Weekly Wrap: Uncertainty on the Way for U.K. Banks

Scott Halver: The U.K. goes to the polls; Tesla moves to vertically integrate; and Facebook invests to defend its moat--this time on the Morningstar Weekly Wrap.

U.K. voters headed to the polls on Thursday and voted by a narrow margin to leave the European Union. This result has serious implications for global markets--one sector that will be shaken particularly hard by Britain leaving the European Union is the UK financial sector, says senior equity analyst Stephen Ellis.  

Stephen Ellis: We are disappointed to see that the U.K. decided to Brexit and has decided to leave the EU. We expect that this will result in substantial uncertainty in the UK banking system and it will take several years to fully play out. We do think the immediate concerns right now will be handling volatility in the stock, bond, and pound markets and there could be potential trading losses at banks. We would also expect to see certainly a lower level of M&A activity that will impact investment banking fees for the U.K. banks; we would also expect to see higher funding costs for the banks. Particularly investment banks will likely need to move many of their employees outside of London to other countries to ensure that they can facilitate capital markets activity. A bank that we consider undervalued in this environment would be HSBC, which is largely exposed to China. While it is domiciled in the U.K., we do think it is diversified enough that the U.K. exposure would not be of particularly significant impact to them.

Halver: Tesla Motors made an all-stock offer to acquire SolarCity this week in an effort to vertically integrate. Our analysts see this deal as negative for Tesla shareholders, but positive for SolarCity shareholders.

David Whiston: Elon Musk and Tesla Motors surprised the market this week by announcing an offer to acquire SolarCity. The goal here is to make Tesla a one-stop-shop for sustainability to help save the world--meaning you’d have solar panels on your roof to generate electricity from the sun, use a Tesla powerwall or powerpack if you’re a business to store that electricity, and then, in theory, then use that electricity to recharge your Tesla electric vehicle. I understand to a point doing more vertical integration if you’re Tesla, but all that is predicated on, does the customer want solar panels in addition to an electric car--that’s a big "if". So there’s a big leap of faith here that Tesla shareholders have to make and you’re taking on a lot of dilution right off the bat for something that may or may not work out, and even if it does work out--it’s a very long way off. So we’ve cut our fair value because of that.

Travis Miller: From SolarCity's perspective we weren't at all surprised to see chairman Elon Musk effectively bail out the company earlier this week. The deal that he proposed on an all-stock basis is a significant premium to where we thought the value lay for SolarCity. SolarCity struggled with a strategy of growth and then changing to a strategy of cost-cutting, and we thought that the deal that Tesla offered is a significant premium for shareholders. We raised our SolarCity fair value estimate from $20 to $35 to reflect the fact that SolarCity shareholders now will get to trade their overvalued shares for shares of Tesla, which we think is substantially undervalued.

Halver: It was reported this week that Facebook has made strategic partnerships and investments with up to 140 media companies or celebrities as it tries to grow its Facebook Live product. Analyst Ali Mogharabi sees this as an effort to defend its moat in the face of growing competition in the video space.

Ali Mogharabi: With the objective to increase engagement among its more than 1.6 billion users, Facebook is focusing on live-streaming premium content and, according to reports, the company has signed deals with various media companies. 

This is a necessary investment as the emergence of Snapchat, with mostly online video content, could be impacting the engagement time among Facebook users. This could also attract online video ad dollars for Facebook. 

Other companies are going along the same route--distributing live video content to keep users engaged. For example, Twitter will be live-streaming Thursday night NFL games this upcoming season.

Overall, the competition for the fast-growing digital online video ad dollars is heating up among social network companies, along with Google's YouTube. 

This latest news does not impact our projections, nor our valuation of Facebook. We maintain a wide-moat rating and a $120 fair value on the stock. Given where the stock is currently trading, we see the upside as limited.

Halver: Also on Morningstar.com this week, be sure to check out Christine Benz's article on what 5 fees could be hurting your investment returns.