MACQUARIE Group chief executive Nicholas Moore leavened news of a mild profit guidance downgrade yesterday by saying that market conditions were returning to "more normal levels", but that prompted an obvious question. What is normal? Is it the pre-global crisis period, when Macquarie was minting money and its shares were threatening to break through $100, more than twice what they are worth now? Or is it something less?
Good question, said Moore, before admitting that Macquarie wasn't actually saying what normal was, just saying that what's happening now doesn't feel normal, in the equity markets and the businesses that underpin them such as trading, underwriting and mergers and acquisitions in particular, and when volumes picked up, the pendulum would swing back.
Nobody expects or wants the pre-crisis iteration of normal to return. It was an unsustainable market too heavily geared against capital that was priced too cheaply, and rotating in the system too quickly.
The new normal will see stronger equity markets and corporate activity than we are seeing now, but risk aversion and regulation will trim the peaks.
And when normal does arrive, Macquarie will be a different animal.
In fact, it already is, with 40 per cent of group income today coming from businesses that didn't exist five years ago. Whether it peaked as a profit machine before the crisis will be shown in the way that restructuring continues.
Macquarie is not a cheap investment. Yesterday's downgrade points to earnings of between $900 million and $950 million in the year to March instead of the $1 billion that had been expected. On that basis, the shares are trading at 14.9 to 15.7 times earnings. You can buy Goldman Sachs for 10 times their expected earnings this year, and Morgan Stanley for just under 11 times.
For that to make sense, Macquarie has to offer superior growth, and it aims to get it through new streams of overseas-sourced income to replace much of the cash it was harvesting until 2008 from retail and wholesale investors as an acquirer, bundler, on-seller and manager of a sprawling stable of investment funds and companies. (It still does that, but in a smaller way, and primarily for wholesale investors).
There are several legs to the growth strategy, and to some extent investors will have to suspend disbelief if they are to buy the Macquarie story. Our mining industry might lead the world, but in the finance sector, Australian success stories overseas, such as QBE's, are the exception rather than the rule.
None of the big four banks have expanded successfully and sustainably overseas, for example. And while Macquarie might claim to be the exception because it sources about half its income overseas it's been doing that for about half a decade to complete its restructuring it needs to significantly increase the percentage, in two markets in particular Asia, and North America.
Asia looks promising. It's in the right time zone, and it's the source of soaring trade flows with Australia that need to be funded and hedged. Macquarie is building up Singapore as a regional hub for fixed interest, currency and credit trading. The Sydney desks are stepping down from 24/7 duty as Singapore and other regional hubs form a follow-the-sun trading network. It has a regional equity market presence, and the commodity trading skills that should play well in the region.
North America is a less obvious target competitive and, after the global financial crisis, depressed but Macquarie is nothing if not persistent. A series of acquisitions has increased the North American headcount in the two years from September 2008 from 1991 to 3732 27 per cent of global employees, compared with 14 per cent. The region's contribution to global income has risen from 8 per cent to 27 per cent in that time.
Macquarie is presenting itself in the Americas as a full-service investment bank with a commodities, infrastructure and funds management bias. It is aiming at the middle market, where deals top out at about $US5 billion, and where whales like Goldman and Morgan Stanley are less active.
An army of smaller boutique firms competes with Macquarie for mid-market mandates, but most lack Macquarie's breadth, or its balance sheet and willingness to use it, even as a co-investor when needed.
It's a reasonable plan, and so far well executed, but the effort is more than fully reflected in its share price.
Macquarie is placing a large bet on the US regaining its mojo, and while the middle market it is aiming at is traditionally where American economic upswings come from, right now it is where the US is weakest.
mmaiden@theage.com.au
Frequently Asked Questions about this Article…
What caused Macquarie Group's recent profit guidance downgrade?
Macquarie cut its profit guidance because market conditions and transactional volumes in areas like trading, underwriting and mergers and acquisitions have been weak. Management now expects full-year earnings of about $900–$950 million to March instead of the previously forecast $1 billion.
Is Macquarie stock cheap compared with other global banks?
No — Macquarie is not presented as a cheap stock. The shares trade at about 14.9–15.7 times expected earnings, which is higher than peers mentioned in the article such as Goldman Sachs (around 10x) and Morgan Stanley (just under 11x).
Why does Macquarie need stronger overseas income to justify its valuation?
Because a relatively high price/earnings rating means Macquarie must deliver superior growth. The bank is relying on new streams of overseas-sourced income to replace some of the cash it used to generate from domestic retail and wholesale activities before 2008.
How has Macquarie changed its business mix in recent years?
Macquarie has evolved: about 40% of group income now comes from businesses that didn't exist five years earlier. The group has been restructuring and building new income streams, particularly from overseas markets.
What is Macquarie's strategy in Asia and why does it matter to investors?
Macquarie is building Singapore as a regional hub for fixed interest, currency and credit trading, expanding regional equity presence and applying its commodity trading skills. For investors, Asia represents a growth area that could help lift overseas income and diversify the group's revenue base.
How is Macquarie expanding in North America and what has it achieved so far?
Macquarie has pursued acquisitions in North America, growing headcount from 1,991 to 3,732 in the two years from September 2008, and lifting the region's share of global income from 8% to 27%. It is positioning itself as a full-service investment bank focused on the mid‑market with strengths in commodities, infrastructure and funds management.
Will Macquarie return to the pre-global-financial-crisis 'normal' performance?
The article says nobody expects a return to the pre-crisis era, which was unsustainably leveraged. A 'new normal' is expected: stronger equity markets and corporate activity than today, but with more risk aversion and regulation trimming the peaks — and Macquarie itself will look different as it continues restructuring.
What are the main risks everyday investors should consider about Macquarie's plan?
Key risks include execution risk for overseas expansion (especially in North America and Asia), heavy competition from global and boutique firms, regulatory and market-volume uncertainty, and the fact that much of the company's future upside is already reflected in its share price, meaning investors must believe in sustained superior growth.
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