Is CYBG drool-worthy?

In the 1890s Russian physiologist Ivan Pavlov investigated the topic of dog salivation (presumably he didn't get out much). Pavlov discovered that an external stimulus – such as a ringing bell – could cause a dog to salivate if it had previously associated that stimulus with being fed.

Well, I'm salivating. The stimulus in my case is the discount to book value on offer at CYBG plc (an acronym for Clydesdale and Yorkshire Banking Group). This company contains the UK banking assets of National Australia Bank, and it will demerge from that company and list on the ASX on 3 February.

Prior to the listing, CYBG is conducting an initial public offering for institutional investors, who will set the final price. National Australia Bank announced details yesterday, with CYBG proposed to be priced in a range between 175 pence and 235 pence per share.

This range equates to 0.56 to 0.76 times CYBG's 2015 net tangible assets. Compare that to Commonwealth Bank (ASX: CBA), which trades at 3.0 times its 2015 net tangible assets. Or perhaps more relevantly, the much smaller Bendigo and Adelaide Bank (ASX: BEN) on 1.4 times.

These higher multiples partly reflect the more concentrated banking industry structure in Australia compared with the UK. There's also no doubt CYBG comes with a few warts (which we'll discuss in our forthcoming review). CYBG doesn't yet deserve a premium to book value.

Sources of value

But value-seekers know that ugly warts often fade with time (or at least an application of the corporate equivalent of Compound W). One potential source of value for CYBG is the new chief executive David Duffy, the well-regarded former chief of Allied Irish Banks. Another is CYBG's high cost-to-income ratio, which Duffy plans to lower from 75% to 60%.

CYBG is also less expensive than many international banks, which themselves are arguably cheap. Certainly the manager of the PM Capital Global Opportunities Fund (ASX: PGF) thinks so, as colleague Jon Mills argued in today's review PM Capital backs foreign banks.

We're not arguing that CYBG is worth buying just yet. There's a bit more analytical work to do.

What we are saying is that the conditions for good value are in place. CYBG is a spin-off and virtually the definition of an unwanted asset. It has also been involved in various scandals and therefore has an ignominious history.

Then there's that National Australia Bank is proceeding with the demerger even though market conditions have been weak. And the global banking sector – outside Australia – is still suffering a hangover from the global financial crisis.

All this adds up to the potential for CYBG to be excellent value. Put it on your watchlist, and keep an eye out for Intelligent Investor's detailed review closer to the 3 February listing date.

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Disclosure: The author owns Commonwealth Bank.