SVB Financial Group (SIVB 0.91%), the parent company of Silicon Valley Bank, has seen its stock get battered and is now down about 66% this year. The bank, which caters heavily to start-ups, venture capital, and private equity companies, has been significantly impacted by the struggles in the tech sector and the private markets this year.
Funding for start-ups is slowing, start-ups are spending their cash, and some companies are seeing their valuations lowered because of what has happened to tech stocks in the public markets.
Considering SVB captures inflows on about half of all U.S.-backed venture capital investment, issues in the tech sector are certainly going to impact the stock. While the company is struggling right now, I believe SVB has built a great business that will do very well once the tech sector rebounds. Wall Street analysts seem to agree as well, with analyst price targets suggesting minimal downside and the potential for a multibagger opportunity.
Why the business has been hit so hard
SVB has many different business lines. It banks start-ups at various stages and in a variety of sectors, makes short-term loans to venture capital and private equity companies so they can execute investments quickly, has an investment banking arm to take start-ups public and help with mergers and acquisitions. It also operating a private banking unit to support high-net-worth individuals. SVB also runs several funds on its own that either invest in start-ups or in other VC and PE firms.
As a result, a lot of its deposits come from banking early-stage tech start-ups. SVB’s business boomed in 2020 and 2021 when VCs and PEs were raising incredible amounts of money and investing heavily, and tech companies were quickly rising to meteoric valuations. Quantitative easing and start-up creation led to a flood of deposits. In 2021, SVB almost doubled its non-interest-bearing deposits from over $50 billion to just shy of $100 billion. These deposits don’t cost interest and are the best kind of deposits a bank can have.
But this year, client inflows have slowed along with U.S. venture capital investment activity, which only hit $43 billion in the third quarter, down from $90 billion a year earlier. Meanwhile, clients that bank with SVB are burning through cash quickly now, more than double the burn rate before 2021.
This has led to significant deposit outflows, with average non-interest-bearing deposit balances falling by close to $20 billion between the end of the first quarter of the year and the end of the third quarter. This forces SVB to rely on higher-cost funding sources to support its interest-earning assets, which is squeezing the bank’s margin. Management also lowered its forecast for the full year and did not provide an outlook for 2023. Investors don’t like uncertainty, so this sent the stock tumbling after the recent earnings report.
Management has built a good business
Nobody likes to see a stock take such a beating, but the tech sector clearly was in a bubble in 2021 and SVB simply rose to a valuation that left very little margin for error. But the stock price now trades at pre-pandemic levels and at just 121% of its tangible book value (TBV), or net worth, which is toward the bottom of where it has traded over the past decade.
And it’s hard to say the business hasn’t gotten better. SVB has significantly beefed up its investment bank, launching more products and services and hiring a lot more bankers. The bank also purchased the wealth manager Boston Private, and at a very attractive price, which came with a digital wealth management and private banking platform that will help SVB bulk up its own private bank and better serve high-net-worth individuals.
Furthermore, SVB continues to gain new clients at a record pace, adding 1,800 new clients in the third quarter, which bodes well for when the tech sector rebounds.
Despite non-interest-bearing deposits outflows, they still make up 53% of the bank’s total deposits, which is still a very strong number. Management does expect further attrition but should still maintain a strong percentage of these zero-cost deposits. Lastly, the bank has been through several cycles and credit quality has held up extremely well. Credit continues to look very healthy right now.
The Street is bullish
Even after multiple downgrades since its earnings report, the lowest price target among analysts is $225 per share; the stock currently trades at about $242, suggesting very little risk. The median forecast is $312.50, suggesting about 29% upside over the next 12 months. The high price target is still $750, which would be a 210% gain from current levels.
Yes, there could be continued struggles in the near term, but once the tech sector recovers, SVB is very well positioned to thrive — which is why I believe this is a good entry point and a good long-term play.