Replies to post #508927 on Fannie Mae (FNMA)

[Commons_Cancelled]

Excellent post. Math doesn't lie.

[HoldenWalker99]

Everyone needs to read and understand this post.

You will have to be way more specific than this. To make a share price estimate, you need to answer the following questions:

1) What is the market cap? (for FnF combined, using combined numbers is much easier)
2) How much capital do they need to raise?
3) What proportion of the companies' equity will the new buyers insist on? (this answer should be higher than #2 divided by #1)
4) Will the warrants be exercised?
5) Will the juniors be offered a conversion? If so, will it be full or partial, and at what rate?
6) Will the seniors be converted to commons? If so, at what rate?
7) If any of #4, $5, or #6 is yes, what order do the four events occur in: junior conversion, warrant exercise, senior conversion, equity raise?

Only then can you actually make an educated estimate.

Let's start with the high end and make everything extremely optimistic.

1) $300B
2) $100B
3) 40%
4) No
5) No
6) No
7) N/A

With 1.8B existing shares, the new buyers get 1.2B so that they have 40% of the total: 1.2B / (1.2B + 1.8B) = 40%. This makes for 3B shares. $300B market cap divided by 3B shares is $100 per share. So we hit your number right on the nose, but it's the absolute highest, top-end number in this model.

However, is it even realistic? Otting said that FnF have to go from $6B in capital to $150-200B. I only used $100B just to be optimistic: this assumes two full years of retained earnings. The $300B number is also higher than any of Moelis's estimates. And this assumes no warrant exercise, meaning that if these new buyers wanted much more than 40%, neither FHFA nor Treasury would have a reason to tell them no. Speaking of Treasury, they get absolutely nothing here: seniors and warrants both get cancelled. Highly unrealistic to me, given Treasury's veto power over release. (For what it's worth, I assign a 0% probability to this scenario)

Changing #1-3 to $250B, $125B, and 66% leads to a share price of $46.30. Still pretty high, but it shows how sensitive the model is to changes on the optimistic end.

Let's toss the warrants in and see what happens:

1) $300B
2) $100B
3) 40%
4) Yes
5) No
6) No
7) Warrants exercised, then equity raise

Exercising the warrants gives 7.2B new shares, or 9B total pre-raise. The new buyers get 6B more shares: 6B / (6B + 9B) = 40%. $300B / 15B shares = $20 per share. So yes, changing #4 from No to Yes really does just straight up divide the answer by 5.

Now add in a junior conversion, with half of shares converted at 4 commons per $25 of par value (slightly above the current market ratio of 3.6:1):

1) $300B
2) $100B
3) 40%
4) Yes
5) Yes, half converted at 4 commons per $25 par share
6) No
7) Juniors converted, then warrants exercised, then equity raise

The juniors get 2.66B new shares: $33.19B / 2 (only half are converted) / $25 * 4 = 2.66B. Then Treasury gets 4 times the new total: 4 * (1.8B + 2.66B) = 17.84B. Now the new buyers get 14.87B to make 40% of the total. This works out to $300B / (1.8B + 2.66B + 17.84B + 14.87B) = $8.07 per share, and Treasury's warrants are worth $144B. This is realistic to me, and I assign a 20% probability here. (Note: the juniors actually end up at 136% of par here)

Lowering the market cap to $250B keeps the conversion and warrant shares the same, but means #3 has to be more than 40%, so I'll use 60%. Then the new buyers get 33.45B shares, and the share price is $300B / (1.8B + 2.66B + 17.84B + 33.45B) = $5.38, so Treasury's warrants are worth just shy of $96B. I think this is highly plausible, and I assign a 50% probability. The prefs end up at 107% of par.

Now let's say that the Fifth Circuit remands the Collins case back down, meaning that the government will have to settle in order to get all the cases cleared out before their timeline runs out at the end of 2020. The seniors will have to disappear, so converting them to commons makes the most sense because it doesn't involve any cash changing hands. The seniors' $193B liquidation preference (par value, if you will) dwarfs the ~$5B in current common market cap, so a senior-to-common conversion at par obliterates the commons: 5B / (5B + 193B) = 2.53% is all they retain, and that's before the equity raise! The juniors would decline any conversion by the way. If we keep #3 at 60%, commons end up with 1% of a $250B company, so their 1.8B shares are worth $1.40 each. I assign a 20% probability here.

Of course, we haven't hit the most pessimistic scenario yet.

1) $250B
2) $235B (Otting's high end minus one year of retained earnings, plus $60B from #5)
3) 99.5% (how high can you go? there's very little room for certainty equivalents here)
4) No (with #3 this high it's not worthwhile anymore)
5) No, but sold back to FnF for $60B
6) No
7) N/A

Now the current commons only get 0.5% of $250B companies, for a $1.25B valuation on their 1.8B shares. That makes $0.69 per share. Treasury makes $60B, not bad, but the best they can do if the new buyers are putting in nearly all the capital. I assign a 10% probability here. Ironically, in this case the warrants never get exercised and the seniors get cancelled!

This is where I get my final share price estimate for the commons.

20% * $8.07 + 50% * $5.38 + 20% * $1.40 + 10% * $0.69 = $4.65. This is a gain of 79% compared to a current price of $2.60 (FNMA/FMCC average)

For the prefs:

20% * $34 + 50% * $26.75 + 20% * $25 + 10% * $25 = $27.68. This is a gain of 185% compared to a current price of $9.70 for FNMAS, and a gain of 246% compared to $8 for some of the other series.

While only one thing will happen, I don't think it's prudent to just make one set of assumptions, and I have an inherent mistrust of models that do.

[robertus]

You missed question 8. will common shareholders sue the Gov in any of these possibilities

[YoYoMa57]

Although I disagree with some of your assumptions the post is pretty thorough. What do you do for a living may I ask?

[Cubshawk]

Why would anyone use current market cap of two companies in conservatorship as the basis for future share value???

The only thing I see in these numbers is a fundamental lack of understanding of market stock pricing. Current market cap is in no way indicative of future valuation of the GSE's after release. End of story.

[Chronic The Hemp Hog]

This is a well laid out post and I appreciate you taking the time to write it all out. Yes there are a lot of variables but it allows everyone to make their own assumptions plug in the numbers. From worst case to best case scenario we get a range of $4.65 - $20. Even worst case still sounds good to me from where we are at currently!

[Latergater]

Mods, this is a post that actually deserves a sticky. There is real analysis in these estimates rather than just spit balling.

[HappyAlways]

Thanks for the excellent estimation.

Suggest to consider the following as well:
1. UST will need to refund the excessive NWS payment ($16.1B as estimated in a court case).
2. Bailout is fully repaid. So, warrants are no longer valid.
3. Earning per share will be the base to determine the price of to be issued new common shares. I would estimate that $10 per shares at minimum to be reasonable, given the dilution and the annual earning of $9B.
4. To release from C-ship, FHFA may waive the capital requirement for 5 years. But, I don't think the capital requirement needs to be $100B.

[toeknee01]

This is a great post....thanks.