Why does the discount exist?
A reasonable question might be how and why such an opportunity exists. There are at least two reasons this bank is trading for half of book value, and the reasons are largely short term or fixable.
First, virtually all the public finance sites, including brokers’ sites, report figures on TFS Financial incorrectly. They’ll say the market cap is around $3 billion and that the price to tangible book ratio is an average-sounding 1.8, keeping investors away from this cheapie. You simply can’t quickly screen for this type of company, keeping a few people in the know and most people out. That’s due to the nature of TFS’s operations as a thrift and the process of demutualization that it undertook in 2007.
In a mutual bank, a mutual company holds shares on behalf of customer-owners. When a bank decides to demutualize and go public, it typically sells 30%-40% of its shares to the public, with the remaining shares held by a mutual holding company. These latter shares do not trade, but at some later date, a bank can sell those shares to depositors and put the proceeds in its own coffers. This acts as a means to raise capital for banks that need it. But with such a strong capital position, TFS has no need to raise cash.
Because of this partial demutualization, finance sites say that TFS has 309 million shares outstanding, but the actual public float is just 81.9 million. That inflates shares outstanding without giving the company credit for the cash that it could raise from selling the remaining shares. Factor in just publicly floated shares, and TFS is cheap, around 50% of book value. Investing in demutualizations is a trick that legends such as Peter Lynch and Seth Klarman have exploited before for great profit. So incorrect finance sites and the overhang of potentially new public shares keep TFS’s price down.
Second, TFS has a pending regulatory action against it, preventing it from buying back stock or issuing dividends. The regulatory action concerns the company’s corporate governance, which TFS had been working on before even being contacted by the feds. This concern is correctable. TFS has already cleared other regulatory actions that are more operational in nature (for example, on its interest rate exposure), so I expect its concerted effort to satisfy regulators here as well. That would clear the way for buybacks, which could really drive the stock higher.
How much higher? As my title suggests, it’s not hard to foresee the stock at $20 or more this year, if the company is able to repurchase a sizable number of shares. That would still put the price to tangible book value well below one, leaving more room for upside if buybacks continue or a dividend is initiated. For now, though, the market hates the uncertainty. Well, it will pay dearly later for complete certainty.
Foolish bottom line
With so many catalysts and a misunderstood stock, my Special Situations portfolio is buying an initial position of $2,000 — about 5% of my capital — of TFS Financial on the next market day.
The article This Bank Stock Could Be a Double originally appeared on Fool.com and is written by Jim Royal.
Jim Royal owns shares of TFS Financial. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple, Bank of America, Citigroup, JPMorgan Chase, and TFS Financial.
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