For many investors, the crisis in the Irish banking system is viewed as an opportunity. The banks that once raked in profits hand over fist from a booming mortgage market were forced to take state-funded bailouts to maintain their solvency. With the potential parallels of a banking comeback, investors are looking for ways to play this financial recovery. But one of the banks is a far better priced option than the other.
The collapse of Ireland's financial system led the government to develop the system so two pillar banks could emerge to run the new Irish financial economy. With the winding down of Anglo Irish bank and the splitting of Irish Life and Permanent, Bank of Ireland (OTC:IREBY) and Allied Irish Banks (OTC:AIBYY) were left to run the new Irish banking economy.
Although shareholders of both banks saw massive dilution in the scramble to raise billions in capital, investment from outside private investors kept the government's stake in Bank of Ireland to 15%. In contrast, Allied Irish Banks was unable to attract such private sector interest and has been taken over 99.8% by the state.
Both banks are expected to eventually return to profit, so why is Bank of Ireland a much better buy? It has to do with the share structure and mispricing issues.
An expensive bank
Despite the massive state holding and current losses, The Irish Times reported that Allied Irish banks was valued at roughly 64 billion euros (that figure has since slipped to 60 billion euros following a general slide in European bank stocks on Oct. 23). For context, this market cap approaches that of Lloyds Banking Group (NYSE:LYG), a profitable British bank whose state-owned stake is 32.7% and falling. Allied Irish's market cap is also significantly above that of Deutsche Bank (NYSE:DB), a bank generating profits and based in a more financially stable country.
Perhaps most importantly, Allied Irish's market cap is now around eight times that of Bank of Ireland, even though Bank of Ireland is in a far better position financially.
Why the difference?
Normally we talk about shares outstanding in millions or billions, but Allied Irish Banks has more than half a trillion shares outstanding on the Irish exchange. (U.S. ADR shares have undergone a reverse split.) However, those not aware of the massive share count have bid Allied Irish shares up, giving the bank a total "value" of 60 billion euros.
By contrast, Bank of Ireland, which has been largely driving the Irish banking recovery, has far fewer shares outstanding and hasn't soared to the ultra-high market cap of Allied Irish.
Where to go
Investors looking to capitalize on a broader European recovery may be more interested in banks such as Lloyds Banking Group and Deutsche Bank. Both offer large exposure to the European market while not being concentrated in a financially troubled nation. In addition, Deutsche Bank pays a small dividend of around 2%, and Lloyds is planning to reinstate a dividend in the near future.
However, those investing in Irish banks have two main ways to play. Looking at respective market caps, state ownership, and profit expectations, Bank of Ireland currently looks to be the better investment in Irish banking.
The Irish Times also noted that an independent analysis of Allied Irish Banks shares valued the shares at 0.0079 euros each for a market cap of 4.1 billion euros. While it is fairly likely that the Irish-listed shares would be reverse-split before then, if Allied Irish does fall back to this market cap it could be a turnaround play worth further examining.
The bottom line
Ireland's banking system has been hit hard, but even after a strong rally there is room for further recovery. Based on market cap and financial health, Bank of Ireland is currently a far better investment than Allied Irish Banks when one considers the 60 billion euro market cap at Allied Irish Banks. Investors looking for a banking play in Europe with this size of a market cap are likely to find better values in a bank like Lloyds Banking Group or Deutsche Bank.
To be clear, I haven't given up on Allied Irish Banks, and I still see the bank as having a major role to play in Ireland's recovery. However, I will hold my Bank of Ireland shares for now while waiting for Allied Irish to trade at a more realistic market cap before deciding whether to initiate a position.