Special Situations: ‘Raisins’ Analysis
June 23, 2015
- OTCBB: FNMAS
- Recent PPS: $3.81 (15.1% of $25 par)
- Implied FNMA Junior Preferred Market Value: $2.92B ($19.13B par)
I jotted the following notes down on the Scratch Notes page this morning, which formed the basis of the discussion to follow:
- Horne v. the U.S. Department of Agriculture
- 1937 law created the Raisin Adminstrative Committee, which imposes raisin quotas in order to create artificial raisin scarcity, which in turn raises prices
- “In the 2003 and 2004 seasons, the committee tried to seize 47% and 30%, respectively, of the Horne family’s harvest – or else pay a $684,000 fine.”
- “The liberal Ninth Circuit Court of Appeals propped up the Raisin Committee by holding that this clause only applies to real estate, not personal property. Writing for the majority, Chief Justice John Roberts shreds this distinction: ‘Government has a categorical duty to pay just compensation when it takes your car, just as when it takes your home.”
In the on-going Private Sector v. Government F&F debate, the Private Sector camp now has Starr v. The United States and Horne v. the U.S. Department of Agriculture on its side. Starr says the Government cannot do as it pleases in a crisis situation – i.e. it must follow the law (shocker, yes) – while Horne says the “Government has a categorical duty to pay just compensation when it takes” your possessions. The Ninth Circuit Court of Appeals believed the Takings clause only applied to real estate; the pro-Government camp believes the Takings clause does not apply in a Government-run conservatorship where private shareholders (preferred & common) knew full well that the typical ‘rights’ attached to their securities did not exist.
As explicitly defined in HERA, the Conservatorship was designed to nurse F&F back to health; if unable to return to a ‘health’, then FHFA had the power to place F&F into receivership. HERA was/is the law; as such, there was/is a LAW in place to wind down F&F. The private securities (preferred & common) were allowed to continue to trade for a reason. Yes, post-HERA they traded with the big Surgeon General’s Warning that there may be zero future value because F&F were no longer to be managed for the benefit of shareholders…but “not for the benefit of shareholders” does not imply “for the benefit of the Government”. And yes, the U.S. taxpayer was to be compensated for the risk is backstopping F&F, but that was done via the Senior Preferred Stock & Common Stock Warrant. “Not for” the benefit of shareholders means:
- Stabilize F&F’s operations, and thus the 30-year mortgage market
- Compensate Treasury for its
back door bailout of the banking system after charging F&F to increase the riskiness of its lendinginvestment
- Return residual value to the still-publicly-traded private securities
The Government allowed the private securities to continue trading, thus the right to residual value remained. The 3rd Amendment – i.e. the “Net Worth Sweep” – eradicated any possibility of residual value ever accruing to private shareholders. It is really, truly, as simple as that.
RESTRUCTURING & VALUATION
It is fascinating how easily the Government could have avoided this entire mess. Had the Government collected its 10% dividend thru FYE 2014, FNMA would currently have a 2.56% total leverage ratio – which just happens to be a hair over the Pershing Square-estimated 2.5% required leverage ratio – and the Government would have been sitting in pristine legal position to continue collecting preferred dividends (not to mention capital appreciation from the Warrant) into perpetuity. Now the Government just looks utterly ridiculous, fighting tooth & nail with a Florida-based investment fund (a mutual fund no less!!) over ‘discovery’ documents. Gee, I wonder if it has something to hide…
Most F&F bulls believe the NWS will be vacated, and the Senior Preferred treated as if it was partially paid down since the NWS began. Perhaps – but I prefer to conservatively assume that the full $117,149 million face value remains in place in the event the NWS is vacated. As such, Pershing Square’s fully-taxed Net Income estimate of ~$14.9B (at an 80bps G-fee level) leaves approximately $3.2B of annual earnings available to pay Junior Preferred dividends. At a 6% dividend rate, FNMA Junior Preferred dividends would be ~$1.15B, which leaves approximately $2B available for the common stock, or ~$.35 per share. At 12.5X EPS, the FNMA common stock is worth approximately $4.38, and the market value of the Government’s total investment is just under $193B, or 1.65X its original investment.
While I believe this scenario is a reasonable mid-point, it could take a longer-than-expected amount of time to reach. As such, I continue to be baffled at where the FNMA common stock currently trades – $2.43 at the most recent close. Even if the Junior Preferred is restructured at 50% of par – or $12.50 – FNMAS currently trades for just over 30% of this figure, providing a far larger margin of safety than the common stock.
I recently moved the FNMAS position to the upper end of my comfort zone, as I believe there is tremendous near-term upside over the next 6 to 12 months with the Fairholme case working its way thru the Sweeney Discovery process. While long-term I believe success is likely (as I explained on June 10th, there is a significant amount of ‘smart money’ still involved in this situation that believes there is a high probability of success over the long-term here), it is the medium-term risk/reward profile that I find enormously attractive here; one which could turn a great year into a “lights out” year, while having a relatively muted impact in the downside scenario (to be fair, I am playing with the ‘house’s’ money a bit being up what I am YTD; thus I have risk capacity, if you will).
While I believe the market is frequently wrong, I believe it is highly efficient in that it very effectively incorporates new information into prices. As such, I am a little bit of a market junkie – for lack of a better phrase – in that I enjoy studying prices and what they are ‘saying’. Crudely glancing at the FNMAS 5-year chart on Google Finance, here is where FNMAS has traded since August 2012 (FNMA’s PPS is in parentheses):
- Pre-NWS (August 10, 2012): $2.30 ($.28)
- Post-NWS (October 5, 2012): $.83 ($.28)
- Pre-Fairholme (March 8, 2013): $1.87 ($.29)
- Post-Fairholme MT High (May 24, 2013): $6.14 ($2.97)
- Pre-Lamberth High (March 7, 2014): $12.31 ($5.33)
- Post-Lamberth Low (October 8, 2014): $3.35 ($1.72)
- Post-Lamberth High (May 1, 2015): $5.06 ($2.82)
- Most Recent PPS (June 22, 2015): $3.81 ($2.43)
Since Fairholme became involved, at these various price points FNMAS has averaged over 2X the trading FNMA trading price; currently, it trades for 1.57X. That is hardly analysis – more just interesting food for thought, as 2X FNMA’s most recent closing price FNMAS would trade for $4.86 (28% upside).
More practical is the downside scenario analysis. FNMAS traded for $2.30 pre-NWS and $1.87 pre-Fairholme, the average of which is $2.09. This seems to be a reasonable downside case (-45% downside), as it represents where FNMAS traded on reasonable expectations of some sort of restructuring. $2.30 pre-NWS is of particular interest, IMO, given that F&F were not yet profitable at the time…
Conservatively I believe the probability of courtroom success lies somewhere between the post-Fairholme high of $6.14 and the pre-Lamberth high of $12.31. The average of those two price points is $9.23, which is approximately $142% upside from FNMAS’s most recent closing price.
Personally, I believe FNMAS should be trading much closer to the pre-Lamberth high…