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The Rock - a solid earner

Northern Rock shares float on the Stock Exchange this Wednesday and it appears that City interest is muted, at best, writes Richard Phillips.

On Friday, the shares were quoted on a grey market basis at 400p-410p - cheap, in comparison to the valuations obtained by the Halifax or the Woolwich, for example. This may well work to outside investor's advantage. Northern Rock offers the potential of a smaller building society with a strong franchise in a few specialised areas.

One point prospective investors should be clear on, however, is the role of the Northern Rock Foundation, a charity set up by the building society to fund good works in the North East. Northern Rock has promised to pay five per cent out of its pre-tax profits to the charity, for the next three years at least. Although the Foundation should not be confused with a poison pill, this special dividend will also serve to deter predators interested in snapping up a tasty morsel. While it will make Northern Rock a more expensive proposition to buy, it does not prevent a takeover, but it does mean that any bidder will have to pay slightly more. The shares should, for that reason, trade at a slight discount to the price they would have stood at had there been no Foundation.

Northern Rock has some attractive features. Unlike many of its peers, it has made a special effort to stick to its building society roots. Almost 95 per cent of its lending is still traditional mortgage finance, and the bank has said it will not look stray from this sound base in the medium term. All well and good, given how the society has performed, especially against the competition. Although it is a small player, Northern Rock has consistently expanded its share of new business at a faster rate than most other lenders. One reason is its use of low-cost distribution channels - such as direct marketing - to sell mortgages, while avoiding a high- cost branch network.

The result is a low-cost business, allowing the Rock to target new borrowers with special cut-price deals. Among the big lenders, only Lloyds TSB, and the Alliance & Leicester have higher figures for new lending in the first half of this year. The comparison with Lloyds TSB is apt, since Northern Rock follows a similar path. None the less, it looks as though the stock market will be prepared to grant it a rating no better than more lowly ranked lenders, such as Barclays or Abbey National.

The shares are cheap at any price below 410p, and appear to offer good value up to 440p. In three years, the relationship with the Foundation could change, encouraging the prospect of a takeover which would add fizz to a share likely to offer good earnings growth, but little else to excite.