Knight Vinke's view on HSBC's results

The activist investor suggests HSBCÆs 18% earnings increase is due to one-offs and that radical action may be necessary with respect to the bankÆs subprime-affected business in the US.
Knight Vinke Asset Management, an activist investor based in the US, has released its view of HSBC's 2007 financial results that were issued earlier this week. Knight Vinke has been a critic of HSBC's management since September 2007, condemning the bank for its ôstrategy of seeking earnings diversification above all elseö.

Knight Vinke continues to argue that businesses like HSBC's operations in France lack critical mass and scale, while its US subprime business has no strategic fit with the rest of the bank. The asset manager also contends that a preoccupation with some of these markets has caused HSBC to neglect its comparative advantage in Asia and emerging markets.

As reported by FinanceAsia earlier this week, HSBC appointed four new board members - two internal promotions and two independent nominees. Knight Vinke expressed approval of the move and said that the board-level changes had alleviated some of its concerns with respect to corporate governance and insufficient independence of the board.

Knight Vinke's analysis of HSBCÆs recent 2007 results concludes that the 18% increase in earnings per share to $1.65 can largely be attributed to: ôone-offs, acquisitions and currency charges rather than underlying improvements in operating performanceö. It recast HSBCÆs net profits to corroborate this assessment and estimates that continuing businesses, after adjustments, are actually 14% down year-on-year.

On Friday last week (February 29), before HSBC released its results, Knight Vinke sent a briefing note to shareholders that termed HSBCÆs decision to enter the subprime business in the US ôa catastrophic strategic errorö. The firm believes HSBC Finance Corporation, the bank's US subsidiary, is unable to support the $150 billion of debt currently on its balance sheet and suggests HSBC ôring fence HSBC Finance Corporation by selling the business, spinning it off or, more radically, walking away from itö. Knight Vinke has been proposing options for the US subsidiary since May 2007.

In its statement on Friday, Knight Vinke also said that the strong financial performance HSBC was expected to announce for its core business in Hong Kong and emerging markets was in line with the results declared by the other emerging markets bank, Standard Chartered. It termed HSBC ôthe worldÆs most profitable emerging markets franchiseö.

But on Friday, and again yesterday, Knight Vinke said it believed HSBC would be trading ú2.00-ú3.00 ($3.97-$5.96) higher had the bank not acquired HFC. HSBC was trading on Wednesday at ú7.84, up 0.15%. Knight Vinke believes ôthe true value of HSBC is not reflected in its share price because of investorsÆ concerns about the risk of subprime contagionö.

Citi remains bullish on HSBC. In a research report issued on March 4 the US bank reiterated a buy recommendation on HSBC, with a target price of ú9.50, down only 50 pence from its earlier target, saying that "HSBC's valuation remains compelling with less risks and greater earnings visibility than most of its peers". Citi has factored into its assessment the likelihood of higher losses from the HSBC Finance Corporation business in 2008.

Meanwhile, HSBC got a fillip yesterday when its proposed acquisition of Korea Exchange Bank moved a small step forward. South KoreaÆs Fair Trade Commission has approved HSBCÆs $6.3 billion purchase of a controlling interest in the bank from US private equity fund Lone Star. But the deal is still subject to approval by the Financial Services Commission (FSC). FSC approval may be contingent upon resolution of various issues pending with respect to Lone StarÆs original acquisition of a stake in KEB.
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