|Shares Out. (in M):||64||P/E||0||0|
|Market Cap (in $M):||867||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Hi, guys --
I'm not a closed end fund specialist, and I don't think of myself as a short-term trader, but here's a special-situation short term CEF trade. NHF, which seems to be James' Dondero's preferred means of self-expresssion these days, intends to spin off a REIT by the end of the first quarter. I expect the value uplift from the spin-off to be somewhere between worth getting out of bed for given the short time-frame, and meaningful in absolute terms. So I advocate buying NHF in anticipation of the spin-off – but be warned, there's some hair here.
For form's sake, here's a quick statistical snapshot of NHF, all numbers as of the 2/27/2015:
Leverage %: 31.5%
Expense Ratio: 2.14%
I'm first going to discuss a straight investment in NHF, which is what you'll wind up with if things don't work out, and then explain the situation.
1: Investment In NHF
The secret to value investing is to convince yourself that
you're surrounded by idiots while staying humble about the whole thing.
I started looking into this about 4-5 months ago, and said to myself, “You know, this is a pretty good idea, how should I size this?” And then I thought, “Well, why not 100%?”
NHF is a multi-strategy hedge fund in a CEF wrapper. Dondero thinks this is the wave of the future, and he might be right. The manager gets permanent capital; investors get exchange-traded liquidity, transparency, SEC regulation, etc., sounds like a good deal for all concerned.
Dondero is a veteran. He's been around for a long time, having helped to invent CLOs back in 1994. There are some warts here. A lot of his vehicles blew up in the financial crisis, but so did I. He's going through a nasty divorce:
But guess what? My divorce shows every sign of turning ugly, it's just that The Post & Dealbreaker aren't going to care. I'm sure I'm an all around nicer guy than he is, but this all about the money, right?
Is there really any reason to think I'm better at this than Dondero? Here are the past few years returns (N.B., Dondero didn't take over the portfolio manager position on late 2012):
, and if this situation works out, 2015 will get off to a nice start.
Here's what I think I've got going for me:
I'm small enough so I can invest in nano-caps. Sometimes this works, sometimes it doesn't.
Deep down, I really don't care what anyone thinks of me, so I can buy things other people wouldn't touch. Sometimes this works, sometimes it doesn't.
Just lucky, I guess.
Dondero's got structured product and distressed-debt capabilities I can't think of matching – a good chunk of the huge 2013 came from American Airlines debt – and has had a hot hand in equities lately. Sure, there are some fees involved, but:
They're less than what a lot of club members aspire to,
The returns above are net of fees, and
They're substantially mitigated by that juicy 15% discount.
So, seriously, why not 100%? I'm not saying he's a god or genius, but am I any better than him? Maybe I should let him run the money and get out of this racket and do something useful with my life for a change, like teach adult literacy or something.
If nothing else, NHF is decent place to park as-yet-uncommitted funds while hoping to recieve hedgy-type returns.
Here are a couple of links:
Interview with the COO
Latest holdings, for those who want to look under the hood (this is as-of September)
2: The Situation
So, along with everything else, NHF incubated this value-added apartment REIT that buys fixer-uppers in the South East. They're spinning it off because concentration limits prevent them from putting more capital into it. Here's the latest from managment on the spin-off, from February 2:
“On September 29, 2014, NHF announced that the board approved the spin-off of NexPoint Residential Trust (NXRT) and plans to list it on the New York Stock Exchange under the ticker NXRT once the spin-off is completed, which we anticipate will be completed on or before March 31, 2015.² On January 26, 2015, the board announced a record date of February 2, 2015, for approving the advisory agreement between NXRT and NexPoint Real Estate Advisors, L.P. at a special meeting of the shareholders to be held on February 27, 2015. Although the board of NXRT will set the dividend policy, we believe NXRT will have approximately $0.30 per share of original NHF shares of annual income available for distribution. Additionally, management believes NHF can maintain its current $0.72 per share of annual distributions. In other words, management believes NHF can maintain the same dividend on a lower NAV base, effectively increasing the yield. “
2014 pro-forma Adjusted Funds From Operations was $25MM, or about $0.40/share. They're shooting for an 80% pay-out ratio, so the dividend should in fact be around $0.30.
So then what? Who cares? Well, I think good things happen as a result of the spin-off, how good, I'll leave for you to decide. Here's a table of calculation inputs:
|PostSpin Div Yield||8.49%|
I'm assuming they're carrying the REIT at invested capital.
And now here are two honking big matrices showing potential returns based on NHF post-spin discount, and valuing the REIT either on a yield or a Price/FFO basis, Price/FFO first:
According to Merrill, Price/AFFO is currently around 24x for apartment REITs.
Here are the returns based on dividend yield for NXRT:
I just eyeball these things and have a hard time seeing how this trade will lose money, although actual returns will of course depend on how NHF performs in the meantime. If the REIT winds up trading for invested capital, and the NHF discount doesn't widen, you win. And if all goes according to plan, this is a 30-day hold, so anything positive annualizes to something nice.
Before anyone gets too excited, let me note a couple of things:
1: Small cap REITs can trade significantly more cheaply than large cap REITs, and,
2: NXRT has a large exposure to Texas. Here's a state-by-state revenue breakdown:
The Texas buildings are pretty much all in the Dallas/Fort Worth area. Here are some (non-cherry picked!) links & quotes about how bad things might get there as a result of the collapsing oil price:
From the Centerpoint (another REIT with a lot of Texas property) conference call:
“The other thing that people start to talk about with this broad brush about Texas is that Dallas and Houston are connected via oil. Now Houston, I will admit, is definitely more concentrated on oil. I'm going to talk about Houston in a minute. But if you -- there's a report out that we've been interested in that BBVA Compass research put out. And at $40 oil, they estimate the annual GDP impact of each city, and Houston does have a negative GDP impact from $40 oil and I'll talk about that a little more in a second. But Dallas-Fort Worth, for example, show -- they show a 2% increase in GDP in Dallas-Fort Worth as a result of $40 oil. Obviously, Dallas-Fort Worth is more diversified than Houston, from an oil perspective. It's a transportation hub, and with low, low oil cost or low gas cost, it actually improves the Dallas economy. San Antonio gets a minor lift from $40 oil. Austin gets about a 1.5% increase in their annual GDP from $40 oil as well because of its tech business and low-cost gasoline also helps Austin. So when you think about Texas, you have to remember that Texas isn't all Texas. It isn't all oil.”
I forget where this comes from:
“Dallas and Ft. Worth, with a combined population slightly below Houston’s, are now better insulated from a single-sector decline, having learned valuable lessons from the 80s, when the city was more heavily coupled to energy.”
For more information on NXRT, here's a link to their “Information Statement”:
3: Some Notes And Uncertainties
NHF has a “loyalty program”, which I haven't taken advantage off, that allows you to buy stock at 2% off.
Dondero is a consistent buyer. I have mixed feelings about this: It's nice he's eating his own cooking, but who wants to invest with someone who thinks he's a genius?
I'm not sure about the tax treatment of the spin. Here's what they say:
“The distribution of NXRT’s common stock and cash in lieu of fractional shares, if any, will not qualify for tax-free treatment, and an amount equal to the fair market value of the common stock and the amount of any cash received by you on the distribution date will be treated as a taxable dividend up to the amount of your share of any current and accumulated earnings and profits of NHF for the year of the distribution, including any capital gains and dividends income taken into account by NHF with respect to the distribution by Freedom REIT of interests in the multifamily properties to NHF and the distribution by NHF of the NXRT common stock to you.”
The, “up to amount of your share” part is where I start getting confused. NHF used to be Highland Credit Strategies Fund, one of the Dondero vehicles that blew up in the financial crisis, and it looks like they're still sitting on losses from that period.
Spin-off, supposedly by the end of the month.