JP Morgan Chase Missing Strategic Opportunity in the UK
JPM's Digital Bank is a Waste of Time
JP Morgan Chase (“JPM” or “Chase”) is missing a strategic opportunity by not making an acquisition in the UK. Instead, JPM is entering the consumer banking market in the United Kingdom by creating a start-up digital bank. I believe this is a waste of time and resources for the bank. This digital bank will take decades to impact JPM’s bottom line. Instead, JP Morgan Chase should take advantage of the low valuations among UK banks and acquire Barclays PLC. Acquiring Barclays would immediately give JPM the #2 position in the UK banking market and provide significant financial benefits.
Chase’s entry in the UK market with a digital-only bank doesn’t make sense for a variety of reasons:
1) There are several digital challenger banks in the United Kingdom already. The top seven banks in the UK control 92% of the market. UK banking regulators have been encouraging challenger banks to enter the market. Chase will face significant competition trying to capture consumers who are willing to leave the existing High Street banks.
2) None of the challenger banks have demonstrated sizable returns to date. Why bother with an investment where none of the existing players have earned excess returns?
3) JPM’s start-up digital bank in the UK will take years to positively impact the bank’s financial performance. JP Morgan Chase will make about $30 billion this year. For Chase’s new UK digital bank to represent 10% of the bank, it would require $300 billion growth in deposits and demand $15 billion in bank capital.
4) Chase’s brand in the UK market is unlikely to have the power it does in the US. The Chase brand is powerful in the US. Chase has had a long association with the Rockefeller family. In the U.S., Chase has national lending businesses such as credit cards, mortgage, and auto. So, even if Chase does not have bank branches in their city, many consumers are existing customers of Chase or are at least aware of the Chase brand. When Chase enters a new US city (like Washington DC) with branches to build deposits and small business lending, it generates strong growth because of the strong Chase brand. This same dynamic won’t exist in the UK because Chase’s brand is weaker in the UK. Although JP Morgan Chase has operated an investment bank in the UK for decades, Chase does not have the same presence in national lending businesses that it does in the US.
5) JPM doesn’t have the same need to enter the UK consumer banking market that Goldman Sachs did when it started Marcus UK a few years ago. JP Morgan has one of the best deposit franchises among US banks. In contrast, Goldman is mostly funded with wholesale liabilities at substantially higher rates. Goldman was able to enter the UK banking market with only a high-yield savings account offering. The deposits Goldman raised in the UK replaced higher-cost wholesale funding. JP Morgan Chase doesn’t have this same need for low-cost funding.
Instead of entering the UK with a digital bank offering, JP Morgan Chase should buy Barclays PLC.
1) Buying Barclays will immediately give JPM the #2 position in UK retail banking. Retail banking is a scale business due to technology costs and advertising efficiency. By immediately getting the #2 market share position in the UK, JPM will save decades of clawing for growth from its new digital bank in the UK.
2) Barclays’s stock is so cheap that acquiring the UK bank will provide JPMorgan Chase HUGE Financial Benefits. Even if JPM paid a 30% premium to Barclays’ current market price, JPM would reap gigantic financial benefits by acquiring Barclays. JPM trades at 13.5x 2022 estimated earnings per share (“EPS”) and 2.38x tangible book value. Barclays trades at 8.2x 2022 EPS and 0.68x tangible book value. We estimate that estimates for JPM’s 2022 EPS would increase from $11.43 to $12.00, and tangible book value would increase from $65.30 to $72.85. This estimate only assumes a 10% cost savings on Barclays’ expense base, which is very conservative.
3) Jes Staley, a former JPM executive, has been remaking Barclays since he became CEO in late 2015. He closed or sold operations in 12 countries. This has narrowed Barclays’ operations to mainly the UK and the US. Since Barclays has been restructuring for 5+ years under Staley, JPM would not have to exit many non-core businesses. Jaime Dimon knows Staley well as the two worked together for nine years.
4) JP Morgan is prevented from acquiring additional deposits in the US because the bank already has more than 10% market share for deposits nationally. JPM would be able to divest Barclays’ US deposits easily and still have the capacity to fund Barclays’ US credit card business.
5) JP Morgan would consolidate the US credit card market by acquiring Barclays, which is the 9th largest credit card issuer in the US. Barclays has important credit card partnerships with American Airlines, Uber, JetBlue, and Wyndham.
6) JP Morgan would also eliminate a competing Wall Street investment bank. Dimon has been resistant to buying another investment bank. Since most institutional customers and corporations do business with every firm on Wall Street, when two investment banks combine, their customers tend to do less business with the combined firm than the sum of what they did with each firm previously. I believe the big prize of acquiring Barclays is to get the #2 position in the UK retail banking business for below book value. I believe Barclays’s investment bank has been a drag on its returns and its valuation. If the Barclays investment bank shrinks as part of JPM acquiring it, I believe it would not result in a loss of value. There are at least two positives from combining the JPM and Barclays investment banks: 1) if the combined investment bank shrinks as a percentage of the overall bank’s revenue, investors may place a higher valuation on the overall bank, and 2) removing a large competitor will reduce the competitive intensity of the business. Within Fixed Income, Currency, and Commodities (“FICC”), JPM had a 19% market share in 2019, and Barclays had a 7% market share.
The main problem with my proposed plan is Barclays has to be a willing seller. Many stakeholders who may veto the deal: Barclays’s management, Barclays’s Board of Directors, and the UK government. However, I believe each of these stakeholders can be won over because of the strategic logic of the acquisition.
My proposal of JPM acquiring Barclays ignores a second objective of JPM’s digital bank in the UK, which is to create a de novo model in the UK for JPM to use as a template to enter banking markets in other countries. This is an attractive long-term benefit of starting a digital bank in the UK; however, I believe the short-term financial benefits strongly outweigh the potential benefits of perfecting a digital bank model to replicate in other countries. Also, my idea doesn’t preclude JPM from entering other countries with digital banks. It would make more sense for JPM to take this approach in countries where the banks are highly valued.
Even if JP Morgan Chase doesn’t acquire Barclays PLC, its entry into the UK via a digital start-up is a waste of resources. The most important wasted resource will be management attention. Even if the UK digital bank is successful, it will take decades to positively impact JPM’s financials.