Tuesday, October 23, 2007

Jamie Dimon's Chase: "Time To Grin?" Not So Fast.......

Last Thursday's Wall Street Journal's Money & Investing section featured a glowing, fawning article on Jamie Dimon, CEO of JP Morgan Chase, entitled "J.P. Morgan's Time To Grin." Dimon's smirking mug is prominently displayed next to a stock price chart showing Chase having a 97% rise, compared with Citi's 27%, since Dimon's "arrival" at Chase.

If you only read the article, you'll think Dimon walks on water and has miraculously led Chase to financial success while his old outfit, Citigroup, stumbles under Chuck Prince's mismanagement.

However, the Journal article contains, in my opinion, several errors in reasoning and fact. And investors are not limited to just these two choices in the equity marketplace.

From my proprietary research on equity performance, I have observed certain relationships between key variables and the ability of a company to sustain superior total return performance.

The nearby chart presents some of that information for Chase, from 2001 to the quarterly information available as of the end of last month. The table which is its source appears a little further on in this post. Both may be viewed as larger images by clicking on them.

The Journal article contends that,

"J.P. Morgan Chase & Co.'s record third-quarter earnings showed that the financial-conglomerate strategy can work.

A three-year crusade by J.P. Morgan Chief Executive James Dimon to relentlessly slash costs and invest heavily in technology and core businesses appears to pay off amid a global credit crunch that has roiled Wall Street."

First, one quarter does not a successful performance make. It certainly does not 'show that the financial conglomerate strategy can work,' over time. Merely that in one quarter, it out-earned a crippled rival.

And, by the way, commercial banks are not "Wall Street." This is a mistake no investment banker would ever make. Per my post yesterday, here, I would suggest that simply by virtue of being a commercial bank CEO, Dimon is not a Wall Street executive. He's a commercial banker. Period.

The Journal article further states,

"J.P. Morgan's financial results underscored the potential of the so-called universal bank, a model that Mr. Dimon helped create under the wing of legendary deal maker Sanford Weill at Citigroup. Yet it also shows how the corporate strategy, in which assorted financial businesses are brought under one roof to balance out a bank's performance in tough times, requires a strong and nimble management in order to prosper."

I think it is far from clear that Jamie Dimon "helped create" the "so-called universal bank" under Sandy Weill. James Robinson, Weill's one-time boss, at American Express, failed with the 'financial supermarket' model in the 1970s and '80s. Buying ShearsonLehmanBrothers was one of the steps that disproved the model. Renaming it a 'so-called universal bank' doesn't really change much about it.

The original idea, which Weill also subsequently borrowed from Robinson, was to unite all financial service businesses under one 'umbrella,' pun intended, i.e., the old red Travelers Insurance umbrella logo that Weill so loved. Cross-selling to hopefully capitalize on presumed brand loyalty of financial service customers has been the real driving force of financial services diversification. And it's never worked yet. Not even the purer European 'universal banks' were able to sustain profitable growth, neither prior to their US appearances, nor subsequently.

Thus, I find myself in disagreement with the Journal article's authors regarding Chase's imminent prospects.

To the contrary, I believe that the trends displayed in the chart, drawn from original Compustat data, depict a bank already in a financial performance stall.

Look at growth in revenues and NIAT. Annual revenue growth has been declining since its peak of 50.5% in 2005. It is now down to 18.5%. Similarly, annual NIAT growth declined by more than half in 2007, from 70% in 2006.

Both of these trends are not indicative of long-term consistently superior total return performance.

Over the past five years, Chase has outperformed the S&P, 28.5% to 15.4% per annum. Yet it has not done so consistently. The bank has bettered the index in three of the past five years, but its annual returns oscillate wildly from a high of 90% to a low of -11%.

This leads us to examine the volatility of those total returns. Over the past five years, Chase's return standard deviation is 40%, versus the S&P's 5%. It's common knowledge that holding just one stock will expose you to far more volatility than holding the market, via an index such as the S&P. That said, a simple adjustment of dividing Chase's and the S&P's five-year average total returns by a denominator of one plus their standard deviations yields risk-adjusted total returns only 3 percentage points apart.

What I believe has occurred at Chase is an initial reduction of discretionary and, then, core expenses by Dimon soon after his arrival at the bank. This temporarily swelled operating margins, as revenue growth crested against a lower expense base. As revenue growth has been affected by the cost-cutting, it has slowed.

NIAT growth, as a function of the temporary margin expansion, swelled in 2005 and 2006, only to fall precipitously this past year.

If you are familiar with Dimon's mentor, Sandy Weill's origins, then none of this should surprise you. Weill was the original low-cost consolidator of the brokerage industry wire houses in the 1970s and '80s. He was never an investment banker. Rather, his specialty was combining commodity-like retail brokers, combining back offices, sometimes improving technology, and reaping the improved margins. Eventually, he ran out of wire houses to buy and consolidate, so he sold out to American Express.

By the time he was ousted from Citigroup, Weill had demonstrated that he had learned no new tricks since he lost control of ShearsonLehmanBrothers to Amex. Citi's topsy-turvy growth and increased complexity resulted in serious lapses in risk management and attention to business details. Significant growth was not something Citi achieved, sans acquisition, under Weill.

Personally, I doubt that Dimon knows much that he did not learn from Weill. His signal achievement since being tossed out of Citigroup consisted of giving BancOne the "Weill treatment." It is not yet clear he's done anything more at Chase, nor that he is capable of more, either.

It would take at least four years of consistently strong revenue growth at Chase, with corresponding NIAT growth, before I would believe that Dimon is capable of leading a financial services conglomerate to consistently superior performance, either fundamentally or technically.

1 comment:

Alessandro Machi said...

You should update this specific article to see where Chase Bank stands now.