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Tuesday, April 17, 2012

Is BTG Pactual better than Goldman Sachs?

Is BTG Pactual better than Goldman Sachs?

William Wright

17 Apr 2012
In late 2005, André Esteves turned down an offer from Goldman Sachs to buy his investment bank. Instead he decided to sell Pactual to UBS and then buy it back three years later.

Esteves is the power behind BTG Pactual and its biggest asset, which might pose problems for future shareholders

This week Financial News was the first to report that André Esteves, chief executive of the Brazilian investment bank BTG Pactual, was under investigation for trading on his personal account in 2007. With just over a week to go until the bank’s IPO, which is expected to value the company at around $15bn, the Italian regulator Consob has fined Esteves €350,000 for alleged insider trading and frozen €4.2m of his assets. BTG Pactual says Esteves will appeal against the ruling, and that it will have no impact on the bank or on Esteves’ position.

Setting aside this controversy, Financial News takes a look at BTG Pactual to see if it really does live up to all the hype of being “Better than Goldman”.

So, how does the Brazilian bank stack up against its larger American cousin?

One thing we know for sure is that BTG Pactual is better at creating wealth for its partners than Goldman Sachs. Shortly after UBS acquired the bank for $3.1bn plus retention payments in late 2006, Esteves said in an interview: “I like making money. I’m good at making money. It’s exciting to create wealth. Otherwise, I wouldn’t be a banker.”

Esteves has been true to his word. The man who made his first billion when he sold the bank to UBS owns 24.5% of the bank pre-IPO, and assuming a valuation of $15bn (based on an acquisition it made early this year), his stake will be worth around $3.7bn – over $1bn more than Esteves paid for the whole bank when he bought it back from UBS in 2009.

The wealth creation doesn’t stop with Esteves. BTG Pactual’s 163 partners own 84% of the bank between them, which implies an average stake of around $55m each. This pips the average stake each of Goldman Sachs’ 221 partners had in the firm when it went public in 1999 – $52m. But it’s more concentrated at the Brazilian firm. The 35 senior partners at BTG Pactual (excluding Esteves) own just over 45% of the bank, which works out at an average stake of around $195m each.

Not bad when you consider that some of them – such as Huw Jenkins, the former chief executive of UBS Investment Bank, who is now a managing partner at BTG Pactual in London – have only been with the firm for a few years. To put this in perspective, Hank Paulson, who was chief executive of Goldman Sachs when it went public, had a stake worth about $220m in the firm that he had joined in 1974. (The remaining 127 junior partners at BTG Pactual will have to make do with an average stake of just $17m).

In absolute terms, BTG Pactual is still the baby brother when compared with Goldman Sachs in the last fiscal year before it went public. BTG Pactual revenues of $1.7bn last year are just one fifth of the equivalent number for Goldman Sachs in 1998. Pre-tax profits of $1bn are around a third those of Goldman Sachs in its final year as a private partnership, according to the two banks’ IPO filings. BTG Pactual’s balance sheet of about $60bn is one quarter the size of Goldman Sachs before it went public; with just 1,255 employees it has less than 10% of Goldman Sachs’ workforce back in 1998.

To put BTG Pactual in perspective, in 2011 Goldman Sachs made as much in revenues roughly every three weeks as the Brazilian bank made in the whole year.

To understand why people are drawing such excitable comparisons between BTG Pactual and Goldman Sachs, you have to look at BTG Pactual’s profitability, growth, partnership structure, and dominance of the Brazilian market.

A glance at some of the bank’s ratios in 2011 shows that in almost every respect, BTG Pactual is not only better than Goldman Sachs when it was preparing to go public, it is showing its US rival a clean pair of heels.

At a time when most investment banks have struggled to define a profitable business model, BTG Pactual has increased its revenues at a compound annual growth rate of 17.2% since 2009, a little less than Goldman Sachs in the two years running up to its IPO, but a world apart from the 21% annual fall in revenues at Goldman Sachs over the past two years.

BTG Pactual’s cost-to-income ratio was just 42% last year (compared with 66% at Goldman Sachs in 1998 and a painful 79% last year). Its pre-tax return on equity was a best in class 21.8% last year. That compares with a 46% return on partners’ capital at Goldman Sachs in 1998 and a miserable 8.1% underlying pre-tax ROE last year.

And when it comes to valuation, $15bn would give BTG Pactual a healthy price tag of just over three times’ book value – about the same as Goldman Sachs when it went public but five times higher than Goldman Sachs’ price-to-book ratio at the end of 2011.

Carnival in Rio?

The most obvious reason for the apparent decoupling of BTG Pactual’s performance from the rest of the investment banking industry is that the bank dominates the fast-growing Brazilian financial markets (it only has three offices outside of its home market – in New York, London and Hong Kong).

Over the past five years it has been involved in a staggering 69% of all Brazilian equity issues by value. In debt capital markets, it has averaged a more mortal 9% market share over the past five years, while in mergers and acquisitions its share of Brazilian deals since 2009 has been an enviable 26%, according to the prospectus. BTG Pactual is the sixth largest broker in the Brazilian stock market and produces some of the best research on Brazil and Latin America for both equities and fixed income. The Brazilian capital markets ground to halt last year, but few rivals expect BTG Pactual to be a spectator as and when they return.

This strong presence in an exciting market means that BTG Pactual’s employees are unusually productive, generating (on my count) around $1.4m in revenues each last year – more than double the equivalent figure for Goldman Sachs in 1998.

It is at this point that the bank’s partnership structure kicks in to keep costs down. With a high number of partners relative to staff (one in eight employees is a partner), BTG Pactual is able to keep its staff costs down to almost unheard of levels: its compensation ratio last year was less than 24%, compared with 43% at Goldman Sachs. It helped by allocating bonuses as a fixed proportion of revenues.

So, the bank can pay its staff 15% more on average than an employee at Goldman Sachs ($339k versus $295k), yet they generate nearly five times as much pre-tax profit per employee ($792k versus $167k). The partnership structure is complex, with restrictions on partners selling their stakes to anyone but other partners at anything other than book value. This should help the bank retain its ethos after the IPO.

Drill down a little further and you see that BTG Pactual is also more diversified than Goldman Sachs when it went public. It is already tapping into the rapidly developing private equity and wealth management markets in Brazil. Just 32% of its revenues come from sales and trading, and only 8% from investment banking. Goldman Sachs made two thirds of its money from investment banking and sales and trading in 1998, and nearly 70% last year. Other significant businesses at BTG Pactual are corporate lending (11%), asset and wealth management (21%) and private equity (6%), with the balance made up from interest income.

A one-way bet?

On paper BTG Pactual looks set to breeze through its IPO and continue to print money. What could possibly go wrong?

Well, Esteves did not become Brazil’s youngest billionaire and (on paper at least) one of the world’s wealthiest bankers without a highly developed sense of timing. An investment in BTG Pactual’s IPO is a concentrated bet on the Brazilian economy, on BTG Pactual’s ability to maintain its growth and margins in Latin America, and on its ability to successfully export its business model to more competitive markets overseas.

Esteves’s decision to go public now taps into investor excitement about Brazil. But all the indicators are pointing to a less than stellar recovery in the country’s economy. After growth of 7.5% in 2010, the International Monetary Fund expects GDP growth of just 2.9% last year and 3.0% in 2012.
Esteves has rapidly built up BTG Pactual in the past few years in a land grab that on the one hand provides the bank with a strong platform, yet on the other could start testing its margins. Acquisitions include a small Swiss private bank, a commodities broker, a Latin American commercial bank, and a Chilean broker.

It has also launched several real estate ventures. An uncomfortably large chunk of BTG Pactual’s growth last year came from acquisitions (and nearly half of the growth in revenues came from interest income on its own capital), raising questions as to whether its rocket-propelled growth could start running out of fuel.
At the same time, BTG Pactual is looking to export its Brazilian expertise into more developed markets from a low base (it has just 46 registered staff in the UK). In these markets it will face competition unlike anything it has experienced in Brazil. BTG Pactual’s margins in its home market will also come under pressure as Brazil becomes a more stable and attractive long-term prospect for international competitors.

But perhaps the biggest risk for potential new shareholders in BTG Pactual is what has, until now, been its biggest asset: Esteves himself. Esteves is the controlling shareholder and the prospectus makes it clear that many of the decisions at group level are “his and his alone”. It is difficult to imagine BTG Pactual without Esteves. But having this sort of power concentrated in one individual has got many investment banks into trouble before.

-- William Wright is a writer and commentator on investment banking and financial markets. He can be reached at or on Twitter on @williamw1

Read the story online here: Is BTG Pactual better than Goldman Sachs?

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