Large opportunities will present themselves during erratic market behavior with a fair degree of frequency. Felcor Lodging Trust (FCH) is currently a beautiful example.
Purchase FCH-A around $23.40 and it should return to normalized value $25.50 around January 1st as the tax selling comes to a close. This will generate capital returns of 8.97% plus a quarter dividend of 2.08% for total returns of 11.05% in just over a month. This unique opportunity has a very high chance of being successful with almost no downside. The reasoning will be detailed below.
How the opportunity was created
Felcor suspended dividend payments on its preferreds in the second quarter of 2009 and resumed distributions in the first quarter of 2011. These 7 quarters of accrued dividends were to be paid in June and October of 2012 and the share price rose to nearly $27 to reflect this announcement. Adding in the normal dividend, the A and C were about to pay out $3.9 and $4.0 respectively so these were still a great buy even at $27. The successful completion of this distribution event was followed by a large sell-off which caused both to fall below par and the Series A to even drop below $23. This sell-off had 3 primary causes:
1) The reasonably publicized opportunity to capture the accrued dividends resulted in a wide variety of investors who would otherwise have nothing to do with Felcor or its preferreds suddenly having large positions. It seems likely that many of these investors would want to exit the unfamiliar territory having netted far more in dividends than the premium they paid.
2) Tax selling occurs every year, but it was particularly pronounced this year. Many of the FCH-A holders may have sold it below the premium they paid in an attempt to wash taxability of the dividends. I use the word "attempt" because they would have in fact incurred a tax gain. While the information is not readily available, according to an e-mail I received from Stephen Schafer (VP of investor relations) all of the distributions were a return of capital. As such, it functionally reduced the cost basis of investors to well under their various sale prices causing a tax gain.
3) Lack of buyers: With a market cap of only $490mm, Felcor has a rather small following. The preferreds have even less following, so there were simply not enough buyers to absorb the rampant selling, and the price fell well below reasonable values.
Why it will work
At a price of $25.50, FCH-A yields 7.65%. This is significantly higher than newly issued preferreds and is very desirable in the current yield hungry market. Preferreds historically and currently tend to trade above par and those without threat of redemption can trade even higher. All the factors which have caused FCH-A to become so cheap end at or before January first, so I believe it is very likely we will see a return to its normalized value around that time.
Some investors may be worried that it may be difficult to acquire a material number of shares of such a thinly traded issue. However, the illiquidity is on the sell side. It is a paucity of buyers that caused the price dip in the first place. Millions of dollars of preferred shares have changed hands at these low prices.
In summary, the recent events have given us the opportunity to pick up FCH-A at prices which should generate capital appreciation and an 8.4% yield.
This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.
Disclosure: 2nd Market Capital and its affiliated accounts are long FCH-A and FCH-C. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.