Last December, the British government ruled that the Royal Bank of Scotland (RBS) Group (NYSE:RBS) should focus its resources on its U.K.-based operations – a directive that cast a shadow of uncertainty over the group’s businesses in the U.S. and Asia, especially the Citizens business (see ICB Directives to Stunt RBS’ Growth, Could Lead to Citizens Sale). Although RBS has held on to its position that Citizens is part of its core operations, the 81% government-owned banking group may soon buckle under pressure and may be forced to sell it off in the near future. While we understand the British government’s goal of recovering as much of the £45 billion in taxpayers’ money it pumped into RBS in 2008 to bail it out as possible, we believe that a forced sale is not the best option for the group in the long run.
We maintain our $9.50 price estimate for RBS’s stock, which is in-line with the current market price.
When the U.K. government bought into a majority stake in RBS at the peak of the global economic downturn, it made its strategy clear – it will exit the stake systematically and profitably as market conditions improve. But as the European debt crisis drags on and as the U.K. continues to see depressed economic activity, the chances of the original investment being recovered itself are diminishing.  It is therefore hardly a surprise that the British government is pushing for more drastic measures in an attempt to improve profitability by slimming down RBS’s geographically and operationally diversified business model.
As can be seen from the chart above, the Citizens business contributes to about 8% of our estimated value for RBS. But at the group level, the business has had a comparatively bigger impact on the income statement over recent years simply because its operations in Europe have suffered a lot. Better economic conditions in the U.S. compared to that in the U.K. have helped RBS maintain a respectable bottom-line even as impairments and slowing loan growth have eroded value on its home turf.
So is exiting the Citizens business a good move? It is definitely not under the current conditions when the slowdown is forcing the industry to undervalue businesses. While RBS may be able to attract a formidable list of suitors for the U.S. business, it will most likely not be able to negotiate a good price.
We believe that a better value can be derived from the business by letting it continue at its current momentum for a few more years until the global economic scenario starts looking better and then taking a call at that time whether to retain Citizens or get rid of it.Notes:
- U.K. Lawmakers Say RBS Bailout Cash May Not Be Recovered, Bloomberg Businessweek, Nov 16 2012 [↩]