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Take
from the rich, and put it in your own pocket:
Buy
DIMEZ as a pure play on the 5th Amendment
by
James Passin
Don’t get me
wrong here. I am not ungrateful to be getting a few hundred
bucks of my own money back from the taxman. I appreciate
the sentiment. But overall, I can’t help but consider
this year’s tax rebate as some sort of a cruel hoax.
Tax reform or not, you and I will still have to work almost
half the year for free just to cover federal, state, and
local taxes. In exchange for this privilege, the government
degrades the value of our remaining income through inflation,
while using the proceeds generated by our indentured servitude
to fund wholesale redistribution schemes that result in
an endless cycle of mass dependency and budgetary expansion.
Call me a crank… a reprobate… call me a shameless
opportunist. But when I see an opportunity to take something
back from the government, I get excited.
The very idea of “justice” has been so corrupted
by the intellectual demagoguery of the liberal Člite that
people now associate it, not with the concept of equitable
relief, but with the image of courtroom antics by greedy
tort lawyer extortionists (and their Erin Brokovich/Pretty
Woman “hooker with a heart of gold” client bait).
Let’s beat those guys at their own game.
Dime
Bancorp (DME:NYSE) is a plaintiff in one of the 115+
cases against the government for breach of contract and
taking of property without compensation during the S&L
crisis cleanup. Based on a review of cases with similar
fact patterns, I believe that DME has an excellent chance
of winning damages. I have discovered a pure vehicle for
playing this litigation: Dime Bancorp Litigation Tracking
Warrants (DIMEZ:OTC).
But
before I tell you why this is not only an opportunistic
but also a prudent speculation to make, let me refresh your
memory about what went on back then.
SnL
In
the late 1970s and early 1980s, inflation spiraled out of
control. Interest rates surged. Eventually, rates rose so
high that the yield on short-term demand deposits exceeded
fixed mortgage rates—a catastrophic situation for thrifts
or savings and loans (S&Ls). S&Ls live on the spread
between the rate needed to attract deposits and the yield
on available lending opportunities. When this credit spread
inverted, S&Ls began racking up losses.
The federal government requires banks and S&Ls to maintain
certain minimal capital requirements. This minimum capital
requirement is the percentage of assets that must be backed
up by actual capital. But in those days, record high interest
rates were eroding capital reserves. As industry fundamentals
deteriorated, Wall Street became leery of providing debt
or equity capital infusions. Weak S&Ls hurtled towards
failure.
Since the federal government insured all deposits, it would
have been on the hook to bail out failed S&Ls. (Consider
the irony: the government was a primary contributor to the
S&L crisis by creating the moral hazard of federal deposit
insurance, not to mention by driving rates higher with loose
monetary and fiscal policies.) Consequently, the agency
in charge of regulating S&Ls was desperate to find a
politically acceptable solution.
First, the government took the easy step of lowering minimum
capital requirements. Then it began encouraging relatively
strong S&Ls to absorb the weaker ones. To give S&Ls
an incentive to acquire failing institutions (and thereby
bail out the government), it made an irresistible offer:
an acquirer could count goodwill, or the excess of acquired
liabilities over acquired assets, as “supervisory regulatory
capital.”
This “supervisory regulatory capital” could count
towards minimum capital requirements. S&Ls could depreciate
this “goodwill” over a 40-year period. The government
was able to arrange mergers based on the economics of this
magical accounting trick.
In 1989, FIRREA (the Financial Reform, Recovery, and Enforcement
Act) was signed into law. FIRREA disallowed the use of goodwill
as regulatory capital. The very S&Ls that were levered
up by the government suddenly found themselves in violation
of minimum capital requirements. This breach of contract
by the government caused tremendous value destruction, forcing
S&Ls to shrink balance sheets and liquidate assets at
fire-sale prices.
American
dream
In
the 1990s, numerous lawsuits were filed against the government
for breach of contract. Few took the S&L cases seriously
until 1996, when the Supreme Court held that the government
was liable for breach of contract in the flagship Winstar
case. Following the Winstar case, all related cases were
assigned to the U.S. Court of Federal Claims.
In one of the first Winstar-related cases, that of Glendale
Federal Bank, Chief Judge Loren A. Smith found that the
government was liable for US$908.9 million in damages. Other
judges in the Claims Court have been less aggressive in
awarding damages. But in every case I have reviewed, at
least some damages have been awarded to the plaintiff.
Recently, a Federal Appeals Court ruling boosted the Winstar-related
cases. The U.S. Court of Appeals for the Federal Circuit
ordered a judge to allow Golden State Bancorp (the surviving
Cal Fed entity) to present evidence supporting its expectancy
damage theory. To date, no judge has awarded Winstar plaintiffs
expectancy damages.
For years, Wall Street banking analysts have mentioned Dime
Bancorp as having one of the strongest Winstar cases. I’m
not a lawyer, but I know an overlooked opportunity when
I see one.
Dime
bag
To
deliver value to shareholders by monetizing its off-balance-sheet
litigation asset, DME spun off its litigation against the
government through the vehicle of litigation tracking warrants.
The warrants (DIMEZ:OTC) entitle the holder to receive
DME shares equal to 85% of the net after-tax value of any
recovered damages.
DME
is claiming damages under three non-overlapping damage theories:
reliance, restitution, and expectancy.
Reliance is “the contracting party’s interest
in being reimbursed for loss caused by reliance on the contract
by being put in as good a position as he would have had
if the contract not been made.” Restitution is “the
plaintiff’s interest in having restored to him any
benefit that he has conferred on the other party.”
Expectancy is “the interest in having the benefit of
his bargain by being put in as good a position as he would
have been had the contract been performed.”
 DME
is claiming US$512 million under the reliance theory, US$740
million under the restitution theory, and US$980 million
under the expectancy theory. Expectancy is the most
speculative, as it requires DME to prove and quantify lost
potential profits—a very difficult task. But the recent
“Cal Fed” decision by the Appeals Court raises
the odds that DME will at least be able to present evidence
in support of expectancy damages.
Assuming DME wins at least some damages, DIMEZ warrant holders
would be entitled to the following distribution: (gross
amount of damages - legal fees - taxes) * 85%. This
distribution would be in DME shares, not cash (cash
would be paid for fractional shares). Legal fees could total
US$30 million or more. The current tax rate would be approximately
46%.
If DME hits the jackpot, winning the full amount claimed
under every damage theory, DIMEZ holders would receive an
estimated US$983 million, or US$8.70 per warrant. Since
cash is better than DME shares, this value has to be discounted.
Applying a 10% discount, DIMEZ holders would receive US$7.80
in value per warrant in the jackpot scenario.
Jackpot
investing
Of
course, litigation like this often drags on for years, so
you have to discount the present value of a future payout.
I think it’s safe to assume that the appeals process
could drag on for four years. Applying a 5% discount rate,
the present value of the jackpot scenario is US$6.38 per
warrant. To determine the expected value of the warrant,
you should multiply the odds of winning a damage award by
the present value of the payout.
The odds that DME will win expectancy damages are slim,
but greater than zero. I would guess that DME has a 5% chance
of winning expectancy damages. But the odds that DME will
win reliance or restitution damages are much higher.
If you assume that DME has a 50% chance of winning reliance,
a 50% chance of winning restitution, and a 5% chance of
winning expectancy, then the DIMEZ warrants have an expected
value of US$0.72 (for reliance) + US$1.06 (for restitution)
+ US$0.14 (for expectancy), totaling US$1.92 per warrant.
Even if you dropped the odds of winning reliance or restitution
to 25%, you still get an expected value of US$1.03 per warrant—4x
the current market price.
Look at it this way: DME is suing for billions of dollars,
the court awarded almost one billion in damages in a case
with similar fact patterns, and yet DIMEZ’s market
cap is only US$31 million (there are 112,975,607 warrants
outstanding).
In my opinion, DIMEZ is trading at a deep discount to the
expected value of the litigation. DIMEZ’s fair value
is conservatively in the US$1 to US$2 range, based on the
assumptions outlined above. If DME wins significant damages
and you hold until the distribution of the award, you could
receive as much as US$7.80 per warrant, compared to the
current US$0.28 price.
Of course, you could also receive nothing, in the event
that the court does not award damages. The warrant will
be worthless if DME loses the case and fails to win on appeal.
Even if the court awards damages to DME and the award holds
up on appeal, the damages would have to exceed US$110 million
for you to earn a profit on expiration against the current
warrant price (including estimated legal fees, taxes, etc.).
Weak
hands
84%
of DME’s float is held by institutions. Major shareholders
include mutual fund giants like Fidelity and Vanguard. Many
mutual funds are prevented by their charters from owning
derivative instruments such as litigation tracking warrants,
or they are too large to worry about managing a tiny, illiquid
position. Following the distribution of the warrants in
December, large blocks hit the market. At the same time,
few visible buyers were stepping in to absorb the supply.
The bearish supply/demand dynamics may have artificially
depressed DIMEZ. Recently, the warrants have stabilized
in the mid-US$0.20 range after fluctuating in a range between
US$0.17 and US$0.37.
Based on my analysis of DIMEZ’s expected value, I believe
it is trading at least 75% below its fair value. DIMEZ has
zero correlation with NASDAQ, an excellent characteristic
in this market. My fund has a position in DIMEZ, a reflection
of my belief in DIMEZ’s risk-adjusted upside.
DIMEZ is an extremely high-risk speculation. DIMEZ holders
face the risk of total loss. Value will fluctuate widely
based on legal events over which DME has no control. The
interests of DME executives could potentially diverge from
the interests of DIMEZ holders.
I
recommend reviewing DIMEZ’s Form 424B3 prospectus on
www.freeedgar.com before investing. Since DIMEZ is illiquid,
avoid buying it after a short-term spike in price.
ACTION
ALERT
Read DIMEZ's From 424B3 propectus on http://www.freeedgar.com
before investing. You can also contact DME at Dime Bancorp
• 589 Fifth Avenue• New York, NY 10017 •
P: 212-326-6170 • F: 212-326-6169
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