This financial company is a recent IPO, emerging from two businesses that fell on hard times during the recent financial crisis.
Ally Financial (ALLY)
from The Turnaround Letter
Ally Financial (ALLY) is one of the largest auto lenders and has an online bank called Ally Bank. The company was originally formed in 1919 as the captive finance unit for General Motors, known as General Motors Acceptance Corp. or GMAC for short. The company went into the mortgage business in 1985, and in 2005 its mortgage division became a separate subsidiary called Residential Capital or ResCap. By that time ResCap was heavily involved in subprime mortgage lending.
During the 2008-09 financial crisis, the U.S. government was required to inject $16 billion into GMAC to keep it afloat, and the ResCap subsidiary eventually filed for bankruptcy. The company changed its name to Ally Financial in 2010 as part of the process of getting back on its feet. After completely separating itself from both GM and ResCap, Ally completed an initial public offering of its stock in April of this year.
Ally has now largely extricated itself from the 2008-09 financial meltdown, and it has a strong position in the financial services market and good growth prospects. Despite this, many investors still have negative perceptions about the company because of its previous affiliations with GM and ResCap, as well as the government bailout. As a result, we believe that Ally stock is currently undervalued.
The company has a powerful franchise in auto lending with a roughly five percent market share. It is the largest non-captive auto lender, and one of the largest players in that sector. Outside of the subsidiaries of the auto companies and a few large money center banks, the auto lending industry is very fragmented, which should allow Ally to grow both organically and by acquisition.
Ally Bank, is an important asset. Originally set up in 2000, the bank has become a leader in direct (internet and other branchless) banking. It currently has $55 billion of deposits and is growing rapidly. Because the bank does not rely on a branch network, it can continue to grow with relatively low incremental cost. The bank subsidiary is allowing Ally to transition its funding sources to deposits and away from bonds and loans, which is meaningfully reducing the company’s costs of funds.
Management is taking a number of other steps to reduce costs. Among other things, Ally has exited 37 non-core lines of business since 2009 to refocus its efforts on auto lending. In 2013 the company reduced “controllable expenses” by about $180 million or 8%, and the reductions have continued into 2014.
The U.S. government has reduced its ownership of Ally from 74% to 16%, and it plans to shed the remainder of its stock by year-end. The government disposals may put a short-term damper on the stock, but that will be lifted in a few months. In the meantime, a number of savvy hedge fund managers, led by Dan Loeb of Third Point, have been building stakes in Ally.
We believe that Ally’s checkered past, together with the pressure from government stock sales, provides an opportunity to buy into a transformed and growing company at a favorable price. We recommend buying Ally Financial stock up to 33.
George Putnam III, The Turnaround Letter, www.turnaroundletter.com, 617-573-9550, September 1, 2014