Tuesday, December 13, 2005

In the Dumps, But Not For Long: Friedman Billings

We love banks -- they're always either buying or merging with each other.

Our two banking plays for 2006 are Citi (C) and FBR.

We believe Citigroup will be broken up within the next 12-18 months.

It's too slow moving a beast to compete with the nimbler regional banks that are pounding the pavement to give you a loan -- New Jersey's Commerce Bank (CBH), for example.

If you live in Manhattan, you'll agree that Commerce Bank is slowly approaching Starbuck's-like ubiquity.

For 2006, we also like Virginia-based Friedman Billings Ramsey (FBR), one of the most hated stocks on Wall Street today.

Considering the basement level price FBR's shares are currently trading at, we find Friedman Billings to be an attractive and viable takeover target.

FBR is despised for 2 reasons: the bank recently broke into the subprime lending business (which resulted in a string of analyst downgrades) and it also suffered a disastrous management change, both of which drove the stock to an ugly 52 week low.

The end result is that we now have a great business with a $2 billion dollar market cap trading at less than 10 X earnings.

FBR still pays a 7.8% dividend, too.

Oh, and lest we forget, FBR is badly undervalued: the banking industry trades at 3 to 4 X book and 4 X sales -- FBR trades at 1.5 X book and 2 X sales.

If there was ever a boutique investment bank a larger player would want to acquire, Friedman Billings would have to be it.

FBR's mergers & acquistions unit is extremely lucrative and ranks among the top IPO teams year after year.

Heavy M&A activity has resulted in phenomenal top line growth for FBR: in 2000, the bank eked out less than $200 million in revenues -- this year, FBR will generate over a billion in sales.

For investors, FBR could be an easy double should the bank decide to sell itself.

Boutiques like FBR have a long history of being swallowed up by larger banks -- the Soundview/Schwab, Lehman Brothers/Neuberger Berman, and Suntrust/Robinson Humphrey deals come to mind.

If FBR can strip off its bloodiest assets and focus on its core competencies, a buyer will emerge.

That FBR is focusing on its strengths and beginning to shake things up is no random fantasy -- two weeks ago FBR announced that it would sell certain assets and liabilities to Cardinal Financial (CFNL), a tiny but growing regional bank.

That move tells us that FBR wants to get its stock out of the gutter.

If you haven't heard of FBR, don't worry -- just a few analysts follow it.

Sometimes, the best stocks like to play dress up: in FBR's case, we have a coiled spring masquerading as a sell.

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