Jeremy Warner's Outlook: Goodwin plots an American charter for growth

easyJet misery
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The Independent Online

By tradition, British bankers lose their shirts when they go shopping in the United States, so it's instructive to reflect on why Royal Bank of Scotland Group seems to be disproving the rule. The acquisition of Charter One Financial for $10.5bn (£5.8bn) expands RBS's retail banking presence in the US by about a half and propels it up the league table of US deposit takers from number 11 at present to number 7. The acquisition will also increase the proportion of RBS's pre-tax profits coming from the United States to about a quarter.

That's a big exposure which in the past would have sent a shiver of dread down the spine. Commentators like me would have written that RBS was almost bound to come a cropper in America's notoriously cyclical and shark infested banking market. Structurally, culturally, and in almost every other respect, US banking is completely different to its British counterpart. This was not a market foreign bankers could ever hope properly to understand, still less succeed in. Disastrous forays by both National Westminster Bank and Midland Bank into the US served as a terrible warning to all. Both lost their independence partly because of them.

Yet the story of RBS's transatlantic expansion is by contrast one of almost textbook precision and competence. With the acquisition of Charter One, RBS is uniquely well placed among foreign players to take advantage of the rapid consolidation of what has historically been a highly fragmented market. RBS is not there quite yet. To gain the position it aspires to, it needs another one or two acquisitions like Charter. But as the US market polarises into five or six big interstate players and a myriad of smaller regional banks, RBS seems to have positioned itself to stand as good a chance as any of achieving premier league status.

RBS's colonisation of the US began as long ago as 1988, with the acquisition of a small Rhode Island bank called Citizens. Since then, there have been a further 26 add-on acquisitions of growing size. Yet it was not until the takeover back here in the UK of National Westminster Bank that RBS gained the size, capital, self-confidence and stature to make a real go of it in the US.

The reverse takeover of NatWest was one of the greatest banking coups of all time which overnight transformed a smallish regional bank, little known outside Scotland's borders, into one of the most powerful banking goliaths in the world. Few takeovers, before or since, have succeeded in created as much shareholder value. Fred Goodwin, the chief executive, was always going to have difficulty finding an act which could in any way follow it. Yet I'm beginning to think that maybe in time the US invasion might come to be seen as a more than acceptable encore.

The process is different, slower and nowhere near as immediately transforming. Nor are the returns to be had from US banking anything like as good as Britain's highly consolidated banking market. Charter One meets RBS's 12 per cent, post-tax return on investment hurdle, but that's little more than a half the return on capital RBS makes on its operations back home. The synergies and cost-cutting benefits Citizens derives from Charter One aren't as big proportionately as some of the previous US acquisitions.

What's more, it is not altogether clear why RBS feels it necessary to place an additional £2.75bn of equity to help pay for it. RBS is throwing off surplus capital by the bucket load. In such circumstances does it really need to tap shareholders for more? No wonder the shares fell more than 5 per cent yesterday. There's good reason for scepticism. On a number of measures, Charter One seems expensive. It also deprives shareholders of the possibility of share buy-backs, at least until capital has been rebuilt. At that point, there will in all probability be another US acquisition, further to mop up the available surplus.

Yet for the opportunity value alone, Mr Goodwin is right to be pushing ahead with his US expansion. A key difference with the doomed banking forays of the past is that, subject to meeting head office controls and targets, the American side of RBS is almost entirely run on an arms length basis by Americans. They take what they can from the British banking model, but there is no attempt to impose it on the US operation, where it would undoubtedly fail.

Mr Goodwin is expanding in America in part because he has nowhere else to go. Competition constraints mean there's little scope for further acquisitions in the UK, while Europe is still too dominated by national sensitivities, cultural differences, and powerful egos to make a meaningful acquisition anything other than extremely high risk. With the marvels of the NatWest acquisition beginning to wear off, Mr Goodwin is faced with the need to find new infusions of life sustaining red corpuscles to keep his bottom line growing. The fragmented and surprisingly immature nature of the American market make it a natural for Mr Goodwin's consolidating talents.

easyJet misery

Here's a tale of our times. Appalled at the prices charged by easyJet for flying to Geneva on any Saturday during the Easter hols, I logged on to the Lufthansa website and eventually found a flight at less than half the price. They gave you a free meal too. Admittedly, I was subjected to the inconvenience of flying via Frankfurt, which is not an experience I would care to repeat, but boy was it cheap. I should have sold easyJet shares short there and then, for it was obvious that deals like these would be hurting the low cost airlines.

So it has proved. Ryanair's profits warning of a couple of months ago produced a smug and self-satisfied "we have no idea what they are on about" response from easyJet. Yesterday it was the turn of easyJet to have the smile wiped from its face. The shares nose dived a stomach churning 25 per cent after the company admitted that it too was suffering from "unprofitable and unrealistic pricing by airlines, across all sectors of the European economy".

Low-cost air travel continues to grow like topsy, but in the process it has spawned a whole legion of me-too, copy cat operators. In their desperation to get at least a few bums on their empty seats, the full service airlines are also cutting prices to cripplingly low levels on scheduled, short-haul flights. It's all great news for the flying public, but it's dire for the airlines.

To date the low cost pioneers have been able to make hay simply by feeding off the soft underbelly of the established full service airlines. It's been pitifully easy to undercut them. Yet now they are being forced increasingly to compete against each other to sustain the breakneck pace of growth. Michael O'Leary, chief executive of Ryanair, reckons he'll have to cut his prices by between 5 and 20 per cent this year to keep growing as planned. A bloodbath of smaller low-cost airlines looks inevitable. Already one of the German new comers has gone under, while Duo, a tiny Birmingham-based budget airline bit the dust on Friday.

Both Ryanair and easyJet look long-term survivors, having already acquired the financial strength, size and breadth of network to see their way through the present turbulence. Despite its profits warning, Ryanair remains hugely more profitable in terms of operating margin than even the best of the full service airlines. Easyjet meanwhile has a balance sheet which is still flush with cash. Neither looks likely to drown in the impending bloodbath.

Yet it's anyone's guess what damage they might sustain before calmer flying conditions return. Commercially, price wars always do enormous damage. The irony of the present battle for the skies is that the budget airlines suddenly find themselves victims of their own success. Enjoy it while it lasts, for one thing seems clear. Conditions as competitive as these cannot persist for ever.

jeremy.warner@independent.co.uk

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