What is the fair value for CIT common under the new Offering Memorandum (available at http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MTc3Mzh8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1)?
Very close zero. Here’s why:
Before we get into the numbers, note this comment in Page 6 Footnote (3): “If the Offers are consummated, the issuance of the New Preferred and the proposed Recapitalization will result in substantial dilution to the Company’s existing equity holders, leaving such holders with little economic or voting interest in the Company.” Translation: current common stockholders end up with almost nothing. And if the Offers are not consummated, then common holders definitely end up with zero (under reorganization/bankruptcy).
And now to the numbers. First, from Page 67 Note B: “If the Recapitalization is consummated, all preferred stock is assumed converted to common stock, which would significantly increase the number of common shares issued to approximately 15.7 billion (from 398.3 million shares pre Recapitalization), reducing the book value per common share to an estimated $1.24 per share (from $29.28 per share pre-Recapitalization).”
What does this imply regarding valuation? First, note that peak earnings for CIT were $1.016B in 2004. Even if CIT reached this peak again (extremely unlikely), this would represent earnings of only $.06 per share post-dilution. OK, so how about using the new book value of $1.24? Well, using RBS (Royal Bank of Scotland, another basket case) as a proxy, perhaps CIT also should trade at 48% of book value? In a word, no – because RBS has received a full UK government guarantee – and of course, CIT has none from the US. Bottom line: just to get a valuation of $.30, we would have to value CIT at 5x PEAK earnings, and 25% of book value. Indeed, since the CIT Series “A” Preferred now trade at 5% of book ($1.33), perhaps we should value the shares at 5% of post-dilution book value at most, or $.06.
One more note on the preferred: under the agreement (see page 136, pp. 1), current preferred shareholders end up with approximately 1% of the common post-dilution, while current common stockholders end up with 2.5%. Given the relative amounts outstanding, the preferred shares should be trading at 11.2x the common. The fact that they are not (and that the preferred is trading at 5 cents on the dollar) reflects the market’s expectation that they are both going to zero.
One final point, regarding Contingent Value Rights as defined in the memorandum (for starters, see page C-26 Section (NYSE:H)). These are rights issued to the debtholders for shares in the company post-reorganization (after current common holders have been wiped out). The inclusion of this unusual provision would only come at the insistence of a substantial number of the bondholders. That it is included, and is only applicable under reorganization, I think indicates reorganization is the likely outcome (and several leaks to the press have corroborated this view). Again, under reorganization, the common goes to zero.
In sum, looked at from several angles, the most likely future value for the common appears to be zero. Under the most optimistic scenario it is worth perhaps $.30.
Disclosure: Author is short CIT Common