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Are Gramercy ($GKK) Preferreds worth it?

January 10, 2012 | About:
whopper investments

whopper investments

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I’m going to do something a bit different with today’s post. I’m going to start by quoting the last paragraph I wrote to (hopefully) whet you appetitie, and then go into the post.

“And that’s why I like GKK so much. The company has a ridiculously strong balance sheet at the corporate level. The common equity is basically a net net. Investing in the preferreds has all the kick of investing in a net net- except with a hard catalyst (dividend payment, either in the near future or once the board is taken over) and even if the catalyst takes a bit longer to realize, it will still result in either very nice or outstanding annualized return. All this for a security with ridiculous amounts of asset coverage and a huge margin of safety.”

I saw this write up on GKK over at long term value. While I have a few quibbles with it, overall I think it’s pretty good.

However, the author raised a point that I think is worth discussing: what if GKK keeps all their liquidity dry to build up the firm and doesn’t pay out preferred dividends?

My answer- it’s a negative…. but who cares???

Ok, that’s not quite my answer. Obviously, I’d prefer the prefereds pay dividends now than later. But think about the return if they delay payment for a few years. BTW- this is the mistake I made when Orchard’s preferreds were at $0.50 and I didn’t do the time thinking for them. I missed a quick triple because of it. GKK preferreds don’t have that much upside but it’s worth noting.

So let’s think about what happens if GKK doesn’t pay out dividends on their preferreds this year. Remember, every year they don’t catch up on their preferreds, the preferreds can elect another director to the board. So GKK currently only has six directors on their board. The first preferred director will be elected this month, making it 7 directors with one from the preferreds.

In one year, the board will have 8 directors with two from preferreds. In two, it would be nine and three. In five years, the preferreds would split control of the board (12 directors total, six from preferreds).

Now let’s start thinking of the returns. Because the preferreds are so secured by cash and investments at the corporate level (there are basically enough assets today to pay all accrued plus five years worth of dividends plus liquidate the preferreds and have left over for the common), I’m going to assume that the preferreds will trade at par when they fully pay out their dividend. This might be a bit aggressive, but you are free to do the math yourself at different levels of trading post dividend.

GKK preferreds currently have ~$6.60 in dividends accrued but not paid. Let’s take a bear case and assume they accumulate dividends for another five years, until the preferred directors take over the board. In that case, another $10.15 in dividends would accrue over the next five years until the payout. With the preferreds trading at par post dividend, that would result in an annual return of 10.8% over the next five years. Because I’m a sucker for giving you more info, let’s go out on a limb say they traded a bit below what NCT’s preferreds currently yield and traded for $21 post dividend. At that level, you’re looking at an annual return of 8.6%.

And those are pretty draconian scenarios. I still personally think the most likely case is the company gets sold and the preferreds paid back in the next year.

So let’s play around with our assumptions. What if it took three years? Trading at par, that’s a 14.7% annual return. At $21 per share, that’s 10.5% annualized.

What if it happens in the next year, like I think they will? If they hit par, that’s a 34.5% return. If they trade for $21, that’s 18.5%. Let’s get wild and say they trade for $19 post dividend, which would be over a 10.6% yield. That would still result in a 10.5% return over the next year plus you’ll own a security yielding 10.5% which, assuming a stable balance sheet, would be ridiculously undervalued IMO.

And that’s why I like GKK so much. The company has a ridiculously strong balance sheet at the corporate level. The common equity is basically a net net. Investing in the preferreds has all the kick of investing in a net net- except with a pretty hard catalyst (dividend payment, either in the near future or once the board is taken over) and even if the catalyst takes a bit longer to realize, it will still result in a very nice annualized return. All this for a security with ridiculous amounts of asset coverage and a huge margin of safety.

Disclosure- Long NCT preferreds, GKK, GKK preferreds


Rating: 3.4/5 (10 votes)

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