April 23, 2013 - 4:38pm EST by
2013 2014
Price: 10.75 EPS $1.12 $1.22
Shares Out. (in M): 253 P/E 9.6x 8.8x
Market Cap (in $M): 2,720 P/FCF 0.0x 0.0x
Net Debt (in $M): 267 EBIT 0 0
TEV ($): 2,987 TEV/EBIT 0.0x 0.0x

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  • Mortgage REIT
  • Spin-Off


     Warren Buffet recently wrote that bond portfolios are wasting assets. As the high coupons of yesteryear roll off, investors are faced with meager choices. A great deal of capital needs current return. I want to invest in those companies which can provide current return. Although they may have messy pasts, they will have their day in the sun. As was noted by Ben Graham's quotation of Horace, "Many shall be restored that now are fallen, and many shall fall that are now in honor."  
     Newcastle Investment Corp (NCT) is a REIT which went public in 2002. It is managed by Fortress Investment Group (FIG). The original business of the company was to underwrite and manage CDOs invested in CMBS and other real estate related debt. These CDOs were sold in tranches with non-recourse leverage. NCT's earnings reports and statements are complicated as the company employes "fair value" accounting. Under the "fair value" convention, assets and liabilities are marked-to-market each quarter. This creates a lot of noise. In 2008, when the real estate market collapsed, NCT reported a loss of $3 billion, a loss per share of $56.61, and negative book value of $48.23. The losses related to the non-recourse CDOs. With the market for these types of securities in complete disarray, NCT repurchased $1 billion of the CDO debt at sharply discounted prices, and NCT continues to repurchase this debt at discounted prices. With the reversal of the CMBS market, and after several issuances of equity, book value at the end of 2012 was $5.86, and that figure is understated by several dollars. The company's 10-Ks are very informative as are their earnings calls. I recommend them to anyone thinking of making an investment in NCT.
     NCT's manager, FIG, is a large hedge fund operator specializing in financial assets. Many traditional operators in the real estate business have withdrawn due to capital constaints and other problems. FIG has bought financial related businesses to become a service provider. They formed Nationstar Mortgage Holdings (NSM) which has become one of the largest non-bank mortgage servicers and purchased American General Finance, which specializes in consumer finance, in bancruptcy. In December 2011, NCT and NSM teamed up to buy the Excess Mortgage Serviving Rights (MSR) of Aurora Bank, a subsidiary of Lehman Brothers. Under the agreement, NSM retained 35% of the MSR, services the mortgages and sold 65% of the MSR to NCT. Since that initial purchase, NCT has invested $629 million in MSR with their last purchase being from Bank of America for $340 million. The expected returns from this business are modelled at 19%. These reurns are sensitive to pre-payments and the capture of refinanced mortgages. In addition, NCT has teamed up with Springleaf (formerly American General Finance) to purchase $4.2 billion face value of consumer loans from HSBC. These loans are to 400,000 individuals. The purchase price was $3 billion of which $2.2 billion was financed on a non-recourse basis. NCT will invest $250 million for 30% of the deal, Springleaf will own 47% and service the portfolio, and a Blackstone fund will own 23%. Last year the RMBS market was the best performing part of the US debt market. NCT holds $477 million of non-agency RMBS which were purchsed at good prices and are financed with $157 million of repo debt.
     NCT has announced that it wants to split into two companies and has gone to the SEC to do a spin off. The spin off will be called New Residential (NRZ). It will hold the MSR, consumer, and RMBS assets. On Feb. 28th, 2013 NCT put out a presentation outlining the economics of the two companies. The presentation runs 63 pages and provides detailed information on the new company and the surviving Newcastle. The presentation models (not promises) that NRZ should be able to produce a net IRR of 14% and pay a dividend of $0.56. A comparison is made to Redwood (RWT), Home Loan Servicing Solution (HLSS), and PennyMac (PMT) which yield, repectively, 5.1%, 7.1% and 8.8%. A yield of 7% - 10% implies a price of $8.00 to $5.60 for NRZ. With the prospect for continued growth in the businss and the dividend, the new company should do well in the market. I am hopeful that I will be able to sell stock for $8.00 and more a year from now.
     The surviving NCT will continue to hold the legacy CDOs, other opportunistic real estate debt, and new investments made in senior housing. Through Dec. 2012, NCT had purchased 8 senior living properties with 836 beds for $153 million financed with $88 million of non-recourse debt. NCT believes that there is a major opportunity in the area as 70% of the indusrty is controlled by "mom-and-pop" operators. FIG owns a senior housing operator, Holiday Retirement, so we will see joint ventures in this area. Last, the CDO market will come back. Fortress is a major institutional real estate investor. It will be able to sell product. The Feb. 28th pesentation suggests that they will pay a $0.50 dividend. Chosen comparables in the commercial finance REIT area trade on yields ranging from 5.7% (RAIT Financial Trust [RAS]) to 12.7% (Resource Capital [RSO]). Healthcare REITs trade between 3.7% (Ventas [VTR]) and 6.4% (Senior Housing Properties [SNH]). Based on this, NCT should be able to sell for $5.00. if it is able to morph into an equity REIT in the senior housing area, it can sell for $7.80 on a $0.50 dividend rate.
     Fortress ia paid a management fee of 1.5% of equity raised. They are incented to sell stock. There is a further incentive to sell equity as Fortress gets 10-year warrants amounting to 10% of every common equity raise. Management owns 3,000,000 shares and has options, many well out-of-the-money on 10,000,000 shares.
     NCT is in a good place. It is generating a lot of cash, distributing a lot of cash, and in a business which presents them with lots of opportunities. I think that the stock will be worth $15.00 to $20.00 in two years, plus I will have recieved $2.00 of dividends while waiting.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


Spin off.
More deals.
Increased dividend.
Revival of the CDO market.
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