NovaStar's Death Spiral Financing Deal With Mass Mutual

From the "desperate times call for desperate actions" department: Turns out rumors of NovaStar (NFI) doing a deal with MassMutual were on the money with yesterday's announcement that MassMutual and Jefferies are bailing out the subprime lender in a highly complex $150 million transaction.

The good news for NovaStar common shareholders: NovaStar isn't filling for bankruptcy anytime soon. The bad news: The nature of this deal, which sounds eerily like a death-spiral financing, suggests just what terrible shape the company is in.

And for those hoping the company will be acquired at some wild premium: It won't be. According to NovaStar, this deal concludes its "process to explore strategic alternatives."

No matter what happens, it appears the common shareholders -- those lured to NovaStar in hopes of big dividends -- are the big losers. With dilution via new shares, the dividend this year will be sharply lower than expected; ditto will the shareholders' stake in the company, which suggest common holders just got their stake in the company trimmed by as much as half, depending on the ultimate number of shares (via preferreds and rights) that will be outstanding.

NovaStar's simultaneous announcement of a 4-for-1 reverse split shows just how badly watered down the common stock will be. (And, as we all know, reverse splits really do little more than make a stock look artificially higher than it really is.)

Furthermore, if this financing doesn't help the company get from here to there, common holders are at the end of a growing line of lenders and creditors who get first dibs on the assets. At this point, for common holders, the stock is an option on the business getting better and being worth something substantially more some day.

As pointed out in previous posts, MassMutual, through its Babson Capital unit, is a large investor in NovaStar at much higher levels. This deal, it would appear, is a last ditch effort to salvage its losses by throwing good money at bad. It's the ultimate subprime loan, I suppose.

NFI 1-yr chart:

Comments

[bammer4:]

Well Herb, you did it. You called the deal a death spiral in your headline showing that you either have no idea what you are talking about or you have other motives.

Three questions.

1) How can a deal held 2/3 by the shareholders be a death spiral?

2) How can a deal with a floor of $28 per share conversion rights be a death spiral?

3) Did you even read the 8K like I suggested to you last night?

Obviously, you didn't. For you to call the deal a death spiral and even post a scary picture shows that you have no idea what the details of the deal are and that you have an extremely negative bias.

If NFI gave you a brick of pure gold, it would be too heavy, it would cost too much to convert to cash, it would be too shiny, it wasn't diamonds so there is obviously a problem with the company, and why wasn't it diamonds in the first place?

We all know that NFI's delinquency rates are within historic norms. The only problem with NFI is your hedge fund buddies massively shorted the ABX index that they themselves created to cutoff lending funds to the companies they had also previously shorted. There was no other way they could get to NFI and profit on their gigantic naked short position.

Note that there are over 330,000 open Put contracts on NFI representing a naked short hedge by the options market maker of nearly 90% of the entire NFI stock issue. Add to that 20 million shares legally shorted and we all can see the reason for your bogus headline.

2007 Jul 17 07:39 AM

[Jeanne M Ca...:]

Thanks bammer4. 100% RIGHT ON with your reply to Greenberg's obviously self-serving NFI article. Looks like it might be a last gasp attempt to sink NovaStar. Thanks again for getting the truth out there. I could not have said it better

2007 Jul 17 12:16 PM

[jimmyb1967:]

bammer,

There is no language in the 8-K which stipulates that the $7 conversion ($28 post-split) is a floor.

2007 Jul 17 12:55 PM

[gembree:]

Straight from the 8-K:

"The Series D-1 Preferred securities are initially convertible into 7.5 million shares of common stock of NovaStar based upon the initial conversion price of $7.00 per common share. The Series D-1 Preferred securities are convertible into common stock at any time at the option of the holders, based on a conversion ratio which is subject to certain adjustments. The Series D-1 Preferred also may be converted into common stock at NovaStar’s option, under specified circumstances. Dividends on the Series D-1 Preferred securities will be payable in cash."

It sounds like death spiral financing to me, largely because of the vagueness. If it's an adjustable ratio, it's hard to believe it's not adjustable downward. On the plus side, the D-2 available to shareholders is also convertible at the same ratio, but that just makes it a play-at-home version; the negative incentives remain intact. I don't think there's malicious intent so much as a desire to preserve their investment at the expense of the common should things go sour.

I don't think Herb pointed out that the dividend will be a preferred convertible stock dividend, terms TBA, payable to common and preferred holders; the only cash dividends available going forward accrue to the Series D-1, which is only available to MassMutual and Jefferies.

2007 Jul 18 02:15 PM

[bammer4:]

They were asked this same question three times during the conference call. All three times the answer was the same. The conversion price would be $28 regardless of the share price in the market. They also said that the conversion price was not dependent on the share price in the market either up or down.

Spin that any way you would like.

BT

2007 Jul 20 11:01 AM

[gembree:]

Yeah, the full 8-K is now out and it is adjustable based on dilution, but not based on market price. My error, I didn't hear the call.

2007 Jul 23 01:46 PM