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‘Is the Bank of Italy really only worth €1.2 bln?’

Unlike the Bank of England (BOE), the Bank of Italy (BoI) is not owned by the state. It is in fact owned by sixty individual financial institutions (primarily banks) who were issued shares back in 1936. Of these the largest shareholders are Intesa Sanpaolo (42.4%) and UniCredit (22.1%). Using their reported carrying values implies that the BoI is worth approximately €1.2 bln1. Can this be right?

However not all shareholders report their BoI stake at the same value. Indeed, two of the other top ten shareholders revalued their stakes a couple of years ago after conducting their own in-house valuations. These imply that the BoI is worth between €18.7 bln and €22.1 bln1. The table below shows the reported carrying values of these stakes and their implied values of the BoI.

Table 1: Selected shareholders and their Bank of Italy carrying values

Source: Bank of Italy, company annual reports

It is probably no coincidence that the two smaller banks, who are both capital constrained, have valued their stakes upwards significantly. Although these stakes in the BoI do not count towards regulatory capital, one suspects they were attempting to highlight an area of hidden value to the regulator.

Nonetheless, an upward revision is not without merit as Italy’s Economy Minister Fabrizio Saccomanni announced at the end of October this year that his own task force (which he set up in September this year) believed the BoI to be worth between €5 bln and €7.5 bln3. This value was derived using a dividend discount model and applying a 20% liquidity discount. While the discount rate used of 4.6% is generous (as the lower the discount rate the higher the derived value), the dividend itself is not. In 2012 the bank paid out a nominal €70m in dividends to its shareholders after reporting a €2.5 bln profit (a 2.8% payout ratio), and it is this level of dividend payments that has been used in the official model (with an assumed €74m dividend for 2013). Clearly discounting such a low earnings stream leads to an undervaluation. To put this in perspective, the resulting official value range of €5 to € 7.5 bln would put the BoI on a PE of 2.5x (using the mid-point value of €6.3 bln).

However this is only half the story, as the book value of the BoI is considerable and dwarfs the new official revaluation.  According to the 2012 accounts, the BoI’s book value (equity) is €23 bln. However this needs to be adjusted for retained earnings (€1 bln) and the revaluation of Italy’s official gold reserves of 79m oz (€87 bln) which are owned by the bank. To this we also need to deduct Italy’s share in the capital of the Eurosystem (€71 bln)4. The resultant equity value is €39 bln, meaning the official revaluation values the BoI at a P/Book value of 0.16x. Interestingly, this could actually be €53 bln if we also added the provision for general risks of €13 bln, the bulk of which we believe is capital originally put aside by the BoI for forex operations in order to stabilise the then Italian Lira. We can’t confirm this though and as it is listed as a provision we have not included it as equity. The table below shows our calculations.

Table 2: Adjusting the book value of the BoI

Source: Bank of Italy annual report, European Central Bank (ECB)

Nonetheless, both the new official value and the book value are considerably higher than that of the implied value reported by its two largest shareholders. This clearly implies that there is potential hidden value to be realised, the extent of which is shown in the table below (before tax).

Table 3: The impact on carrying values of the BoI stake using the new official value and the reported book value

Source: Bank of Italy; company reports

Clearly Intesa has the most to gain from any revaluation. The problem though is that a revaluation itself is of no benefit as the BoI stake is not included as regulatory capital, and even if it was, Intesa already has more than enough capital. Indeed a revaluation with capital gains tax consequences is exactly what the bank (and largest shareholder) would not want.  And tax consequences there probably will be, as this is where the government’s agenda probably resides (although the applicable tax rate itself is not clear). On the other hand, the smaller banks are generally capital constrained and would like their stake in the bank of Italy to be counted towards their regulatory capital, and are thus pro any revaluation. Lastly there is public opinion. A massive revaluation of the BoI’s stake may be seen as a “gift” to the banks, which probably would not be taken too well.

Undoubtedly this exercise will be mired in politicking, but the wheels seem to be in motion for a revaluation of the Bank of Italy. While the extent and methodology is as yet unclear, the direction is not.

Greg Bennett
Fund Manager

*As a consequence of the official revaluation, Banca Monte dei Paschi took a writedown on its stake of €228m in its Q3 report (implying a value of the BoI of €8.8 bln).

** Market capitalisation as at 19 November 2013

Sources:
1 Company annual reports
2 Bank of Italy annual report
3 Bank of Italy valuation report
4 ECB

This document has been provided for informational purposes only solely for Professional Clients as defined by the FCA and does not constitute investment advice. Information and opinions expressed in this material are subject to change without notice and to the best of Argonauts knowledge are correct at the date of producing the document. They have been obtained or derived from sources believed by Argonaut Capital Partners LLP to be reliable but Argonaut Capital Partners LLP make no representation as to their accuracy or completeness. The writer of this piece may have conflicts of interest as may have personal holdings in the companies mentioned.