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WaMu Seesaws On M&A Speculation
Tony Racki

Mar. 23, 2014 12:33 PM ET | 3 comments | About: WMIH, Includes: JPM, KKR
Disclosure: I am long WMIH. (More...)
Summary

$5.97B NOL assets with 273M shares.
WaMu may become "KKR special purpose acquisition vehicle".
KKR's Head of Financial Services joins WaMu board.
Expect high volatility.
6-month target: $4.30.
March 19th marked the two-year anniversary of Washington Mutual's (OTCQB:WMIH) emergence from bankruptcy, signaling a possible new future for the 119-year-old former banking giant and its diehard shareholders. Brought down in September 2008 by tightening credit markets, poor mortgage investments, short sellers, and now accusations of LIBOR price fixing, the FDIC seized the bank in a controversial move in which JPMorgan (JPM) profited by some $28B, but left WaMu shareholders with nothing. The company's 41-month bankruptcy itself was not without its fair share of conflicts including claims of insider trading, the company's own legal team accusing shareholders of milking the system, creditors receiving hefty interest payments, and over $1.1B in reorganization costs. At the end of the day, carving up WaMu's remains proved quite profitable for most parties involved. JPMorgan walked away with $5.3B in tax refunds, cash, and securities, the FDIC $844M in tax refunds, over $325M went to WaMu's attorneys, and up to 125 cents on the dollar was awarded to WaMu's corporate creditors. Meanwhile common shareholders received just 3 cents per share of equity in the reorganized WaMu, shares that once sold in the analyst Kool-Aid days of 2007 for $45. While most institutional investors bailed out long before the judge signed off on the company's POR, diehard retail shareholders doubled down, hoping to recover some of their losses.

A New Beginning, Old Habits

In December, WaMu's new beginning started in earnest with the announcement of a commitment for strategic investment with KKR & Co. L.P. (KKR), in which shares surged some 50% on the first day alone. Since then shares have returned over 290% on speculation that WaMu may soon merge with another company in order to start utilizing its $5.97B in NOL tax assets. While its NOL usage possesses a number of restrictions -- making utilizing them quickly a difficult task -- by surpassing its two-year mark WaMu can now look outside the financial arena at possible targets whereas before it could not. WaMu may not have to look far however. Some have speculated that KKR may have taken on WaMu with a bigger play in mind. Stephen J Errico of Locust Wood Capital Advisers has characterized WaMu as a "KKR special purpose acquisition vehicle," and to, "expect acquisitions to be announced sooner rather than later." With over $90B of assets under management, KKR certainly has the size and the rolodex to make a deal happen. It may very well already have a plan in motion, though shareholders will be the last to find out.

At WaMu's June 2013 annual meeting, information disseminated by the company's board to shareholders was exceptionally vague, leading many to believe little was happening, even though the KKR deal had been brewing at least a month prior, a detail was not released until January 2014. At the time, shareholders questioned what caused shares to pop up 47% in May 2013 for reasons unexplained. Indeed, on May 17, 2013, WaMu shares experienced over a 2400% increase in average volume, leading some to question if insider information was still leaking out.

In WaMu's most recent annual report, the company states that as of the end December 2013, no definitive acquisitions had been determined, though more than 20 potential target companies had been considered. However, shares have still climbed 20% in the past month alone without any material information. It is fair enough to reason that if insider activities were engaged in during bankruptcy (settled without admission of guilt) and again in May 2013, those unseen hands may again be tipping as to the company's prospects.

Reading Between the Lines

March has been a high volatility month with shares seesawing some 39%. With the announcement of a merger or buyout able to occur at any time, volatility will likely persist. The expectation is that a deal is soon to come. In a recent straw poll amongst shareholders in a closed forum, 54.1% predicted an announcement by May 18, with only 6.5% after September 7. Whenever it does occur, upon such an announcement WaMu shares will likely surge, akin to the December 10 KKR announcement. With the continued limited information, the best conclusions as to WaMu's future can only be gathered from what is read between the lines. For example:

KKR would only invest in WaMu if there was an adequate risk vs. return to be made. With 61.4M warrants blended at $1.38/share, the securities have only appreciated 235% based on WaMu's March 21 close. In a high speculation stock such as WaMu, KKR would certainly expect more of a return than that. KKR's 7.5% PIK notes indicate how much they view the speculative nature of WaMu shares.
Tagar Olson, KKR's Head of Financial Services, has been appointed an observation seat on WaMu's board of directors. Mr. Olson would not be on the board unless plans were in motion.
KKR's investment will eventually add 71M additional shares, or a 26% dilution. During bankruptcy proceedings, Steven Zelin of Blackstone Advisory Partners stated that WaMu's NOLs would likely be discounted by 25% to 35% for transaction risk were the company merged in an all-stock transaction with another entity. Is KKR signaling that it will eventually consume WaMu in its entirety? In December, KKR made a bid to take over its KKR Financial (KFN) affiliate.
The KKR deal was seven months ahead of shareholder knowledge. They know more than anyone else does at this point.
KKR has the right to participate in future WMIH equity offerings, up to an aggregate of $1B. Such a number indicates that KKR sees a future value in WMIH of at least that amount.
Hard Numbers

At this time, WaMu lacks hard numbers in order to put a future value on shares, forcing one to resort to a large amount of guesswork and reliance on past results to predict future outcomes. As it currently stands, WaMu has about $65.1M in equity, a number relatively unchanged in the past year because projected losses by its subsidiary reinsurance arm have been less than expected. This is a good thing because its subsidiary still owes $105M on notes paying 13%. The better-than-expected losses have negated interest payments, resulting in a $338K profit for the year, verses a $12.4M loss in 2012. If the housing market continues to improve or tread water, WaMu may be able to eventually profit off its reinsurance arm, which had been left for dead by JPMorgan.

With $65.1M in equity, $10.6M from the sale of preferred stock to KKR, and an eventual $84.7 in cash from the sale of warrants to KKR, WaMu's total hard equity rises to $160.4M based on 273M shares, or $.59/share. After that, the math gets fuzzy because it becomes a matter of valuing the company's NOLs. If WaMu is able to use them in their entirety, they will be able to save $2.1B in cash. With 273M shares, the NOLs could be worth up to $7.65/share. However, using up the NOLs will likely take years, or at least three based upon KKR's warrant agreement. This NOL value coupled with hard equity creates a total market value of $2.24B. While such a valuation seems pie in the sky, it is supported partially by KKR's right to participate in future WMIH equity offerings, up to an aggregate of $1B and including a cap in ownership by KKR of 42.5% of WMIH's common shares. Based on the $1B for 42.5% ownership valuation, WMIH's market cap would weigh in at $2.36B, a differential of just 5%. While this is no way an assurance of future value, it does lead credibility to the $2.24B value, otherwise why would KKR request such a right. Under this evaluation, KKR's 26% interest in WMIH for $95M would reap $620M for KKR's equity -- a tidy 650% return -- a number in line with the speculative nature of WaMu (see #1 above).

For those of a more conservative mind, if KKR's rights offering states they view the company having at least $1B in value (see #4 above), then shares should reach between $3.66 and $4.95 depending on the future 273M or the current 202M shares. Under this projection, it assumes either half of the NOLs expire unused or the company takes on further dilution. However, because of IRS Section 382 limitations, WaMu's current shareholders need to maintain at least 50% ownership of the company, which limits dilution. Based upon this $1B valuation and blending the price ranges, a $4.30 six month price target is a projection within reason but likely to change once WaMu and KKR announce their first move.

http://seekingalpha.com/article/2103953-wamu-seesaws-on-m-and-a-speculation?source=yahoo