On October 1, day one of the Value Investor's Congress, Whitney Tilson teased a new short position, promising a whole new sector with unsustainable dividends funded largely through secondary offerings: "So, effectively, they're Ponzi Schemes."
The next morning, Tilson refused to identify the short while on CNBC, despite determined prodding from the Squawk gang. Despite Tilson's coyness, there's plenty of room for speculation. Given his clues, we're looking for high dividend yields (presumably greater than EPS), recent secondary offerings, and a relatively new appearance in the equity markets.
Two possibilities immediately come to mind: REITs and MLPs.
Both REITs and MLPs are tax-advantaged securities that earn their lofty status through different means, but arrive at the same point - via a requirement to pay out 90% of income via dividends. This requirement forces REITs and MLPs alike to periodically raise capital via secondary offerings in order to grow their businesses.
Among those two asset classes, only one sub-sector has given me pause previously: mortgage REITs. While MLPs and traditional REITs own and generate income from real assets, mREITs invest in mortgage-backed securities (MBS) and generate income through interest rate arbitrage and significant leverage. These REITs are extremely exposed to changes in interest rates due to their reliance on short-term debt.
A quick check of NASDAQ's list of Secondary Public Offerings shows that 21 companies with dividend yields greater than 3.5% raised capital through secondary offerings this past quarter (July-September). Of those 21, 10 were REITs and 11 were MLPs.
The three highest yielding, however, were mortgage REITs Apollo Residential Mortgage (NYSE:AMTG), Mortgage Investment Trust (NYSE:MITT) and Western Asset Mortgage Capital Corporation (NYSE:WMC) with current dividend yields of 14%, 12%, and 15% respectively.
All three of the above mREITs are strong candidates to be Tilson's next short. All three are relatively new companies, with all three beginning operations concurrently with their IPOs - AMTG and MITT in July 2011, and WMC in April 2012. Since those dates, each one has more than doubled its outstanding shares through secondary offerings and both AMTG and MITT have raised additional capital through offerings of preferred stock.
Although not mentioned in Tilson's tease, all three are among the most levered mREITs on the market. AMTG maintains a 5.5 debt-to-equity ratio, MITT a 6.2, and WMC over a 9.
My thesis for this article is only that these stocks best fit Tilson's tease among dividend payers that have raised capital through recent secondary offerings. It will take deeper analysis than the scope of this article to determine whether or not their dividends are unsustainable or directly funded by these secondary offerings.