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Summary

  • Synchrony Financial witnessed a disappointing public offering.
  • It seems that GE being an eager seller left some money off the table, creating momentum to split off the rest of the business.
  • I like the valuation in relationship to the healthy financial position at the moment.

Synchrony Financial (NYSE:SYF) is the spin-off of the former GE Capital (NYSE:GE) business. The company provides credit cards and has relationships with key partners including national retailers and manufacturers. These credit products are offered through the company's own bank which is now called Synchrony Bank.

The public offering and anticipated split-off going forwards originate from GE's decision to further cut its exposure to financing activities, a business which almost bankrupted the company during the financial crisis.

I like the valuation and strong capital position of the company and while I am typically not a big fan of investing in financial institutions, the relative risk/reward opportunity at this moment is appealing to me.

The Public Offering

Synchrony offers credit card products through three separate subdivisions or products. The retail card business is by far the largest of these three. Some 34.2 million active accounts use this service at over 34,000 retail locations including the most prominent retailers of the nation. The payment solutions is available at many more locations, yet just 6.7 million active accounts use these services which are typically used to finance promotional financing such as no-, reduced or deferred interest payments. The CareCredit business has just 4.4 million active accounts and it focuses on financing for healthcare procedures and related services.

With the credit cards, Synchrony has an attractive proposition for the partner, which most often is the retailer, in order to increase sales, boost customer loyalty and improve marketing. Consumers benefit from instant access to credit, discounts and loyalty rewards.

Synchrony sold some 125 million shares for $23 apiece, thereby raising $2.88 billion in gross proceeds. All of the proceeds from this offering will benefit the company with no shares being offered by selling shareholders, in this case of course GE.

Shares were offered at the low end of the preliminary offering range of $23-$26 per share. At the public offering price of $23, shares were valued at about $19.1 billion. It seems that GE and its underwriters would like to see a successful debut, creating momentum to sell the remainder of the business.

A whole range of banks lined up to aid the company in becoming a public firm. This includes all the big names like Goldman Sachs, Bank of America/Merrill Lynch, J.P. Morgan, Credit Suisse, Citigroup, Morgan Stanley, Deutsche Bank as well as many others.

Valuation

Synchrony Financial's operations are of a very large size. In total the business financed nearly $94 billion in purchases for the year of 2013 through 329,000 partner locations in the US and Canada. The company has about 57.3 million active accounts which results in a total of $54.3 billion in loans receivable. Even through the financial crisis, the company states that it has remained profitable.

The company stresses the partnership model with retailers, as well as the long and stable relationships which have been built over a period of multiple decades. Yet given the impact of the capital business on the overall GE business during the crisis the company has finally made steps to reduce its reliance on the financing business, starting with this transaction. Following the offering, GE holds nearly 85% of the stock in Synchrony, yet this holding will be divested in a split-off going forwards.

Given that the company will no longer be operating under the big GE corporation flag, the intended proceeds will indeed be used to fortify the balance sheet. Following the offering the company has a Basel-III Tier 1 common ratio of 14.5%, while it will reduce or even eliminate the reliance on GE Capital in terms of the financing of the business.

For the year of 2013, the business posted sales of $11.31 billion, a 9.7% increase compared to the year before. Provisions for loan losses rose by 19.8% to $3.07 billion which combined with an increase in other expenses hurt the bottom line. Consequently, net earnings dropped by 10% to $1.98 billion. Adjusted for being a stand-alone business, which results in higher interest costs, earnings came in at $1.83 billion for the year.

Revenues for the first quarter of this year were up by 8.5% to $2.93 billion as earnings rose by 55% to $558 million amidst lower loan loss provisions. Again adjusted for the pro-forma impact of higher interest costs resulting from being a stand-alone business, earnings came in at $526 million.

The balance sheet looks quite strong as well. The total asset base of $66.6 billion is supported by $9.1 billion in equity and ample liquidity as well. Total cash and equivalents stand at nearly $12.7 billion. The accounts receivable book of little over $55 billion is being roughly 50/50 financed through both deposits as well as loans.

Trading at $23 per share, shares are valued at $19.1 billion which is the equivalent of roughly 2 times pro-forma equity and roughly 10 times earnings. While the bank has a strong capital ratio and is very profitable, the company still needs approval from the Federal Reserve Board for paying out dividends.

Investment Thesis

As noted above, the public offering of Synchrony Financial has not been successful. Shares were sold at the low end of the preliminary offering range and ever since have traded in a tight $22.50-$23.00 trading range.

Like with any business there are of course risks. The biggest risk is of course the state of the economy which has an effect on demand for loans as well as delinquency rates, and often these factors correlate quite heavily. Another risk is the partnership on some of the key partners with The Gap (NYSE:GPS), J.C. Penney (NYSE:JCP), Lowe's (NYSE:LOW), Sam's Club and Wal-Mart (NYSE:WMT), combined making up 50% of sales. Increasing costs of regulation and potential cyber attacks are real risks as well.

In total the company has made allowances of about $3 billion for its $55 billion loan book, about 5.5% of the outstanding amounts. This compares to 4.1% of loans which is currently past due on 30 days terms and 1.9% which is past due by more than 90 days. Perhaps the greatest risk is regulation tied to the effective interest rates being charged. Given the $11.3 billion in revenues, on $94 billion in payments volume, this results in a 12% rate per annum. Note that however the current outstanding receivable base is just $55 billion, which means that these average loans are just about 7 months long in duration, resulting in effective interest rates of about 20%. As such any regulatory action to cut or limit interest rates being allowed to charge could have a big devastating effect.

While I am usually not a big fan of financing business, banks or other financial institutions, I must say that the current valuation in terms of price-earnings and the strong balance sheet are comforting to me. The public offering is definitely not priced for perfection leaving some real room for potential triggers including the strong capital position, a potential dividend at some point in time and organic growth. I might initiate a modest position in the coming days.

Source: Synchrony Financial - Relative Appeal At This GE Capital Split-Off