Taking Stock / Hapoalim Profited. Shari Didn't

The difference between the American billionaires and Shari Arison is that she's still at the bank. Maybe that is because she doesn't think IRR is the stuff of life.

Let us recap what we learned from the television and newspaper headlines this week:

Bank Hapoalim (TASE: POLI) netted a record NIS 1.6 billion.

Its profit is at the expense of the unhappy public, forced to pay bloated fees.

The bank is paying huge dividends to shareholders.

Its shares are rising.

Shari Arison, a shareholder, is growing richer. Her bank is a mint. This year alone she gained half a billion shekels from the bank.

Poverty is spreading and Shari is growing richer, richer and richer.

All true, but that's an emotional view of reality at best, and a populist one at worst. It is the world of people who understand nothing about economics or financing. In the real world the story goes the other way around.

Shari Arison's late father Ted bought the controlling interest in Bank Hapoalim on September 6, 1997, together with members of the Dankner family and a group of Wall Street sharks, mostly his friends:

Michael Steinhardt, manager of some of the biggest hedge funds on Wall Street. He's said to be worth half a billion dollars.

Len Abrahamson, who established the medical services company U.S. Healthcare and sold it to Athena for a billion dollars, cash.

Lew Ranieri, a Wall Street legend and one of the stars in "Liar's Poker" by Michael Lewis, about Salomon Brothers. He runs a billion-dollar private equity fund.

The late Charles Schusterman, an American oil baron and billionaire.

Ted, Michael, Len and Charles, together with the Dankners, paid the state $1.37 billion for 43 percent of Bank Hapoalim. Meaning, they bought the controlling interest at a company valuation of $3.2 billion.

Last week the foursome sold some shares in the bank, at a company valuation of $3.8 billion. Two months earlier they had sold shares at a company value of $3.5 billion.

Now for some math. The four investors sold shares at an average company valuation of $3.7 billion. En route Bank Hapoalim paid dividends of $1.1 billion.

Their total return (price at exercise plus dividends divided by the original price) is about 50 percent. Over seven years, that works out to an average of 6 percent a year on average in dollar terms.

That calculation is not actually precise. To calculate internal rate of return (IRR), you have to factor in the precise timing of the dividends. The earlier they were paid, the higher the IRR. Roughly speaking, their IRR is about 7 percent.

Now for the facts of life.

If Steinhardt, Ranieri, Schusterman or Abrahamson had only made deals returning 7 percent a year, they would not have been billionaires. They would have gotten nowhere at all. Your average housewife from Milwaukee made more on her mutual funds in the last 20 years.

The IRR in Steinhardt's funds is around 28 percent, meaning, each seven years he multiplies investors' money by 5.6. At Bank Hapoalim he barely got 1.5 times his money.

Cruise to financial oblivion

There are other ways to look at those returns. Right before buying Hapoalim, Ted Arison sold shares in his main asset, Carnival Cruise. He sold $900 million worth of shares to free money for the Hapoalim deal.

The Carnival Cruise shares he sold for an average of $15 each are trading today at $45. If Ted had been concerned solely for the greater good of his daughter Shari, he'd have done better leaving his money in Carnival Cruise, which achieved roughly three times the returns of the bank.

Carnival Cruise is a rather exotic investment, you say? Fine, let's compare with Citigroup. From September 1997 to date, its shares have returned 140 percent, three times what Hapoalim achieved.

A real dollar yield of 7 percent does not compensate for the risk in buying a share instead of a bond. It does not compensate for the risk of buying a share in Tel Aviv, which lies somewhere in the Middle East. A return rate of 7 percent is a burning disappointment for all shareholders in Hapoalim.

Happily for the American investors, they had borrowed about 40 percent of the amount for investment, which increases their return on equity. But it is still a bad deal.

Why? Regulation? The Bachar report? The Bank of Israel?

Probably not. Bank Hapoalim was a bad deal for several reasons:

1. The Americans paid full price for Bank Hapoalim, paying a 30 percent premium above its shareholders equity. That is an enormous price for a bank.

2. In 2002 and 2003, Bank Hapoalim's profits collapsed because of its lax lending habits during the bubble days.

3. The bank failed to lift its profits substantially. If the Americans had hopes of aggressive streamlining and efficiency drives at the bank, they were disappointed. Even after firing 900 people two years ago, wage costs have climbed more or less consistently for seven years. That's the custom in Israeli banking circles.

As for Shari Arison, the relevant math isn't that she made "several hundred million shekels from the bank," as the headlines say. It is that she lost money, going by the alternatives she had.

The difference between the American billionaires and Shari Arison is that she's still at the bank. Maybe that is because she doesn't think IRR is the stuff of life.