- Whiting USA Trust trades at a 64% premium to expected remaining distributions.
- Trust payments will terminate on 3/31/15 and units will be valued at 0.
- Given the opportunity to avoid onerous borrow fees associated with short selling, selling calls may be a better option.
Whiting USA Trust (NYSE:WHX) is a misunderstood stock. While buyers are lured by what appears to be a 60% yield, most seem to be unaware that dividend payments will cease in just 12 months. As noted by Russian Hill Capital, in Whiting's recent 10-K filing, it warned investors to expect an "abrupt substantial decrease in stock price." While shares declined 35% Friday, they remain 64% higher than my best estimate of the remaining future distributions to investors. As such, there is an opportunity for the enterprising investor to benefit from further price declines by shorting shares (either directly or synthetically as I will discuss below).
As a bit of background, the Whiting Trust was set up to allow investors to receive payments, which derive from a total of 8.2 million barrels of oil (unit holders contractually are entitled to receive 90% of the benefit from 9.1 million barrels of oil). Thus far, unit holders have received payments related to 7.1 million of the 8.2 million barrels, meaning that they are entitled to receive payments on only the remaining 1.1 million barrels of oil. The final payment date is expected to be March 31, 2015 - unit holders are entitled to receive just four more distributions. The past four distributions have ranged from 45c to 59c and averaged 53.2c. Assuming that distributions remain roughly constant, trust holders will receive a total of $2.13 per unit on an undiscounted basis. This implies 39% downside (assuming a discount rate of 0%).
Aside from the distribution, there is other reason that owners of Whiting USA may choose to be long the shares - to collect a share of the borrow fee charged to short sellers. Interactive Brokers is charging over 80% to borrow the shares and shares half of this with the owner of shares. As such, being long the shares, one may be able to come out whole - of course, this assumes that 1) the Whiting Trust is able to maintain a premium valuation. If, however, the shares fell to my estimate of fair value, i.e., $2.13 and the rate remained constant at 80% (again only half of which flows to the long position), the total payment, distributions and interest, would be just $2.98 or 15% downside and 2) that the cost of borrow charged to short sellers remains 80%. If that rate fell to 40%, total payments to the long position would be just $2.85 (19% downside).
This is precisely what happened to holders of the Great Northern Iron Ore Trust (NYSE:GNI). Shares were trading at nearly $70 while expected remaining distributions were about $21. The cost to borrow shares was nearly 90%. However, following Night Heron's SA article, Great Northern shares declined rapidly (all the way to $21). To make matters worse, the cost to borrow declined meaningfully - Interactive Brokers reports a cost of 39% today. This makes sense, as the demand to borrow shares for shorting will fall as shares become less overvalued (and could disappear entirely as shares become fairly valued). A similar risk is faced by Whiting USA unit holders. Given that Russian Hill looks to be actively informing the public of Whiting's overvaluation, it seems reasonable that shares will decline, and if shares decline significantly, it is likely that the payments holders of Whiting receive to loan out their shares will decline. This is a vicious cycle, in my opinion.
My short position is entirely synthetic - I've sold in the money calls (September 2.5s). While I face the risk of the calls being exercised early (most likely ahead of the next quarterly distribution), I avoid borrow costs in the interim. As I think that the units are worth less than $2.5, I think these options have a value of zero.
Disclosure: I am short WHX. 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.
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Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.