An Ally in Finance

10/06/2014 7:00 am EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

Our latest featured turnaround was originally formed in 1919 as the captive finance unit for General Motors, known as GMAC for short, explains George Putnam, editor of The Turnaround Letter.

That auto loan company went into the mortgage business in 1985; during the 2008-09 financial crisis, the US government was required to inject $16 billion into GMAC to keep it afloat and the mortgage subsidiary filed for bankruptcy.

The company changed its name to Ally Financial (ALLY) in 2010 as part of the process of getting back on its feet.  Ally completed an initial public offering of its stock in April of this year.

Ally now has a strong position in the financial services market and good growth prospects. Despite this, many investors still have negative perceptions. As a result, we believe that Ally stock is currently undervalued.

The company has a powerful franchise in auto lending with a roughly 5% market share; the auto lending industry is very fragmented, which should allow Ally to grow both organically and by acquisition.

Ally Financial's bank subsidiary, 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 US government has reduced its ownership of Ally from 74% to 16% and it plans to shed the remainder of its stock by yearend. 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.

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