Sometimes, you take the gifts the market gives you. This is how I felt when I saw shares of Commonwealth REIT (CWH) jump so sharply in late February. Dividend Growth Portfolio, it was a stock that had been left for dead. Wall Street hated management, earnings had been disappointing for months, and the stock had lost nearly half its value over the previous two years. But the REIT was cheap, trading at barely half its book value, and the share price looked to have finally stabilized. In my opinion, it seemed a decent contrarian bet for the next 2-5 years. The value of the underlying properties limited my downside risk, and I could continue to collect the dividend indefinitely. There was always the possibility that the dividend would be cut—and in fact it was late in 2012. But even at the reduced yield, Commonwealth paid a better dividend than most of the alternatives. All told, Commonwealth seemed like a very reasonable investment. No matter how incompetent management could be, I believed it would be hard to lose with a portfolio of high-quality properties selling for well below their book value. Or so I thought… You can never put it past management to do precisely the wrong thing at the wrong time. Rather than buy low and sell high, public companies have a bad tendency to do the opposite. They often buy back their shares when prices are high and issue new shares when prices are low — a destruction of shareholder wealth that should be unforgivable. Commonwealth recently announced plans to massively dilute shareholders with a new offering of more than 30 million shares. Not only was this a dilution of nearly 40%, but the shares were being offered at a 43% discount to book value. While I was pondering selling, two large shareholders, Corvex Management and Related Fund Management, sued the company for breach of fiduciary duty and offered to buy the company for $27 per share. Corvex and Related claimed that an independent assessment of Commonwealth’s properties put the value of the REIT at $40 per share. The stock jumped. Maybe Commonwealth is worth that, and maybe it isn’t. But in a situation like this, it generally doesn’t make sense to find out. At time of writing on March 5, Commonwealth is trading for a little less than $24 per share. If the Corvex and Related offer at $27 was approved, investors would be looking at 12-13% gains in a very short period of time. But what if it isn’t approved?
Deals can fall through for any number of reasons. And in this case, a failure would mean that we are back to where we started —looking at 40% share dilution. Commonwealth has become a coin-flip investment with very unappealing odds. Heads, you win a little. Tails, you might lose 40% or more. This isn’t investing; it’s gambling. And with terrible, risk-seeking odds. As a result, I sold Commonwealth in my Covestor portfolio.The investments discussed are held in client accounts as of February 28, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
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