Bank of America announced last night that they bought a 9% stake in China Construction Bank for $2.5 billion. This purchase, while relatively small for a $260 billion market cap bank like BAC, is testing our resolve in the stock this morning. This is a tough decision because we have made a ton of money in the stock and it will be difficult to sell.
However, one of my cardinal rules is to question any stock that announces an investment in China —
"I double check the thesis of any stock I own when they tell me that China presents the next opportunity for revenue growth. Beware the lure of Chinese math – "If we just sell one gizmo to 1% of the Chinese population, we’ll make billions." The latest example of this is Federal Signal (FSS). There were scores and scores of companies that fell into this category in the 1990s including Gillette (one razor for every China man) among numerous other household product companies. The only company that this rule didn’t work on is Qualcom – that stock just kept going and going. "
The purchase of a stake in the China bank raises several questions –
1. Is the growth in the US slowing so much that BAC deems the need to diversify into China? I would guess that BAC is seeing the writing on the wall – the stock has been driven by the productivity improvements from aggressive restructuring of all the properties that Hugh McCall bought in the 1990s. I would guess that the majority of the benefits have been accrued and earnings growth will be much harder to come by.
2. How much due diligence can you really do on a Chinese bank? Does BAC have the expertise to know what they are getting into? I would guess none and no. How do you judge the quality of a loan in China if you don’t know much about China? The fact that BAC is buying a stake in a bank that it probably knows little about "just because China is growing" raises a question about the competency of top management.
3. Why would Construction Bank or the Chinese government allow a purchase of the bank? Is it distressed? How many hidden bad loans are on the books that BAC will be on the hook for when something goes wrong?
4. Will Bank of America change its name to Bank of the World? This seems to be moving the bank away from focusing on solid execution in the US to "empire building" a la Hugh McCall. And I believe McCall did more to destroy shareholder value than almost any CEO I’ve ever seen.
5. How long will Congress allow BAC to "help" its customers by allowing them to overdraw their checking accounts with a debit card and then tacking on a $28 service fee for each transaction that was overdrawn? Ok, this question isn’t related to the China acquisition. Its a question of legality ("usury lending rates") and ethics, both of which I believe BAC is breaching with this practice. Of course, as a shareholder I don’t mind the $7 billion in service charges it earned last year…but as a consumer, I find this practice pretty revolting.
If you really want to understand the bear case against owning BAC, go to Tom Brown’s Bankstocks.com. He hates the stock with a burning fervor that’s hard to describe. Of course he’s been dead wrong about it for about five years now, so I wouldn’t listen to a word he says. However, it is amusing to read his well reasoned critiques and then flip to a chart of the stock, which has gone up pretty much in a straight line since 2000.
Despite the strong outperformance, the stock is still reasonably valued as well.
So as much as I don’t like BAC’s acquisition in China and its debit card overdraft fees, its still a difficult decision on whether or not to sell the stock.
Kudos to you! I hadn’t thguhot of that!