The stock aroused my interest as I learned that prominent value investors, such as David Einhorn, Seth Klarman and John Paulson had taken long positions in Pireus Bank (via stock or warrants). I basically tried to “reverse engineer” their decision-making process, i.e. try to understand where the value is by looking intensively at Pireus financial statements. To make a long story short: I could not find any reason to buy the stock: the balance sheet looked horrible, with steadily increasing NPL ratios and one-third of the book value of the bank due to a rare bird – a “negative goodwill” item booked as a profit from takeovers of failed Greek and Cypriot banks. Just to explain: if this value (“negative goodwill”) is correct, it implies that shareholders of the taken over banks have been massively screwed due to the forced takeover, i.e. they were paid less than their assets were worth. This is theoretically possible due to the good political connections of Pireus Bank management (the current governor of the Greek central bank worked at Pireus in the past).
Anyway, the market disagreed with my analysis and even priced the Stock at a slight premium to book value (1.2x). The stock has derated somewhat since then (I wrote about it in April), but still trades at 0,92 x book!
What has happened to the fundamentals since then?
the NPL ratio has risen in Q2 2014 to 38,5% from 37,9% in Q1, i.e. asset quality has deteriorated further. Net profit ytd. is around EUR -80 million (unaudited Q2: + 164, Q1: -247), not as bad as it was but still no reason to assume this stock could justify a valuation of EUR 8.5 billion. By the way, as long as the NPL ratio shows no sign of falling I do not trust profit figures of any bank: a rising NPL book basically means that bank management cannot unload NPLs at book value as selling them would lead to additional losses. I am sure they would, if they could. But, it gets worse…
Dubious accounting practices at Pireus bank
I have had debates about Pireus bank with Klaus Kastner, a retired Austrian banker whose wife is Greek and, I understand, spends a considerable time in Greece. He generously shares his thoughts about the Greek economy on his blog “Observing Greece” which I read regularly, also because I am still trying to understand what the gentlemen from Manhattan find valuable in this stock.
He recently had a piece about a deal between Pireus and Marfin Investment Group (MIG), a well-connected Greek conglomerate. The piece is worth reading in full and can be found here. For those of you lazy to read the post, here is a quick summary:
MIG is basically insolvent (negative tangible equity), bleeding cash and, oh, almost half its debt is in contractual default (I am taking Klaus’s analysis of the financial statements at face value here). Nevertheless, Pireus bank managed to book a gain – presumably a release of previously booked loan loss reserves – of EUR 144 million by refinancing its loan by a convertible whose sole buyer was, drumroll, the bank itself. At least, now I know how they managed to book a profit of EUR 164 million in Q2!
Only I few days ago I wrote about my recent trip to Asia that I felt the business practices leave something to be desired there. I also wrote how he types of deals seen there would not be possible in Europe and the US. Well, I stand corrected (in record time): carrying the debt of a defaulted company, with no signs of a turnaround, at par is ridiculous and requires a blind eye by regulators and auditors.
(A word of caution: given that neither Klaus nor myself have full disclosure about the nature of the transaction we, of course, might miss important details about this deal).
For me there is no doubt that Pireus’s earnings are of very low quality. The same goes for its book value of which 1/3 is due to a “negative goodwill” item. I fail to see how the market can price this stock anywhere close to book. The transactions mentioned above should raise all kinds of red flags with Einhorn or Paulson and I would have a few tough questions for management. I have never understood – and now understand even less – how they can touch this stock. Is it due to the institutional imperative of showing activity to your investors?