Iceland's Hedge Fund Hotel
Goldman Sachs and a trio of hedge funds snapped up 30 percent of Iceland's Arion Bank last week, a nicely timed symbol of the country's return to normality and lifting of capital controls imposed after the financial implosion in 2008. 1
The strange part is that, as the group already owns 64 percent of Arion's parent Kaupthing, they're buying from themselves -- at a valuation that looks steep when compared with far bigger banks in richer European countries.
It's a partly defensive move. Kaupthing, which collapsed in 2008, needs to sell Arion, formed from its domestic assets, to repay money it owes to the government and to allow its hedge fund owners to sell stakes they took in the bank following the financial crisis.
Still, the price the four are paying suggests they're optimistic there might be more value to be unlocked from an eventual initial public offering of Arion.
Whether those expectations are justified will depend on the country's economic boom not turning to bust -- and ordinary Icelanders' frustration with what they see as Wall Street speculation not getting in the way.
The Arion deal should be seen in the context of hedge funds' rocky relationship with Iceland since 2008. Hopes of making a killing on failed banks' assets turned to frustration when it came time to exit the country. Amid growing public hostility, the government imposed a one-time 39 percent levy -- but funds could avoid it provided they met certain demands. One of them involved Kaupthing repaying debt to Iceland through the sale of its stake in Arion. So the sooner that happens, the sooner the funds can be free.
But at what price? Arion's valuation of 0.8 times book value looks rich indeed. It's in line with France's No. 1 bank, BNP Paribas SA, whose balance sheet is some 200 times bigger. Iceland's pension funds, surely the obvious long-term anchor investors for an asset like this, reportedly balked at paying that much.
The hedge funds could yet get the last laugh. An optimist would argue that Arion's whopping 27.1 percent capital ratio and exposure to domestic loans make it look undervalued -- especially when set against best-in-class Scandinavian lenders like Swedbank or Handelsbanken, which trade for 50 percent more than their book value.
An IPO outside Iceland might lure other pension funds and sovereign investors eager for dividends and exposure to banks.
It's not a slam-dunk pitch. There are concerns that Iceland's economic growth could suddenly cool. And financial regulation is still very much in the spotlight of public opinion. Economist Asgeir Jonsson, in his book on the country's collapse, recalls how popular ire moved from greedy bankers to "vulture funds" said to be using shadowy investment structures to turn a quick profit from the collapse.
Icelandic officials are under pressure to crack the whip and scrutinize current and future investors in Arion. The country's supervisor has made sure that the details of each investor in Arion are publicly disclosed.
Finding those reliable anchor investors and going the extra mile on disclosure should help the hedge funds close their Icelandic experience on a happy note. And with the government still owning 13 percent of Arion, it's in all their interests to stay optimistic.
Goldman made its investment through its ELQ Investors II subsidiary. Och-Ziff’s was acquired by an affiliated entity, Sculptor Investments.
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