NCT - Newcastle Investment (spinoff)

[Olmsted]

I'm battling severe cognitive dissonance this morning as I contemplate buying some more NCT after having sold half of my shares a few months ago in the 8s.  I also apologize to the board for making the case for this now, and not immediately following the spinoff news when you could get in under 10, or a year ago when you could get in under 5.

 

That said, and recognizing that this is way up - I think there is a good chance for a 20-30% appreciation over the next couple months as NCT splits itself into two parts (expected in March), and those parts are valued on a standalone basis.

 

Please don't be shocked at the level of rigor in this analysis:

 

-New Residential will be to NSM as HLSS is to OCN.  It will own MSRs initially, and may branch into other residential-focused investments.  It will pay a $.56 a year dividend.  If it gets priced to a 7% yield like HLSS, that's an $8 share price.

 

-Newcastle will own the CDOs and senior housing portfolio.  It will pay a $.50/year dividend.  Its assets are ~90% CDO-related and 10% senior housing-related.  The senior housing portion deserves a ~5% yield based on comps, the CDO part probably deserves a 8-10% yield.  A weighted average would be somewhere in the 7.7%-9.5% range.  This gets you to a price range between $5.25-$6.50.  (On an asset basis, I get to just under $5/share - $800m in recoverable CDO principle, $76m in the senior housing, $112m debt, and $30m cash versus 172.5m shares.)

 

-The sum of the two upon the spinoff and subsequent repricing would be $13.25-$14.50, versus a most recent share price of $11.20.

 

This analysis was mostly spoon-fed to me by the company here:

 

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDkzNzM4fENoaWxkSUQ9NTMxODU4fFR5cGU9MQ==&t=1

 

There's also some interesting slides about where the company thinks the next opportunities are presenting themselves.  AIG gets an indirect shout-out (via Springleaf, their JV with Fortress).

 

#specialsituation

#spinoff

 

[17thstcapital]

Same boat as you.  I started trimming in the 8-10 range and exited completely around 11.  Also agree that there could be decent upside from rerating of the different pieces.  I don't think I want to buy the size that I owned before (the risk/reward not that interesting to me) but have been looking into ways to play this through options which don't appear to be pricing in such a rerating. 

[Olmsted]

Good thought - I've done options around spinoffs before and they almost always seem to be mispriced.  I think the potential is even greater for a stock like NCT which has high retail ownership - I bet a pile of dividend investors are writing covered calls like clockwork without thinking about it too hard.

 

The options seem real cheap.  And the pricing as of this morning was very weird across different durations.  The April 10 calls had a higher ask than the May or August calls.  Strange...

[thomcapital]

Thanks for the idea Olmstead. How do you choose which expiration on the options? (balancing the fact that normal post-spin selling may occur vs. the time needed to reach your sotp)

[vpagano]

Very strange indeed Olmsted, and like you two here I had scaled out of my buys from way back at $4.40.

 

I nibbled on the Jan '14 $10's today, figured it would give time for this re-pricing thesis to work. The market wasn't assigning much of a premium over today's levels. This is asymmetric as I see it in that:

 

Conservative heads: $13.25 (the low end of your range, which I agree upon) =  + 2X

Tails: Say $10.80 = - .5

 

I like those odds considering I think by expiration there's a chance it could be $14-$15 or +2.5-3X vs. -.5X. Also, this is a company a few of us have held for some time and know that management has delivered value consistently.

[Olmsted]

Yep, I agree that it's a nice risk-reward with thinking along the same lines as you (though I always use -100% as my downside for options trades). 

 

You also see this morning that Edens bought another $1m in the secondary last week. 

[Olmsted]

Thanks for the idea Olmstead. How do you choose which expiration on the options? (balancing the fact that normal post-spin selling may occur vs. the time needed to reach your sotp)

 

Short answer - I don't know.  I'm no expert.  I've done this a few times but certainly have not compiled any empirical work on how long the repricing takes.  NCT's options seem quite cheap across several durations - so there doesn't seem to be a compelling reason to get aggressive on timeline.  I stretched out until August.  That is a full 4 months for management to roadshow the new standalone companies before expiration.

 

If I had to guess - and this is wild, imprudent speculation - I would say that repricing happens a good deal quicker, and that $13 is hit shortly after the actual separation.

[vpagano]

You also see this morning that Edens bought another $1m in the secondary last week. 

 

I did see this, and following their buys has proven fruitful in the past and I expect that to continue.

 

I stretched out until August.  That is a full 4 months for management to roadshow the new standalone companies before expiration.

 

If I had to guess - and this is wild, imprudent speculation - I would say that repricing happens a good deal quicker, and that $13 is hit shortly after the actual separation.

 

I paid a little extra to stretch until January since it was cheap time insurance so to speak.

My optimistic outcome? It gets around $13 quick after the spinoff, I sell half the calls for a double, and let the rest ride into the fall. Guess we'll see!

 

[Hielko]

About the options: think they mainly look cheap because the company is paying an 8% dividend. That matters a lot for the pricing.

[Olmsted]

Good point.

[17thstcapital]

I'm sure they also looked cheap when stock was at ~7-8  ;)

[vpagano]

About the options: think they mainly look cheap because the company is paying an 8% dividend. That matters a lot for the pricing.

 

It is a good point but this is sort of a trade on price disparity between components and not a long-term investment (unless converted to shares at expiration of course).

 

I just see it as the pieces being worth more after than pre-spun NCT, due to other yield-seeking long-term investors who will re-price those pieces accordingly. I guess you could make the same trade by buying common and collecting dividends, we just chose to kill the dividends in the meantime in the name of implicit leverage.

 

Anyway, yup good point and totally correct.

[Olmsted]

Well my timing sucks

[Olmsted]

There seems to be a little investor consternation in the recent deal - buying half of $4.2b in UPB of consumer loans from HSBC.  The whole package was bought for $3.2b.  HSBC said the package of loans was last valued at $3.4b.  The deal looks kind of like its co-investments with NSM in MSRs - NCT is buying 50% and Springleaf (FIG/AIG JV) is buying the other 50% and doing the servicing.

 

The last time NCT entered a completely new space - MSRs - it turned out very well.  So I am inclined to give management the benefit of the doubt here.  For some color on the consumer loan space, here's an interesting snippet from the most recent PSEC earnins call:

 

we looked at multiple economic cycles, multiple recessions, analyzing delinquencies and charge-offs. And we're quite intrigued that in that business and businesses like that, yes, there's an impact during economic recessions but not as severe as one might surmise without doing further investigation analysis. So we like the steadiness of the business. We like the attractive cash yields. There's a ready stable of lenders, primarily banks, who give you ABL-type of financing, generally in the 60% to 85% range for these types of businesses. That enables you to enhance your yield attractively. But given the unlevered yields are sort of in the mid teens, so push came to shove, and you had to pass the senior debt, you still do pretty well in their mind. We're looking at the possibility of securitizing some of that debt....

 

These businesses have been around for very a long period of time. They're highly diversified. They provide steady returns, and they suffer from always being out-of-favor. The result is that people who are prudently investing in this area, and we've passed on some, and we've gone after others I think can outperform. I remember Joe Steinberg back in 1985 talking to me about Leucadia being investing in one of these businesses and saying, John, this is the best investment we've ever made. These people always repay their loans for the car or the boat or the TV or the sofa or whatever it is.

 

We're getting attractive unlevered returns, and boosting that prudently as well. With the end result being we're able, in this part of our portfolio, generate 20%, some cases more than that. I think we're collecting more than 30% in one of those deals, which is a very nice piece of our portfolio when you have yield compression that is confronting the more corporate-financed, including sponsor-financed side of things. So it's nice to have other yield contributors when you have that phenomenon occurring elsewhere.

 

EDIT: The lackluster trading may also just be in anticipation of another secondary offering to fund the deal.

 

Another edit: Forgot the link and to credit Seeking Alpha for the transcript: http://seekingalpha.com/article/1169031-prospect-capital-management-discusses-q2-2013-results-earnings-call-transcript

[CorpRaider]

Interesting idea.  Thanks for sharing.  If it gets back down to the last secondary price before the spin, I'm going to take hard look at the LEAPS.

[Olmsted]

Previously-discussed co-investment with Springleaf on a consumer-loan portfolio has closed:

 

http://phx.corporate-ir.net/phoenix.zhtml?c=132209&p=irol-newsArticle&ID=1802188&highlight=

[CorpRaider]

Spin is going to be distributed ~ 05/15 to SH of record on 05/06/13.  Stock is moving a little on the "news". 

[sampr01]

Did anyone bought $NCT options?. what happens to options after split. thanks

Spin is going to be distributed ~ 05/15 to SH of record on 05/06/13.  Stock is moving a little on the "news".

[17thstcapital]

Did anyone bought $NCT options?. what happens to options after split. thanks

Spin is going to be distributed ~ 05/15 to SH of record on 05/06/13.  Stock is moving a little on the "news".

 

Yes, I hold calls.  Post split, the options will be adjusted based on the actual conversion ratio.  Your option will not lose value but it will be a non-standardized option post split - will have a different symbol, diff share reference amt, prob less liquidity, etc.  Prob nothing to worry about for a liquid name like this IMO.  However, your P&L vs owning NCT shares outright might get out of balance depending on how the two pieces trade.  Sometimes you're better off, other times worse off.  What some people do is exit the option trade before the spin, buy the shares and then reposition post spin.

 

This is my understanding - please do your own research.

[vpagano]

New presentation up on the website:

 

phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MTgyNTU1fENoaWxkSUQ9LTF8VHlwZT0z&t=1

 

page 7, $1.11 projected possible combined dividends

[sampr01]

Thanks 17th. on related note, does anyone have a copy of UBS note on NCT spinn off. Thanks

Did anyone bought $NCT options?. what happens to options after split. thanks

Spin is going to be distributed ~ 05/15 to SH of record on 05/06/13.  Stock is moving a little on the "news".

 

Yes, I hold calls.  Post split, the options will be adjusted based on the actual conversion ratio.  Your option will not lose value but it will be a non-standardized option post split - will have a different symbol, diff share reference amt, prob less liquidity, etc.  Prob nothing to worry about for a liquid name like this IMO.  However, your P&L vs owning NCT shares outright might get out of balance depending on how the two pieces trade.  Sometimes you're better off, other times worse off.  What some people do is exit the option trade before the spin, buy the shares and then reposition post spin.

 

This is my understanding - please do your own research.

[Olmsted]

Thanks 17th. on related note, does anyone have a copy of UBS note on NCT spinn off. Thanks

 

Here you go.

 

UBS_NCT_note.pdf

[Olmsted]

FYI, the pieces are trading when-issued today.  At this time, NRZ-WI $6.85, NCT-WI $5. It is providing a nice little bump to the common.

 

Thanks vpagano for pointing it out to me this morning.

[sampr01]

 

Thanks for report Olmsted :) appreciate it.

Thanks

Thanks 17th. on related note, does anyone have a copy of UBS note on NCT spinn off. Thanks

 

Here you go.

[Olmsted]

The spinoff happened - NRZ and NCT are now trading separately.  Combined price 12.65 as I write - NCT 5.7, NRZ 6.95.