The government has warrants to purchase up to 79.9% of Fannie Mae's shares at a price of $0.00001 per share. During the first quarter, Fannie had 5.762 billion in common shares outstanding, including the government's potential stake, according the company's most recent 10-Q filing with the Securities and Exchange Commission. That would make for a market capitalization for the common shares of $14.578 billion, based on Monday's closing share price.
At this point, Fannie's earnings are being swallowed up by the government, because of the revised bailout agreement, but if the company no longer had to pay that dividend, its earnings available to common shareholders would be substantial.
Fannie's pretax income during the first quarter was $8.114 billion. The company's outsized first-quarter results and its dividend to the government reflected an income tax benefit of $50.6 billion, because of the DTA recapture. If we applied, say the top corporate tax rate of 35% to the $8.114 billion in pretax earnings, we would be left with earnings of $5.274 billion. If we then paid dividends on the junior preferred shares of $419 million -- which was roughly the amount of preferred dividends Fannie accrued during the third quarter of 2008 -- we would be left with earnings available to common shareholders of $4.885 billion for the first quarter.
That implies annual earnings power of about $19.4 billion for Fannie Mae. So one can argue that Fannie Mae's common shares are trading for considerably less than one year's earnings.
A bigger question for investors holding the common shares will be just how much additional equity Fannie and Freddie will need to be recapitalized, if and when the GSEs are allowed to repay Uncle Sam. But there's a whole lot of dilution that could be absorbed, considering the GSEs' earnings power.
But the "AIG model," of conversion of government-preferred shares to common shares, as implied by Fairholme Capital Management, could mean a fantastic, albeit limited, return for the junior preferred shareholders, and an even greater return for the common shareholders.
-- Written by Philip van Doorn in Jupiter, Fla.