The Lehman-Sized Hail Mary

Hot girl winter is here for Jerome Powell. Wall Street is waiting for the final results of yesterday’s midterms with the rest of the world, but traders say this week’s inflation report may prove to be far more consequential to markets. Congress is set to be gridlocked, but markets will be moving and their major players are laying off. Let’s dive in. 

Bottom Line Up Front

Contribute something new to the news you’ll coffee chat over 

• Robinhood gave its customers access to 23 IPOs that all flopped. Robinhood’s stock, down by more than two-thirds, is among them. 

• Citigroup announced yesterday it would purchase Deutsche Bank's Mexican license in order to continue its corporate and investment banking operation in the country

• JPMorgan, Invesco and Dimensional Fund Advisors are among large money managers pushing back against proposals by US regulators to crack down on misleading fund names. The SEC’s proposed rule: you can’t have “income,” for example, in the name if you don’t have income in the strategy. Groundbreaking.

But first, a quick note from The BAD Investment Company.

Tired of ESG Bullsh*t? Fortunately, there's a money manager that decided that B-A-D might be the better acronym for investors.The BAD ETF (NYSE: BAD) launched last December and is taking a different stance in this green washed world focusing on 3 industries for which the ticker represents – B-A-D. 

• Betting – Casinos, gaming, and online gaming operations – 33%

• Alcohol – Alcoholic beverage manufacturing and distribution – 23%

• Drugs – Pharmaceutical and biotechnology product development and manufacturing – 33% (Cannabis cultivators & distributors - 10%) 

The case for these BAD industries remains strong for a simple yet important reason – they have historically offered attractive risk-adjusted returns. In addition to these industries overcoming government scrutiny, these industries have shown resilience during economic downturns because people tend to indulge in their vices, or what some call hobbies.  

As a result, we believe these asset classes are typically underappreciated and therefore under-valued but the reality is that people will continue to consume alcohol, gamble, and need medicine in good times, and in BAD.  

In regards to the betting and cannabis aspects, as these industries become more widely accepted socially and legally, they may offer investors additional growth as more states look to legalize those industries for additional tax revenues.

Learn more about the BAD ETF fund details and sign up for our mailing list to get the latest fund insights and information.

Deep Dive: The Lehman-Sized Hail Mary

There’s no historical precedent for a global lender carving out and listing an investment-banking unit. Credit Suisse, now the Street’s “Lehman 2.0,” has revealed their hail mary to stay afloat.  

Credit Suisse has been Wall Street’s latest stepchild sent to boarding school, with many calling it a weak bank with some strong bankers. That’s why Chair Axel Lehmann is considering bringing in outside money to insulate top rainmakers from the parent group’s turmoil. 

This year, being one of the $12B firm’s rainmakers is less fun than it used to. Their stock rewards are under pressure, as Credit Suisse’s share price has dipped 60% since last February. Now, as neighboring banks begin slashing their head counts, Suisse bankers’ risk of ending up out of a job is growing. Client blowups have destabilized the bank, and the cost of insuring Credit Suisse debt against default is rising. 

A Credit Suisse default is now over double that of arch-rival UBS.

Shrinking revenue and fleeing talent are now real dangers. Senior dealmakers have left, including global co-head of banking Jens Welter. The group cut its exposure to leveraged finance, one of its strongest businesses, to $5.9B in June from $10.2B in early 2021. Suisse is also hemorrhaging its share of total industry in mergers and underwriting.

If you love them, let them go

When Lehmann announced sweeping cost cuts as part of his new strategy on October 27th, his problem was that doing so could drive away people he would rather keep. That’s why the headline news from his announcement was one most likely cooked up with board member and former Citigroup rainmaker, Michael Klein. 

The idea? Spin off its investment bank, First Boston.  

The strategy could fund retention payments for managing directors in the bank’s strongest areas, like consumer staples and materials. More crucially, this would let Credit Suisse offer out-performers private stock in a focused dealmaking unit, rather than the struggling mothership. By being one step removed from Credit Suisse’s larger troubles, these out-performers might maintain the semblance of a top firm to put your assets behind. 

Saudi Arabia is playing a pivotal role in this restructuring. Gulf investors including Abu Dhabi’s Mubadala and Saudi Arabia’s Public Investment Fund plan to put money into the carved-out advisory and underwriting unit. The Public Investment Fund owns 37% of the Saudi National Bank, which last week invested $1.5B investment in Credit Suisse to buy a 9.9% stake. All of a sudden, Saudi Arabia is now one of the bank's biggest shareholders. 

Credit Suisse CEO Ulrich Körner recently confirmed First Boston wants to expand in Saudi Arabia, even poaching many of its equity and debt capital markets bankers in Europe. The Saudi National Bank chairman said yesterday that he "likes" Credit Suisse's new leadership. The break off’s appointed leader? The man formerly poised to be Citigroup’s CEO, Michael Klein. 

The Second Coming CEO

Klein has been with Credit Suisse for some time, but isn’t a full-time employee. In fact, the bulk of Klein's career was spent at Citigroup. He joined the US bank directly after Wharton and proceeded to spend over 20 years there. Klein's roles at Citi were many and various: he was CEO of banking and markets and CEO of banking in EMEA. By then, he was poised for the top job. 

Klein’s departure from Citigroup in 2008 was tumultuous. He was ultimately shunted into a range of chairman positions, roles often reserved for veteran bankers en route to retirement. He was long seen as a potential front-runner for CEO, and didn’t last four months after the new one (Vikram Pandit) was appointed.

Citigroup had bought out Pandit’s hedge fund, seemingly as a way to take him on directly as a CEO candidate. Klein, meanwhile, had been at the firm for two decades and was very much the insider. Charles Prince, then-CEO, tried to keep both Klein and Pandit under Citi’s umbrella by cleaving the firm in two for them to run without losing face. But Pandit, once becoming CEO, named his former business partner John Havens in a role above Klein.

Klein quit the firm with a $42M pay out. 

The Second Coming Bank

First Boston is an old Wall Street name that’s re-emerging from Credit Suisse with some new features. First Boston was a U.S. (obviously) investment bank in which Credit Suisse first bought a stake in 1978. The Swiss bank took full control in 1990 after First Boston incurred large losses on loans it had made to clients. The brand was dissolved in 2005.

The First Boston arm of Credit Suisse currently grabs just over 2% of total industry merger and underwriting fees. If it simply keeps up this performance, the now-independent arm would enjoy $3B of annual revenue. That could give it a considerable value relative to Credit Suisse’s own market capitalization. For example, rival Perella Weinberg trades at 0.7 times estimated revenue and Moelis and PJT Partners trade at around double their forecasted revenue. These metrics would put First Boston’s market capitalization anywhere from $2B up to $6B. This is equivalent to half Credit Suisse’s total, depleted worth.

The SPAC Lawsuit 

Now, time will tell if Credit Suisse will succeed in getting out of its own way. The longer Lehmann waits, the more the value of Credit Suisse as a dealmaking force will erode. He has signaled that his bankers won’t necessarily have the bank’s balance sheet at their disposal, calling for a “capital-light” division earlier this year. Besides potential profits, this would be First Globe’s main attraction: independence. But its now-CEO’s past shows just how bad too much if it can be to business.

Klein and his former investment fund, which specialized in SPACs, are currently facing shareholder litigation over claims that they structured a merger between a health analytics business and a blank-check company. A Delaware judge alleges Klein shortchanged public investors while giving insiders a 1.2 million percent return.

SPACs are publicly traded entities raising money on the promise of a reverse merger, or “de-SPAC,” with a private business that can then access public markets without the scrutiny of a traditional initial public offering. SPAC deals exploded in popularity in 2020, leaving regulators to play catch-up.

In the judge’s ruling against Klein, documents cite that if Klein had told his investors the truth about the merger’s details, they likely wouldn’t have a valid claim despite “unique characteristics of a SPAC” that can lead to conflicts of interests. The lawsuit, filed in March, is part of a wave of cases challenging the structural features of SPACs, particularly the standard practice among financiers of giving themselves “founder shares” for fractions of a cent. Each are worth millions if a merger is found, but nothing if a deal falls through.

The judge let the claims move forward, saying the allegations made it plausible that the merger’s “special benefit to Klein” motivated him to do whatever it took to push the transaction through, even if it was a bad deal for ordinary investors.

The value of an investment bank is its people. In this case, First Boston's will be higher if top performers are no longer at Credit Suisse. But time will tell whether Klein brings his reputation with him. 

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