What’s Wrong With Barclays PLC?

Barclays (LSE: BARC) (NYSE: BCS.US) is stuck. Leverage is not a tool the British bank can use to boost returns — cost cuts are. But Barclays should go beyond that, stating its intention to be acquired by a larger rival. Citigroup would be the ideal partner.

Banking On M&A

Barclays is in restructuring mode. It trades below tangible book value, so it doesn’t look expensive. A couple of its business lines — Barclaycard and its UK retail operations – make it an appealing takeover target. Its investment-banking unit is slimming down, which is a good thing, too.

I find it amazing that at a time jumbo acquisitions are struck, and possible deals of $100bn-plus hit the headlines, nobody considers the possibility that banks will try to merge in order to become more efficient and create valuable revenue synergies. Of course, there would be regulatory hurdles  — but not even a whisper, a rumour, nothing. How is that possible in this market?

Regulators keep on asking for stringent capital requirements. Bankers always find their way out in difficult situations, and there’d nothing better than a merger to tweak estimates, reconsider forecasts and put pressure on competitors. A reaction from the banking world is long overdue.

BarclaysBarclays Is Palatable

Think of Citigroup taking over a British bank, for instance.

Barclays has £24bn of revenue and a market cap of £39bn. Citi boasts a market cap of $148bn, with revenue of $69bn.

Citi is certainly attracted to the UK retail operations of Barclays and Barclaycard. The US represents 23% of Barclays’s revenue, and Barclays is taking action in Europe by shrinking the size of its business. The American bank doesn’t need larger exposure in Europe, but would benefit from deeper penetration in the UK market. It needs to revive its business, and swiftly. Its valuation is below tangible book value.

In their current forms, neither Barclays nor Citi will find it easy to deliver value.

In the last 12 months, Citi stock has outperformed Barclays’s by 17.3 percentage points, but is still down 1.3% over the period. The spread narrows to five percentage points in 2014, but Citi is still down 6% this year. Risk still looks skewed to the downside for both.

If a merger were agreed, Citi would command a higher trading multiple and would probably retain a stake of between 65% and 75% in the combined entity. 

What’s Next?

As I wrote three weeks ago when Barclays stock traded in line with its current value of 240p, relentless cost cutting should continue or it’ll be tough times ahead for shareholders.

It takes a lot of conviction to invest in the British bank right now, particularly if the possibility of a transformational deal is ruled out. 

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Alessandro does not own shares in any of the companies mentioned.