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Will GM Buy Ally Auto?

 May 16, 2012 10:42 AM

(By Manikandan) The chapter 11 filing of ResCap may lead Ally to sell the business to strategic buyers and General Motors Co. (NYSE:GM) is a likely buyer for some of these divisions.

Importantly, Ally has an exclusive agreement with GM to provide special subvented financing through 2013 and these loans account for 25 percent of Ally's North American originations. Unlike other buyers, GM can extend this agreement and preserve Ally's competitive advantage.

"Our best guess would be that GM looks to buy a handful of strategic Ally businesses for ~$8bn; however the possible range is $17bn to $3.5b. We expect discussions of the potential acquisition will increase over the next few months; however a sale would likely be a year away," UBS analyst Colin Langan wrote in a note to clients.

Through its AmeriCredit acquisition, GM has access to sub-prime and lease financing during the next recession. However, owning parts of Ally auto would ensure GM dealers are adequately financed in a recession, provide GM with international lending capabilities, and possibly improve customer loyalty.

Banks tend to shrink their auto loan portfolios during recessions. Without an in-house financing subsidiary, GM may be at a disadvantage to other automakers as customers may have less attractive financing terms.

In addition, the credit subsidiary continues to manage the relationship with the customer during the 3 to 5 year life of the loan, resulting in higher customer loyalty to the brand. In 2005, Ford estimated that loyalty from Ford Credit financed customers was over 10 percent higher than customers that used other lenders.

GM Financial, formerly AmeriCredit, is slowly trying to grow their dealer wholesale and lease portfolio, which is mostly provided by Ally today.

In 2006, Cerberus bought GM's controlling stake in GMAC, which was later renamed Ally. After this sale, Ally faced financial difficulties mostly due to its residential mortgage division, ResCap.

During the financial crisis, the US Treasury provided Ally with needed liquidity and controls 74 percent of the company. Unfortunately, ResCap continued to struggle. The division temporary fell below its net worth requirement in the fourth quarter and did not make a required interest payment on April 17 and the intercompany line of credit expired on May 14.

A US Treasury official reported to the WSJ that they would support a bankruptcy filing as the Treasury is likely eager to exit this investment and filed an S-1 for a potential IPO in April. However, the ResCap bankruptcy would likely delay an IPO, and Ally may look to sell the business to strategic buyers.

"The incremental EPS associated with this purchase would be ~$0.40, with a range of ~$1.00 to ~$0.15. Unfortunately, captive auto finance units tend to be valued at book value at the automakers, and therefore any premium paid over book will likely reduce GM's enterprise value (~$1bn impact under base case)," Langan noted.

The analyst, who has a "buy" rating and $30 price target on GM shares, said though any of this range is possible, the best guess would be that GM looks to buy a handful of strategic businesses like leasing, dealer financing, and international lending.

While there are long term benefits to growing the financing subsidiary, investors will likely be disappointed that an acquisition would delay the return of cash to shareholders.

Ally Financial is currently the leading auto lender in the US, the 5th largest residential mortgage company, and an on-line bank.

The company has $186 billion in assets Ally (formerly GMAC). In 2009, the housing crisis severely impacted the value of Ally's mortgage business and resulted in the US government injecting $17 billion into the company. The company was among 19 banks the failed the original test and the only company to fail the most recent Fed stress test on March 13th. Ally's Tier 1 ratio was 7.6 percent as of year end. However under the US Treasury's test, its ratio was only 2.5 percent, below the 5 percent minimum. That said, if the government converted its $5.9 billion preferred stake, the Tier 1 ratio would be 10.5 percent.


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