What does UBS Group AG, which has doubled its valuation and soared, need to catch up with Morgan Stanley?

Since the acquisition of Credit Suisse, the stock price of UBS Group AG has risen by nearly 30%, and it is even speculated by the new shareholder Cevian Capital that its valuation is expected to double in the next three to five years. So, can UBS Group AG really catch up with its fierce competitor, Morgan Stanley?

UBS Group AG's recent series of performances, including slightly better-than-expected financial data (such as the increase in asset size brought by the acquisition of Credit Suisse), Cevian Capital's investment, strengthened shareholder dividends and share repurchases, and the setting of high target equity return rates, have all brought confidence to investors.

After the initial period of doubt, investors have gradually recognized the long-term value and potential benefits brought by this acquisition. However, UBS Group AG's integration and acquisition still face many potential difficulties, and investors still have doubts about UBS Group AG's future growth.

Analysts believe that UBS Group AG may become the next Morgan Stanley, but the premise is that it must successfully promote the integration of Credit Suisse, while maintaining strong growth in wealth management business, and achieve the target of 18% equity return rate by 2028 and 5 trillion wealth management assets.

UBS Group AG's Acquisition Journey

In order to strengthen its leadership position in the global wealth management market, especially in the United States, UBS Group AG acquired the "troubled" Credit Suisse in 2023.

The good news is that UBS Group AG has achieved initial success since the acquisition. Since the acquisition in June 2023, UBS Group AG's total stock return rate has reached 34%, far exceeding the 6% return rate of the Stoxx Europe 600 index during the same period. The Q4 financial report of UBS Group AG shows that its asset size in 2023 has increased by 56% compared to 2022. The CEO of UBS Group AG stated that since the acquisition, net new assets entrusted by clients have reached $77 billion, and this acquisition has significantly increased UBS Group AG's asset size. After the initial period of doubt, investors have gradually recognized the long-term value and potential benefits brought by this acquisition.

The bad news is that UBS Group AG's acquisition of Credit Suisse still faces many potential difficulties. Compared to the 56% growth in asset size, UBS Group AG's revenue has only increased by 18%. And due to the inclusion of significant expenses related to the acquisition of Credit Suisse, UBS Group AG reported a net loss attributable to shareholders of $279 million in the fourth quarter, continuing the downward trend of the previous three quarters. UBS Group AG executives have warned that this year will be the most challenging phase of the bank's merger process.

Furthermore, UBS Group AG's annual accounts show that the financial benefits obtained from the acquisition of Credit Suisse, which were valued at $29 billion, were recorded as a one-time gain and will not be reflected in future financial reports.

It is worth noting that two-thirds of the integration costs of the merger have yet to be paid, and these costs will appear as significant quarterly expenses until 2026. UBS Group AG will face sustained financial pressure in the coming years, intensifying market concerns about the outcome of the merger.

While this strategic acquisition has accelerated UBS Group AG's wealth management pace, it has also brought a series of potential difficulties, such as significant costs, unwinding positions, and legal liabilities brought by Credit Suisse, as well as various complex merger details. UBS Group AG is implementing its expansion strategy while also reducing underperforming or non-strategic businesses to ensure efficient allocation and utilization of resources.

During the process of merging with Credit Suisse, UBS Group AG closed two-thirds of Credit Suisse's investment banking business and almost all of its trading business, while also cutting around 3,000 positions.

UBS Group AG CEO Sergio Ermotti stated that the focus will be on restructuring and optimizing the post-merger business.

Previously, Morgan Stanley's successful merger case set a precedent in the market. Morgan Stanley set a target of 20% return on tangible equity (RoTE), which was well received by the market. Additionally, through a series of acquisitions, including the acquisition of asset management company Eaton Vance and online broker E*Trade, Gorman helped Morgan Stanley expand its business scope and market share in wealth management and online brokerage services.

Under the leadership of former CEO James Gorman, Morgan Stanley successfully transformed from a struggling investment bank into a wealth management giant by setting ambitious financial goals, executing strategic transformations, and making key acquisitions.

Cevian Capital's investment in UBS Group AG boosts investor confidence

At a time when the market is uncertain, analysts believe that UBS Group AG needs a long-term growth story that can inspire investor confidence and interest. Fortunately, UBS Group AG has such a story.

In December of last year, Cevian Capital, one of Europe's largest activist investment firms, invested $1.3 billion in UBS Group AG. Public information shows that Cevian Capital typically invests in companies they believe are undervalued or those that can increase in value through management changes, and actively helps companies make strategic adjustments to enhance their value. Cevian Capital is betting on UBS Group AG's long-term growth potential.

In addition, Cevian Capital may be attracted to UBS Group AG's valuation, as at the time UBS Group AG was valued at only half of Morgan Stanley's valuation. Compared to its American counterparts, UBS Group AG had the potential for value appreciation.

Cevian Capital's investment not only provides financial support but may also bring pressure from management to encourage UBS Group AG to take measures to enhance its valuation.

Wealth management business becomes a "must-win" battleground

After the 2008 financial crisis, there was a reevaluation of business models in the market, and "serving the ultra-high-net-worth individuals" became a sought-after business for financial institutions. Compared to investment banking, wealth management businesses that serve the ultra-high-net-worth individuals can improve capital efficiency and generate higher returns with less capital investment. Additionally, they can typically lock in clients for many years. Through long-term client relationships, banks can achieve stable income and profits.

UBS Group AG already has this popular business portfolio. In 2023, 52% of UBS Group AG's revenue came from wealth management, compared to Morgan Stanley's 49%. UBS Group AG's tangible return on equity in wealth management was only 16%, while Morgan Stanley's was 33%. This difference indicates that although UBS Group AG has a higher proportion of revenue from wealth management, Morgan Stanley has higher profitability in the same field.

Analysts pointed out that the lower tangible return on equity for UBS Group AG is partly due to the integration with Credit Suisse. Additionally, UBS Group AG's earnings were affected by a one-time loss from its stake in the financial services company SIX Group. Without these one-time factors, in 2022, UBS Group AG's tangible return on equity was 25%, which is closer to Morgan Stanley's figure.

UBS Group AG CEO Ermotti stated:

"UBS Group AG's wealth management business aims to attract $100 billion in net new funds this year and achieve this target again by 2025."

Analysts suggest that in order to achieve this goal, UBS Group AG may need to engage in fierce competition with Morgan Stanley in the US. The US market is Morgan Stanley's home turf, and competition there is particularly intense. As wealth advisors play a more significant role in the US, the cost of wealth management is higher. If UBS Group AG wants to achieve growth in the US market, it may need to compete with local competitors for market share in a high-cost environment.

Setting a High Target for Return on Equity, Strengthening Shareholder Dividends and Share Repurchases

In addition, to boost market confidence and raise the valuation of UBS Group AG, the company has taken several measures:

1) Setting long-term targets for return on equity and wealth management assets

Compared to UBS Group AG, Morgan Stanley's high valuation is not only due to the bank's ability to generate high profits from its existing wealthy client business, but also includes market expectations for Morgan Stanley's high growth targets. In fact, Morgan Stanley's growth targets are more ambitious, with the bank aiming to increase its client assets in the wealth and asset management division from $6.6 trillion at the end of 2023 to $10 trillion. According to Visible Alpha data, analysts expect the bank to approach this target by the end of 2027. In order to meet the market's high expectations, Morgan Stanley will need to continue growing its wealth management business and market share.

At the same time, the market expects UBS Group AG's client assets to achieve moderate growth. In order to raise its valuation and change market expectations of low growth, UBS Group AG has decided to demonstrate its commitment to future business growth by setting specific long-term targets. As a result, UBS Group AG's executives reiterated on Tuesday their goal of achieving a 15% return on equity by 2026, and added a new target of reaching an 18% return on equity by 2028. In addition, UBS Group AG has committed to increasing its wealth management assets from the current $3.9 trillion to $5 trillion by 2028.

UBS Group AG CEO Sergio Ermotti told analysts on Tuesday:

"We are not just a restructuring story, we will grow again."

2) UBS Group AG plans to increase stock dividends and resume share repurchase programs.

Analysts believe that while this may temporarily boost investor returns and attract shareholders, it may also sacrifice UBS Group AG's investment funds in other key areas, which could hinder its ability to invest in its business.