David Einhorn's $7 Billion Hedge Fund Is Loading Up on This Stock

By Markets Fool.com

At the end of the third quarter of last year, Royal Bank of Scotland spun off its U.S. regional banking subsidiary, Citizens Financial Group , in an IPO.

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The stock popped 7.4% on the first day of trading to $23.08. Among the buyers that day was billionaire hedge-fund manager David Einhorn through his fund,Greenlight Capital.

Greenlight managed just over $6.9 billion of investor money as of September. The hedge fund's success has propelled Einhorn's personal net worth to over $1.8 billion since its founding in 2006. When Einhorn sees an opportunity, he jumps on it, and more often than not he's right.

The thesis behind the Citizens Financial investment
This week, Einhorn released the fund's fourth-quarter investor letter, which includes updates on the fund's investment wins, losses, new positions, and Einhorn's general outlook on the markets.

The Citizens investment is one the first new investments highlighted for the fourth quarter. Einhorn explains his thesis:

While [Citizens Financial] is overcapitalized and currently generatesa low [return on equity] relative to peers, it plans to improve its ROE over the next two years through acombination of loan and fee income growth, cost reductions, capital return, and a partialnormalization of interest rates. We purchased [Citizens Financial] at $22.01, a discount to tangible bookvalue and a significant valuation discount to its banking peers. Over time, we believe theeventual exit of RBS and improvement in CFG's ROE will drive improvement in thestock's valuation. [Citizens] management received stock incentives at the time of the IPO,aligning their interests with shareholders.

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Einhorn was able to secure a very strong price at $22 per share, and fortunately for those who want to follow his lead, the stock hasn't moved much from that price point.

Don't ignore the risks

Source: Company website.

Like any investment, Citizens Financial is not a sure thing, even if smart hedge-fund managers are buying it. RBS still owns 75% of the company and plans to sell that entire stake by the end of 2016. All that selling will put downward pressure on the price of the stock. That will be a short-term phenomenon, and for value investors, it's reasonable that a short-term ceiling on the stock could be a good thing, providing repeated buying opportunities.

And as Einhorn notes, the bank's financial performance is not at the top of the industry. Management does have a strong plan in place to turn that around, but a strong plan doesn't guarantee execution.

Per the bank's third-quarter regulatory filing with the FDIC, the most recent available, the bank's return on assets was a low 0.67%, its return on equity was just 4.55%, and its efficiency ratio was an ugly 65.3%. The FDIC's Quarterly Banking Profile for the third quarter put the industry average ahead of Citizens on all three metrics. The industry averaged ROA at 1.02% and ROE at 9.04% and reported an efficiency ratio 61.7%.

The bank will report fourth-quarter results on Monday, Jan. 26.

The thesis is for a turnaround with tons of upside
For investors willing to take the plunge into an investment in Citizens Financial, the success or failure of that investment will hinge on the bank's turnaround. Einhorn is confident, and he's putting his substantial money where his mouth is on this regional bank.

The bank currently trades at a price-to-book value ratio of just 0.67. If the turnaround story unfolds as Einhorn predicts, that number could rise substantially over the next few years.

The article David Einhorn's $7 Billion Hedge Fund Is Loading Up on This Stock originally appeared on Fool.com.

Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.