Banco Santander’s Huge Mexican IPO: Why It’s a ‘Smart Move’ During Troubled Times

Last week, Spanish bank Banco Santander announced plans to use the recent strong financial performance of its Mexican unit as leverage to raise $4.3 billion in a stock offering — the largest ever in Mexico’s history. Part of a longer-term expansion plan in Latin America, the move is also designed to signal to financial markets that the bank has high growth potential outside of its troubled home markets in Spain and the eurozone. In an interview, Wharton management professor Mauro Guillen and Adrian Tschoegl, a Wharton lecturer, discuss how the deal fits in with Santander’s master plan. The professors are authors of a book titled, Building a Global Bank: The Transformation of Banco Santander.

An edited transcript of the conversation follows.

Knowledge at Wharton: This is the largest stock offering ever in Mexico, with proceeds expected to reach about $4.3 million. Would you comment on just how significant this is for Banco Santander and also for Mexico itself? Mauro, maybe we’ll start with you.

Mauro Guillen: Well, this is one additional step [for Santander] in terms of fully utilizing their capital base. They either have plans to float — or they have already floated — part of their equity in the Brazilian subsidiary, in the U.K. and now in Mexico. Those are the three most important markets in which they have a presence outside of their home country of Spain. So, this is essentially part of a long standing policy to try to fully utilize their capital base. And let’s remember that there are other banks that have done this, and there are a lot of companies, especially in emerging markets, that have essentially used partners in local markets and floated part of the stock as a way to leverage their resources more broadly and to be able to accomplish more in a shorter period of time. So this is a smart move. But it is part of a long standing strategy on the part of the bank.

Knowledge at Wharton: Does it say more for Mexico perhaps than it does for Banco Santander at this moment?

Adrian Tschoegl: Well, if they were going to float anything, Mexico’s the one to float, because of all the major markets they’re in, it’s the Mexican operation that’s doing best. Last year, it accounted for about 10% of Santander’s global profits, which is just a little bit under [profits in] Spain. But it’s growing; it’s the one where the profits are growing, [whereas] Brazil’s a little off, and Spain is a little off. So, in terms of what’s easiest to sell, it’s going to be the Mexican operation.

Now keep in mind this 24.9%. They actually sold that amount back around 2006 to Bank of America. And then about two years ago, Bank of America sold it back to them. So, in effect, all they’re really doing is putting the same 24.9% back into play, in a way. As Mauro said, it’s part of a long standing plan. Right now, part of the motivation is [that] they just made the 9% capital base that the European banking authority wanted. They want to get to 10%. So, they’ll use the proceeds to up their capital base.

Secondly, at a time when Spain is, let’s say, a little bit in the dog house globally, there’s a problem in valuing Santander. If we can get market valuations for the main components, that puts a floor under the valuation of the whole corporation…. If you add up Brazil, Mexico and the U.K. and some other bits and pieces, then the total thing has to be worth at least that plus at least a little bit for Spain.

Knowledge at Wharton: In Europe, all the banks are having trouble raising money. All the banks are being asked to raise money under Basel III and other new regulations that say they need to beef up their reserves. They are kind of caught between a rock and a hard place. And of course, the economies are tightening. But here’s Santander, able to raise money — at least outside of Europe. Also, I believe a month ago they had a successful bond offering of about 2 billion euros, which did pretty well, especially considering how some of the sovereign bonds were tanking at the time. Are these signs that the market is viewing Banco Santander differently than some other banks in Europe?

Guillen: Well, it is a very unique bank. There are very few banks in the world that have a franchise — that have operations in the regional market in so many different countries. HSBC perhaps is everybody’s favorite example when it comes to global retail banks. But after HSBC, there are a couple more, and Santander is up there among the top five banks in terms of having operations in multiple markets. And of course, the European crisis — and in particular, the problems in Spain — has resulted in a situation in which the stock of at least some Spanish banks is undervalued? Their stock is being heavily penalized by the fact that they are associated with a market that is now in trouble.

But Santander generates more than half of its profits and has more than half of its assets outside of the home country. Much more than half of their profits. And the markets have not seen through that. So this [public offering of stock] in Mexico helps clarify, as Adrian was mentioning, that there’s a minimum that this bank is worth. And no matter how skittish investors are about Spain, or about the eurozone, this is a bank that has major operations outside of the eurozone, so they shouldn’t be penalized in the stock as much.

Knowledge at Wharton: So, the benefit [of the stock offering] to the brand in the market is maybe even greater than the proceeds from the stock?

Tschoegl: Well, if it draws attention to the fact that in Santander it is about 50/50 mature markets and emerging markets. Within the mature markets, in total I’d say Spain [brings in] probably under 30% [of the bank’s profits]. So if [the Mexican stock offering] draws attention to the fact that Santander is really a world player, not a [just a] Spanish player, that can only help in terms of perception of the bank.

[Also,] they are gathering some other funds. You mentioned the bond offering that they just had. They’ve just sold their Columbian operation. They decided it wasn’t growing to where they wanted it to be — 10% market share or better — so they sold that. That’s going to capital. If they now have a better capital ratio than is mandated, one of the best capital ratios in Europe, that, too, pulls them out of the league of troubled entities.

Knowledge at Wharton: In general, how has the European financial crisis affected Santander? We’ve talked about it a little bit, but maybe you could elaborate. And how will it affect it in the future?

Guillen: Certainly. For starters, the price of the stock is at historical lows, obviously. It has hit earnings, because even though Spain is far less than half [of the bank’s profits], it still is an important market for them. Besides that, they have consumer finance operations throughout Europe, western and northern Europe and a little bit in eastern Europe. These operations have suffered because consumption and consumer credit have decreased as a result of the recession and the crisis.

So, they are being hit both as a bank and as a market player in the sense that whatever happens with demand also affects them if the economy doesn’t go well. But other than that, as Adrian was mentioning, then they have a very strong presence in other developed or mature markets that are not in the eurozone — the U.K. and the U.S. primarily. They have emerging markets such as Mexico or Brazil and a couple of others of importance in Latin America. So they are well positioned in terms of their portfolio of businesses in different currency areas and different types of markets to weather a storm such as this, as long as, of course, not all of the economies go south at the same time.

Knowledge at Wharton: You mentioned Brazil, and of course Brazil’s economy has been contracting of late. They have a lot of loans out there. There has been talk about the possibility of some bad loans coming out of the woodwork, too. Is there any possibility that those bad loans could be large enough to give them a big dent? Or is this something that would be considered manageable?

Tschoegl: Probably not. Look, you can always be surprised — the trader who cost UBS $2.5 billion in bad tradings just went on trial today, I think, in London. But in Brazil, Santander had an okay bank, and then when they took part in the breakup of ABN Amro, they got one of the crown jewels, which was a Brazilian operation that was very well run. And the CEO of the Brazilian operation is very highly respected — he ran a good bank, ABN Amro Real. He’s now in charge of the total [operation] and still trying to put the various pieces together. But you have essentially a ‘good’ and a ‘very good’ operation being put together. So it’s not likely that you’re going to have some major surprise there.

And even in Spain, they are pretty good on risk control. They’re a bit below average for their market share in their exposure to the real estate sector — in particular, to residential mortgages. So they have been cautious there too. So again, you can always be surprised, but I wouldn’t expect anything there.

Knowledge at Wharton: The stock offering is the largest in Mexican history. Is it part of a pattern where there are more and more IPOs — and big IPOs — coming out of emerging markets? We’ve also seen this happening in Malaysia and even Indonesia.

Guillen: I think one needs to put into perspective the fact that this is the largest IPO in Mexican history for two reasons. The first reason is that Mexico stands out as a market in which there have been very few privatizations. [That country has] only really had one big privatization, which was the telephone company, and [the company that came out of that privatization] is now controlled by Carlos Slim. That was many years ago. But Mexico hasn’t really privatized anything else. You see, when you look at a lot of countries in Latin America, or you look at even countries in continental Europe like France or Spain, the biggest IPOs have always been state owned companies that went public. But Mexico, because of limitations in terms of how much the state can privatize, [which are] written into the constitution, they … have had very small IPOs. That’s the first reason.

The second reason is that in Mexico, there are large firms, but most of them are controlled by families and not all of them are listed. And if they are listed, they’re listing very small percentages. Here, I’m talking about Cemex; I’m talking about Bimbo; I’m talking about Vitra; I’m talking about [Grupo] Modelo. All of these are large Mexican firms, most of them with a global presence — in cement, in beer, in bread, baking and so on and so forth.

So, it looks big in Mexico, but it is in part because it is a big floatation. But even more importantly it looks big because up until now, not that much has been going on in Mexico.

Knowledge at Wharton: So a bit of a special case there?

Tschoegl: Yes.

Guillen: Mexico’s a special case in many respects. The other reason, of course, is that it’s so close to the United States.

Knowledge at Wharton: And after having literally written the book on Santander, would you comment on how their global strategy is going? You talk about it in your book. You’ve made some predictions there, some of which turned out quite nicely.

Tschoegl: Well, the big one is still open.

Knowledge at Wharton: Let’s talk about that.

Tschoegl: And the big one is the succession, when Botín [Emilio Botín, chairman] steps down. And I’d say that’s still, what, clouded and shadowed in mystery? Because the obvious heir apparent is his daughter Ana Partricia. But it’s not a foregone conclusion at all. So he’s been at the helm, since what, 1986 or 1987? And the bank has done well. He took an okay, what, number six or number seven Spanish bank and made it one of the largest banks in the eurozone. And so there’s: When will he step down? Who will be his successor? And, what effect will that have on the bank? Those are open questions.

Knowledge at Wharton: But in terms of global strategy, half their business is outside of Spain.

Guillen: I think they’ve been following essentially the template. Their template has been, since they started to internationalize in earnest in the 1980s, to grow by entering new markets, for the most part to continue focusing on retail banking, commercial banking and not branching out into other things. And they’ve been entering a number of markets, more than 25,and exiting some of those markets — Bolivia, more recently Columbia — just responding to circumstances. So they’ve been very pragmatic about market entry and market exit.

They’ve also tried to diversify by monetary area and in terms of the characteristics of the economy — mature markets, emerging markets and so on. So in my view the decisions that they’ve been making over the last two years — to expand in the UK, consolidate Brazil, expand into Poland, expand into Turkey and so forth — all of those decisions are really consistent with the last 20 years. So they are not shy about entering new markets, even when other banks were retrenching in the midst of the financial crisis. And they’re not shy about exiting markets if they think that they shouldn’t be there, right? So they are continuing to implement the principles that they established a couple of decades ago as to how they should go about growing internationally.

Tschoegl: They don’t get locked into a market in the sense of developing a sentimental attachment. Try it out. If it works, if they can get the market share — and they do work mostly by acquisition — if they can build up a good position, fine. If it’s a dead-end they leave –Columbia being the most recent example of that. And they’ve got sort of 10 priority markets, that hasn’t changed, and a lot of small ones and they’re going to see how those go. But it’s a continuation of the same overall strategy of the last 20-plus years.

Knowledge at Wharton: They seem to have a certain nimbleness that a lot of bank analysts say banks need, but banks typically lack. So that might set them apart. What about Asia, which everyone talks about as being the future of banking, since it’s the strong growth area? How are they set up for that?

Tschoegl: They were in the Philippines. They did buy some stuff and then they exited because they couldn’t figure out how to make that work. They clearly have an interest in China, but they can’t figure out a way to do that, in particular they can’t find people that can bridge between China and Spain, where the top management has confidence in them. They do not– I could be dead wrong on this, but I don’t believe they’ve taken minority positions in any major Chinese financial institutions.

Guillen: Or in Asian market for that matter. There are really only two or three banks that historically have a presence in, some presence in maybe one or two, at most three markets in Asia. These markets, let’s say, India, Thailand, Indonesia, the Philippines, South Korea, Japan, China, they’re all very different. They all happen to be in Asia, but they couldn’t be more different from one another. They differ in terms of the structure of competition, the regulations, whether there are strong local players or not, and so on. It is certainly something that they’re watching. I think every European bank wants to keep on watching what’s going on over there.

But we’re talking here about a bank that wants to play in retail banking, opening branches and taking deposits, extending loans. Maybe that’s not a part of the world where they should be. They’re exploring. They’re trying to see if it makes sense or not. But they have a lot of room to grow in Latin America, in Europe and also here in the United States. We haven’t even talked about the United States. In the United States they have a major presence in one small part of the country — the northeastern corridor, but that’s about it. And this is a big market that is ripe for consolidation because it’s [made up of] a lot of small banks.

And so they don’t need to grow in China in order to keep on growing. And China, perhaps, is a difficult market. And it seems as if China is following Brazil, right now, in terms of a deterioration of macro economic indicators, especially growth. So it’s not clear to me that China would be [the right move], and of course India is very difficult. You have very sophisticated, entrenched local banks.

So, it’s not clear why they would want, at least let’s say in the next five or 10 years, to allocate resources to that part of the world when they have growth opportunities in Europe, in Latin America and in North America.

Knowledge at Wharton: One last question: You talked about growth opportunities in Europe. A lot of bank analysts say Europe has too many banks, there’s going to be a consolidation, maybe a major consolidation. Where does Banco Santander fit into that?

Tschoegl: They’ve been sidestepping a little by focusing on consumer credit rather than banks. And so if you look at the Scandies, or Germany or so forth, they haven’t really built up a banking presence. They’ve got a bit of a banking presence in Germany and so on, but it’s been more of a consumer credit presence. For many years they’re targeted Italy. They were interested in Italy. They finally got an Italian operation, again in the break up of ABN Amro, and within a month they sold it to Monte dei Paschi di Siena [bank]. Again, no psychological attachment. Even though they’ve been trying to get into Italy for a long time, Monte dei Paschi came up with an offer that was ridiculously high, so within a month they got rid of it.

I think one problem with Europe is, it’s still a continent of nations and it’s very hard for a foreign bank to make a major acquisition without there being a certain amount of concern. Again, thinking about ABN Amro, when that finally fell apart, the Dutch nationalized the Dutch bit, the Belgians took over the Belgian bit, and only Banco Santander came out because they had none of those pieces.

Guillen: Continental Europe is complex. And will there be consolidation? Well, first we need to know what happens to the euro. And then next we need to know whether in the wake of a potential reorganization of Europe’s treasuries, or maybe in the form of some fiscal union, whether then as a result of that governments become less concerned about foreign takeovers of local banks. It is inconceivable of course that, in a context of a currency union, you still have, in each of these markets, the first, the second- and the third-largest banks are local banks. So there’s been no incursions, no invasions of one bank into another one’s turf after 12 years, 13 years of a monetary union. This is really, really strange.

So I think it depends on what happens to the euro. It depends on the kind of fiscal union. If the euro survives it’s obviously going to be with some kind of a fiscal union. So what shape is that going to take?

Are the governments then going to essentially be more open to takeovers in the financing sector? It is a politically sensitive sector, it is a strategic sector. It is, you know, a peculiar sector, that’s why we love talking about it, right? And in Europe, many of these institutions are 100 years old and it’s very difficult to move away from that. Even in the United States it’s sometimes hard to see how there could be more consolidation where perhaps there should be more consolidation. So the problems are pretty much, in this sector, present around the world. Europe is, I think, a very clear case of compartmentalization or fragmentation in the face of a monetary union, which is kind of weird.