Capital Trust: What Does A Reverse Split Of Shares Mean For REIT Investors?

| About: Blackstone Mortgage (BXMT)

Capital Trust (CT) announced April 26, 2013 that it is going to conduct a reverse share split. CT operates as a real estate finance company that focuses primarily on originating mortgage loans backed by commercial real estate assets. It attempts to invest in various types of commercial real estate loans and other debt-oriented investments, focusing primarily on the lodging, office, retail, industrial, residential, and healthcare real estate sectors in the United States and Europe, including mortgage loans. It also focuses on other loans and investments, including subordinate mortgage interests, mezzanine loans, preferred equity, real estate securities, and note financing. The company qualifies as a real estate investment (a REIT) trust for federal income tax purposes. It generally is not subject to U.S. federal income taxes if it distributes at least 90% of its taxable income to its stockholders. The company will conduct a 1 for 10 reverse split of its shares. At the same time, it also is planning to change its name to Blackstone Mortgage Trust, and will also change its stock ticker to BXMT

No popular REIT products, such as Annaly Capital Management (NYSE:NLY) or Agency Capital (NASDAQ:AGNC) will be affected by this announced split. The CT reverse split will be conducted at a ratio of one new share for every ten held. The reverse split will apply to shareholders of record as of the close of the markets on May 6, 2013 and will begin trading at the adjusted price on Friday May 7, 2013. The ticker symbol for the fund will change to BXMT. The stock will be issued a new CUSIP number.

The reverse split will increase the price per share of the fund with a proportionate decrease in the number of shares outstanding. In a 1 for 10 reverse split, every ten pre-split shares held by a shareholder will result in the receipt of one post-split share, which will be priced ten times higher than the value pre-split share. (If you hold 100 shares of CT priced at $2.00 each, then after the reverse split you will hold 10 shares valued at $20.00 each.) Thus, the reverse split does not change the value of a shareholder's investment.

There are two more considerations to think about during this split. What happens with fractional shares, and what happens to owners of options contracts.

Fractional Shares From Reverse Splits

For those shareholders who hold quantities of shares that are not a whole number with an exact multiple of the reverse split ratio, the reverse split will result in the creation of a fractional share. This will affect any shareholder who does not hold a number of shares that is a multiple of ten. After the reverse split occurs fractional shares will be redeemed for cash and sent to your broker of record on or around two weeks post split The major issue associated with such a move is that it forces shareholders to realize either gains or losses, which could result in a small taxable event for those shareholders, in addition to a having a potential loss on investment if prices are below where they were purchased. One way to mitigate this is to purchase more shares to round out your CT holdings to a multiple of ten, or to sell an appropriate number of shares to round out the holdings.

For Those Holding Options Contracts On CT

For those traders who may be holding options on CT, this split will affect your contract, albeit minimally. Once the reverse split is conducted, the contract undergoes an adjustment that is commonly known as "being made whole", which means the option contact is modified accordingly so that options holders are neither negatively nor positively affected by the split. While we know the reverse split will adjust the price of the underlying shares of the CT option, the option will be adjusted so that the changes in price due to the split do not affect the value of the option.

Each CT option contract is (usually) in control of 100 shares of CT at some predetermined strike price. To find the new share coverage of the option after the split, all you do is simply take the split ratio and multiply by the old share coverage (normally 100 shares). To find the new strike price, take the old strike price and divide by the split ratio. Let's look at a hypothetical example of a call option contract for 100 shares of CT at a strike of $1.00. Since the split is 1 for 10 we divide $1.00 by 1/10, generating a new strike price of $10.00. The option will now cover 10 shares because we multiply 100 by 1/10. Thus, your new call option contract (which will expire on the same day as originally scheduled) will be good for a purchase of 10 shares of CT for $100.00. On your brokerage account, the contract may be adjusted to read "CT1" or the new ticket BXMT1 or similar and still state it is worth 100 shares at the original price, but for redemption purposes, the contract would be redeemed for 10 shares at the post-split price.

How Does the Change Affect Investment?

The company is a real estate finance company that focuses primarily on loans and securities backed by commercial real estate assets. It is categorized as a REIT which offers many advantages, specifically for tax purposes and as a shareholder, increased return of capital through dividends. The fact that CT is a sub $5.00 stock may make it unattractive to large investors, including institutional investors. Most institutions have in their management agreements language that prevents them from purchasing stocks under $5.00 due to their high beta movements in share price. This reverse split will bring the share values to around $24.00. This level, obviously being above $5.00 may entice some institutions to get behind the stock, specifically for future growth and dividend potential. As of now, CT does not pay a stable quarterly dividend, however last year it paid a special dividend of $2.00 per share. Given that the current share price is $2.40, if this dividend is repeated (and the company has to pay out 90% of earnings), it would bring the yield to 83%. The company also has a p/e ratio of less than one, at 0.33! This is because the company earned $7.31 last year. The stock has a 52-week range of $1.96-$3.96. Given the reverse split could attract new investment from larger money managers, the incredible earnings profile, and dividends that are expected to continue, this company could be a better buy than NLY or AGNC, especially if the commerical real estate market gains momentum once again.

Bottom Line

CT is down 24% in a year, currently trading at $2.40. This reverse split will truly only 'hurt' investors who own common shares at a total that is not a multiple of ten, as they will be forced to sell fractional shares at a loss, or a potential gain, that could result in a taxable event. Owners of options contracts will not be affected besides being faced with owning a new contract at a different strike price for a different number of shares. The total value of the contract will, however, remain the same.

Disclaimer: This article is not a recommendation to CT, NLY, AGNC or any other REIT. It is for informational purposes only. The options contract analysis can be applied to all splits of other companies in the future by utilizing the outlined calculations.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CT over the next 72 hours. 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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