Ambac Surges On BTIG Upgrade

NEW YORK ( TheStreet) -- Ambac Financial ( AMBC) surged Friday after BTIG analyst Mark Palmer initiated coverage of the recently-reorganized monoline bond insurer with a "buy" rating and a $31 price target.

Palmer appears to be the only analyst covering Ambac at this point, though his thesis on the insurer looks fairly similar to his long-held views on MBIA ( MBI) and Assured Guaranty ( AGO), which have proved to be very good calls, even if they took longer than expected are still well short of Palmer's aggressive target prices.

Ambac soared 10% to close at $26.03.

Palmer initiated coverage of MBIA at $8.50 Nov. 30, 2011 with a 12-month target price of $22.50. The thesis was largely based on the idea that MBIA would settle litigation with Bank of America ( BAC), granting it a $2-3 billion payout and removing a legal challenge to a critical restructuring for the bond insurer. More than 17 months later, Bank of America settled for $1.6 billion, while getting warrants to buy up to 4.9% of the insurer at a substantial discount. MBIA shares popped as Palmer anticipated, but never made it much past $16. They were up 0.34% to $15.34 late Friday morning.

Assured Guaranty, meanwhile, was at $11.25 when Palmer initiated coverage with a $35 target price Dec. 5, 2011. Palmer also counted on the insurer extracting legal settlements from the banks and its "virtually unimpeded opportunity to increase its penetration," of the municipal bond insurance market. While the extended period of low interest rates has made the economics of the muni bond insurance business unattractive, Assured Guaranty proved adept at winning big settlements from the banks. Shares have more than doubled since Palmer's initial recommendation and were trading at $23.94 shortly after noon on Friday.

In the case of Ambac, Palmer's recommendation is once again based in large part on the prospect of it winning legal claims over mortgage backed securities sold by the big banks. Ambac, which came out of bankruptcy May 1, has paid out roughly $2.5 billion to banks including Bank of America, JPMorgan Chase ( JPM), Credit Suisse ( CS), Nomura and First Franklin. Palmer believes legal battles won by MBIA and Assured Guaranty have laid the groundwork for Ambac to extract some relatively easy settlements. Even if it can win just half of what it has paid out, $1.258 billion would exceed its current market cap, he points out.

Another attraction of Ambac is its potential to capture $4 billion in net-operating losses (NOLs) if it can find profits somewhere. Palmer believes a good way to find them would be acquiring a mortgage insurer.

Pulling off an acquisition and/or winning legal settlements, however easy they may appear, seems like a lot of work for a roughly 33% gain, which is what investors would see if Ambac shares hit Palmer's $31 price target. In an interview Friday, he said he may have been too conservative. Also, he argues his thesis isn't dependent on an improving economy. While Ambac could see elevated claims against it if the economy weakens, the company still ought to be able to extract legal settlements or make use of the NOLs in such a scenario. Indeed, Ambac should be able to make an acquisition more cheaply in a weaker economy, Palmer argues.

Counting on legal victories -- however promising the odds may appear -- or an acquisition in order to realize a 33% share price gain seems like a lot of trouble. Then again, Palmer made good calls on MBIA and Assured Guaranty, and his call on Ambac clearly got investors' attention. Shares were up nearly 8% shortly after noon on Friday. Those interested in Ambac may want to let the shares cool off a bit before dipping a toe in.

-- Written by Dan Freed in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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