|Shares Out. (in M):||1,022||P/E||0.0x||0.0x|
|Market Cap (in $M):||2,586||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0.0x||0.0x|
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I propose a long position in the common stock of Popular, Inc. (BPOP, "Popular" or the "Company") as recent transactions have obscured underlying fundamentals, negative sentiment toward its core market is over-hyped, sell-side coverage is sparse and consequently presents an opportunity to invest in a sound banking franchise at a substantial discount to intrinsic value. In addition, BPOP is a well-capitalized bank with dominant market share, preferred relationships with regulators, an underappreciated subsidiary and strong earnings power potential yet currently trades at 80% of pro forma TBV and 4.6x normalized earnings. Those that can look beyond the obscurity of these current transactions are presented with a risk-reward profile that is asymmetrically skewed to the upside.
Nearer term catalysts to value realization include: 1) the illumination of transaction terms and accounting marks that will provide clarity and generate investor interest (Oriental hosted an investor call on 5/21 discussing its FDIC acquisition of Eurobank, Popular will likely follow); 2) a gain on tangible book from the Westernbank acquisition due to negative goodwill from assets purchases below fair value; 3) increased bank size will attract additional sell-side coverage - PR banks are somewhat neglected, most analysts that cover the space only initiated in the last two months; and 4) demonstrated rationalization of the PR banking market.
Puerto Rico entered the recession earlier and experienced a more pronounced downturn than the US as a whole. This has led to a perception that it will be permanently plagued structurally and that sound banking cannot successfully take place in the region. One only need look at the successful banking franchises in the poorer areas of the mainland US to disprove this negative position. Further the assertion that fraud is more commonplace in PR banking is also overstated. There clearly were instances of inappropriate lending activity at R&G, but the overall severity and prevalence of these practices was no different than that of the US market as a whole.
A weak PR economy, credit deterioration, low capital levels and need to raise capital were a drag on stock price through 2009. Since then the Company has successfully raised capital twice (most recently in April) and in a vote of confidence from the FDIC was selected to acquire Westernbank. This deal was one of the most telegraphed FDIC deals in a long time and consequently attracted lots of interest from event driven hedge funds. The deal was announced, the stock ran up and many seemed to have since gotten out. Technical selling pressure and a lack of clarity on fundamentals has kept the stock price depressed.
The size, complexity and limited disclosure surrounding the recently announced acquisition of Westernbank have obscured Popular's financials. Lack of detailed fundamental information has created a degree of aversion to the Company. These dynamics present an opportunity to buy a sound franchise at a substantial discount. Further, Popular's dominant market position will enable it to more efficiently gather deposits and underwrite loans. The stock will rise once these elements are more fully appreciated by the market, once the Company provides further disclosure and fundamentals become clearer. The Company is currently trading at 4.6x normalized earnings, 72% of pro forma TBV and 68% of my 2011E TBV. If a mid-cycle EPS multiple of 10x is ascribed the implied price is $5.50 per share and if you assume a higher multiple of 14x then the share price is $7.50. If these share prices are reached by 2012 as investors refocus on earnings rather than TBV, the implied IRR is 50-55%. I believe neither the bonds at par (<8% YTM) nor the TRUPs at 72 (illiquid) are very interesting at current levels.
Popular's strong capital and loss reserve levels, EVERTEC asset and potentially negative goodwill provide downside protection. In the event that credit challenges increase from existing levels and persist there is still an equity cushion. As depicted in the book run-off scenario below, current valuations are still less than 100% of 2011 downside TBV.
Investment Considerations & Risks
With $43B in pro forma assets, BPOP has been the largest bank in Puerto Rico for over 100 years. The Company operates 187 branches in Puerto Rico, 8 in the Virgin Islands, and in the US mainland: 41 in New York/New Jersey, 24 in California, 20 in Florida and 16 in Chicago. Within its non-Puerto Rico markets, the Company targets area with high concentrations of Puerto Rican decedents (currently 4M in the US). Popular acquired the second largest bank in PR, BanPonce, in 1990 and became the dominant depository institution on the island. Facing fewer growth opportunities in its local market, the Company looked to the mainland US. These subsequent expansion efforts were disastrous resulting in $2.1B in losses from 2007-2009, primarily from sub-prime loans in its E-LOAN segment. BPOP has since divested of much of its mainland operations (assets down 50%, 40 branches closed) and has refocused on its core market. The Company has remained profitable in Puerto Rico throughout the downturn. Losses forced a large common for preferred stock exchange in 3Q'09 that raised its TCE/TA ratio to 5.8% from 2.1%. Though this bolstered its capital ratio, it also resulted in ownership dilution of 56% for common share holders. The Company also raised $1.15B in preferred securities in April to support its roll-up plans.
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