I'm about to buy shares in Investors Bancorp (ISBC), a soon-to-demutualize thrift that is undervalued. The thrift has quickly grown assets since it went public in 2005 and, with improving credit metrics and a solid return on equity, the bank is ready to make the final leap to full public ownership. So my Special Situations portfolio will acquire shares shortly. Here's why I like the stock.
The business
Investors Bancorp offers banking services in New Jersey, Philadelphia, and Long Island. The bank's operations focus largely on residential (46% of assets in 2012), multifamily (29%), and commercial (19%). After its 2005 IPO gave the bank a huge amount of capital to work with, Investors has consistently increased its return on equity, to 9.3% in 2013 -- a solid, if not spectacular, level. In addition, the bank has increased its reliance on stickier consumers, those with checking and savings accounts. Those accounts now comprise about 70% of all deposits, helping to lower overall cost of funding.
Following the credit crisis, credit metrics continue to improve. Nonperforming assets have declined, though they were never at tremendously high levels, having peaked at 1.7% in 2010. Since then, nonperforming assets have fallen to 0.7% in 2013. That is elevated from the 0.1%-0.2% in the boom times of 2005 and 2006, but clearly moving in the right direction.
Equity is an adequate 8.5% of total assets, and that will climb as the company raises more capital as part of its demutualization, selling the roughly 61% of shares that are held by its mutual holding company, and then banking those proceeds.
The special situation
For those of you following my Special Situations portfolio, Investors Bancorp is in a spot similar to First Financial Northwest (FFNW -0.05%) and TFS Financial (TFSL 0.08%), both of which are featured substantially in the portfolio. While Investors Bancorp is still only a partially demutualized thrift (like TFS Financial today), it will soon become a fully public institution, like First Financial.
Demutualizations are one of the great special situations, followed at one time by Peter Lynch and Seth Klarman, among many others. Fellow Fool Alex Dumortier has more on this underfollowed segment of the market in this article. But, suffice it to say, demutualizations are a great place to make money.
Investors Bancorp has already filed with the SEC on the projected pricing of its public offering of stock. While the pricing is not as cheap as some demutualizations, which frequently start off trading below tangible book value, the stock still looks like a value given Investors' strong operations, attractive location in New Jersey, and improving credit metrics. The upcoming cash infusion will give the bank a lot more capital to work with.
Here's how investors can win. If the bank prices its stock offering at the adjusted maximum number of shares, buyers of stock today would receive about three shares in the new company, worth nearly $31.That implies a valuation of 1.18 times tangible book on the post-conversion stock. Not punch-the-lights-out cheap, but cheap enough for a well-performing bank. Even better, you get an immediate arbitrage profit here.
Though it's fairly typical to sell out shares, what if underwriters don't? After all, demutualizations often are priced at 75%-80% of tangible book, so investors may not be inclined to buy at a higher price. What happens if investors want fewer shares? Well, you forgo that immediate arbitrage profit in favor of a lower overall valuation on the stock. For example, at the minimum offering, post-conversion shares would be valued at 99% of tangible book -- quite cheap.
So as long as the offering is finalized, you get an immediate profit now, or a cheap stock later. Even at 1.2 times tangible book, Investors Bancorp is hardly expensive for a profitable and well-performing bank.
The holding company is retaining nearly 50% of the proceeds from the offering, a quite high level, with the remainder going into the actual banking operations. The filing says the holding company cash will be used for dividends, share repurchases, and perhaps acquisitions. Demutualized companies must wait a year following the event before they can start buying their own stock. And with that much cash, I won't be surprised to see Investors buy up some smaller rivals and expand its footprint.
The bank will pay a dividend -- the amount not yet determined -- which will draw a certain investor class to the stock.
Risks
Investors Bancorp has made quite a few acquisitions since it first came public in 2005. Just last year, it acquired Gateway Community Financial and Roma Financial, which ballooned Investors' assets. Poor acquisitions are always a risk here, though the company seems to have a good track record.
The new slug of capital will make the bank's overall return on equity look miserable for a while. That may put pressure on the stock in the short term, perhaps even pushing it below book value. If it does, I'd look to see if management is buying back stock.
And like nearly all banks, Investors is exposed to rapid moves in interest rates, especially upward.
Foolish bottom line
In the next few days, my Special Situations portfolio will invest $500 in Investors Bancorp. The demutualization should allow the stock to trade significantly over book value as the bank puts all that new capital to work.
Interested in Investors Bancorp or have another stock to share? Check out my discussion board or follow me on Twitter: @TMFRoyal.
