phone from specialist lenders. Big companies can go to commercial lenders such as GE Capital and Newcourt Credit. Every day, the banks lose some of their oligopoly power as single-purpose businesses nibble nibble away at their markets.
This is why Canada's banks should look closely at TD's effort to spin off its discount brokerage businesses. Blowing up the banks may be the quickest route to unlocking value.
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