Ally Financial: Little Appeal As Treasury Unloads Stock In This Bailed-Out Company

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 |  About: Ally Financial Inc. (ALLY)
by: The Value Investor

Summary

Formerly known as GMAC, Ally Financial suffers from suboptimal profitability.

This makes Ally not appealing despite trading around its Tier-1 capital.

Regulation, reliance on key OEMs and past memories limit appeal.

Ally Financial (NYSE:ALLY) recently made its public debut after the US Treasury decided it was time to cut its stake in the automotive finance provider. The offering was anything but a success as shares have drifted downward following the offering.

Despite this discount, shares offer little appeal in my opinion thanks to the issues which I will raise in the remainder of this article.

The Public Offering

Ally Financial provides automotive financing both through wholesale as well as retail loans and leases. This makes the 90-year-old company the 19th largest US bank holding company.

Ally Financial sold 95 million shares for $25 apiece, thereby raising $2.37 billion in gross proceeds. Actually the company was selling all of these shares on behalf of the Treasury which stands to receive the cash with no proceeds for the company itself. Following the offering and the exercise of the greenshoe over-allotment option, the US Treasury will hold a little over 14% stake in the business which it bailed out for $17.2 billion back in 2008.

The offer price came as a disappointment for the US government as bankers set an initial price range of $25-$28 per share. Soft demand resulted in a final offer price at the low end of the range.

Some 20% of the total shares outstanding were offered in the public offering. At Tuesday's closing price of $23.93 per share, the firm is valued at $11.6 billion.

The major banks that brought the company public were Citigroup, Goldman Sachs, Morgan Stanley, Barclays, Bank of America/Merrill Lynch, Deutsche Bank and JPMorgan, among many others.

Valuation

Ally Financial focuses on its relationships with OEM partners as well as automotive dealers. Roughly 4 million retail customers are serviced throughout some 16,000 dealerships across the nation. Typically loans are made by individual dealerships which in their turn sell loans and leases to Ally Financial.

Ally has long been tied to manufacturers General Motors (GM) as well as Chrysler, which make up the majority of automotive loans. In total Ally provided loans and leases to 37.3 million used and new cars last year.

All of this resulted in total net revenues of $4.26 billion for 2013 which is actually down by 4.5% on the year before. Net earnings fell sharply to $361 million, yet the vast majority of the earnings decline is due to income tax benefits in 2012. In comparison, in the disaster year of 2009 Ally Financial reported a $10.3 billion loss.

Given the nature of the business it is very important to take a look at the asset and liability side of the business. Ally Financial holds a $151.2 billion balance sheet but employs relatively little regulatory arbitrage by reporting rather high risk-weighted assets of $128.6 billion. The business is supported by $14.2 billion in common equity and $11.4 billion in Tier-1 capital for relatively solid capital ratios. Despite this, a repeat of 2008 would put the business in imminent danger again.

The $11.6 billion valuation actually implies a discount to the common equity of the business and makes shares trade on par to their Tier-1 capital. Suboptimal earnings and a lack of imminent dividends can arguably explain this cautious valuation, not to mention past memories.

Investment Thesis

As noted above, the offering of Ally Financial has been a struggle. The company priced the offering at $25 per share, some 4.7% below the midpoint of the preliminary offering range. A lack of an opening day pop leaves shares trading some 9.7% below the midpoint of the preliminary offering range at levels just below $24 per share.

Perhaps some of the cautiousness has to do with the valuation on traditional earnings metrics as the company trades at 31 times last year's earnings. More anticipated selling from the Treasury might scare off investors some more. This is despite the fact that prominent investors like Daniel Loeb through Third Point LLC will continue to hold onto their stake in the former GMAC business.

I don't think that the weak offering offers great potential for investors to step in, even as the company trades at par with its Tier-1 capital. Suboptimal earnings, potential for tougher regulation, the reliance on major and struggling OEMs, the lack of dividends and fierce competition are all reasons which make me turn cautious. Of course this includes the past memories of the 2008 debacle.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.