Several people have asked me lately about Banco Santander. Here are some thoughts I would like to share.



The Good:



- It's cheaply valued





- Emilio Botín, the chairman, raised the funds to buy the ABN assets by selling 1,200 of its properties across Spain for €4bn just before the market started to crumple, saving his bank from being drawn into one of the biggest housing crises ever.





- Botín also had a lucky escape with Alliance & Leicester: In January 2008, he was ready to pay £5.50 a share for the former building society, but his offer was spurned. Less than six months and a tightening credit crunch later, he picked it up for £2.99 a share and a few weeks after that landed B&B's savings book for an even lower price.





- A small percentage of their income comes from Spain and Portugal. It has practically no exposure to Greece.





- Very big exposure to Brazil and South America which is growing nicely.





- Good management in the sense that they are very conservative in their lending practices.





- Good chairman but a bit too aggressive for acquisitions and not so shareholder friendly in the sense that he has issued more stocks than needed for my taste, which is quite contradictory because his personal fortune is made of STD stocks. It's a third-generation family bank still ruled by the Botín family. Unfortunately, the Madoff case, the Santander frozen reit "Banif immobiliario", the indiscriminate stock dilution, and the probe due to the Swiss tax evasion by his family, have severely tainted his reputation, specially in Spain.





- Some exposure to housing troubles in Spain but quite small. The good thing, if you want to buy cheaper, is that the perception is that it is a big problem, so that also affects the stock price. Also, their mortgage portfolio has far fewer foreclosures and defaults then their competitors (due to their conservative lending practices).





- I do not consider the dividend to be extremely good because it is not what it looks like (see the ugly).



The Bad:



- It was vilified for launching a rights issue just a week after its chief executive, Alfredo Sáenz, said it did not need to raise new capital, but the €7.2bn rights issue were comfortably subscribed. It diluted by issuing a lot of shares at ridiculously low prices at the beginning of 2009. I lost their trust after that. They said they had to do it to reinforce their balance sheet. Unfortunately, it diluted a lot like 20% or more. You can review the exact number — I cannot remember it now, I just remember that they basically sold shares at exactly the lowest price that the stock ever reached. That is a traumatic memory in my investing career.





- They take too much risk by buying a lot of other banks, but they have proven to be able to buy very wisely and cheaply. Fortis, RBS and Santander bought together ABN Amro. Only Santander survived the crisis after buying it, Fortis and RBS practically went broke, or I should better say that several of their shareholders went broke. Their shareholders lost everything.



On the other hand, Santander got very nice South American assets from the ABN pie. That acquisition was incredible — it shows how wise they are. But they do buy too much for my taste. As I see it the CEO Emilio Botin is super excited to see so many destroyed banks and can not stop his impulses to buy them. He looks like a boy in a candy store that is liquidating its merchandise because it went broke.





- Their costs go up if government bonds yields go up, which already are very high and will certainly go higher. This is because if they have to issue debt it is based on the government yields and would be too expensive. So instead they would have to offer higher interests on their deposits to attract capital, but if that happens then they have to raise interests on loans, and the overall result reduces volume and profits. If Greece defaults or if the debt troubles spread to other countries, like Portugal, or even Spain, then interest on bonds goes up. This is already a reality. On the good side they do not have so much dependency on Spanish government bonds, but enough to affect profits.





- The chairman, Emilio Botin, and 10 of his family members are still under investigation for tax evasion. They had millions, for decades, in a Swiss Bank account, undeclared.



The Ugly:



- Ruled by generations as a family dynasty.





- Its Swiss-based fund management business was one of the biggest investors in the hedge funds run by Bernard Madoff. It was Emilio Botin's son in law Guillermo Morenes, who ran M&B Capital Advisers, the Swiss bank that marketed the Madoff funds. Not a good reputation for Ana Botin as a possible Santander successor. Spain's Banco Santander offered to compensate clients for nearly $2B lost to Madoff's Ponzi scheme, giving the bank's American depositary shares (STD) a brief lift. The catch, writes Barron's Bill Alpert, is that the "solution" on offer is a far better deal for Santander than for its clients.





- The CEO, Alfredo Saenz, faces a jail sentence in relation to the bank's housing REIT (Santander Banif) because it froze its payments in 2009 (legally questioned) and before doing it, a list of privileged clients was tipped that they could take out their money. (Note that this is for Spanish readers; most of the news from Santander come directly from the Source: Spain)





- Before the crisis they boosted their capital by selling convertible bonds to their own clients. Now those clients are sitting on huge paper losses. They have a duty to advise their clients on what is the best financial product to buy and selling their own convertible bonds poses a big conflict of interest and risks to seriously displease thousand of their clients their clients, many of them are not yet even aware of this situation.





- All of the dividends are not dividends, they are stock sales disguised as dividends (an ugly practice popularized years ago by At&T). Every year the second and third dividends are offered as cash or stocks; last year 85% of the stockholder chose stocks. Note that the chairman, Emilio Botin has chosen stocks only one time. The rest of the time he prefers to get cash than stock. If he considers the stock so cheap, why does he not buy it then? In 2010 from the 60 cents in dividends per share, 23.6 cents corresponded to the second and third dividend, since 85% chose for stocks then an amount of 20 cents actually corresponded to sales of shares! The ones that chose for it were actually buying shares instead of receiving dividends. Santander does a disservice to themselves by selling their cheap shares. So as you see, just two-thirds of their dividends are really dividends, the rest are stock sales. That's for 2010 only, and note that the dividend amounts can change as they wish. In 2011 they already said they will repeat this ugly practice.





- In 2008 all the dividend was stock sales. They actually ended up that year with 8.2 billion shares outstanding having started from 7 billion! That's why the earnings per share dropped, never recovered, and that's why they never mention their earnings per share anymore in their marketing as much as before 2008. If Greece defaults or Portugal gets in more trouble they could easily have the board approve all the "dividends" as a stock sale instead, as they did in 2008 and 2009. It happened before, and it could happen again, justified by the sovereign crisis, maybe even a better reason than in 2008.



So everyone is hot about this stock because of the dividend, but few know how dirty Santander is regarding their practices to issue shares to finance it.



It's dirty because they disguise a stock sale as a dividend. The one who buys is actually getting more shares just to avoid being diluted, and the one who chooses cash on the other hand gets diluted since his percentage of shares is diminished.



My view:



Overall it's quite a good bank and it bought very cheaply other banks after the crisis. But the situation with Spain has punished it, maybe much more than justified because of wrong perceptions, but in reality their exposure to Spanish problems is small. So if Spain recovers it can maybe really go up, but meanwhile it can also go quite lower. The share dilution is a real problem, but fortunately it has been more than offset by their impressive growth. After all, not so long ago Santander was just a small family Spanish bank originated from a city with the same name. If after this crisis mess they reduce their frantic buying, they could keep on growing nice and organically while being a much bigger and profitable bank.



Unfortunately my timing to buy was exactly some months before the crisis.



I already have enough shares so I will reevaluate adding only if it goes down 10 or 20% more, and if that does not happen I already have enough to make a nice profit when they do recover.



Note that this is not a recommendation to buy. I would suggest you read their yearly and quarterly reports and/or presentations which are on their website in English. They also have conference calls translated to English. If I had no stocks I surely would evaluate it and buy some in several lots, to spread the timing risk. Now its maybe a good time for that; there is a lot of panic going on, the bank is quite good, with small exposure to Spain's problems and fortunately most do not perceive that and are creating a possible entry point by running out of the PIIGS as if they were carrying the pest.



Disclosure: long





Cheers!



Juan

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