Why I’m Buying Investors Bancorp

Check out this demutualization.

Feb 26, 2014 at 10:10AM
Ib

I'm about to buy shares in Investors Bancorp (NASDAQ: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 (NASDAQ:FFNW) and TFS Financial (NASDAQ:TFSL), 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.

Three more Foolish stock picks
It's no secret that investors tend to be impatient with the market, but the best investment strategy is to buy shares in solid businesses and keep them for the long term. In the special free report, "3 Stocks That Will Help You Retire Rich," The Motley Fool shares investment ideas and strategies that could help you build wealth for years to come. Click here to grab your free copy today.

Jim Royal owns shares of First Financial Northwest and TFS Financial. The Motley Fool owns shares of First Financial Northwest and TFS Financial. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers