Hedge Funder Sees KKR's Next Deal in Washington Mutual's Shell

NEW YORK (TheStreet) - Stephen J Errico of hedge fund Locust Wood Capital Advisers expects KKR's (KKR) next buyout deal could come from the publicly-traded shell of Washington Mutual, the failed thrift lender whose assets and liabilities were acquired by JPMorgan (JPM) in a controversial crisis-era takeover.

Errico said at the Harbor Investment Conference in midtown Manhattan on Wednesday that Locust Wood is investing in WMI Holdings, the publicly traded shell of Washington Mutual, because he believes KKR's recent million investment in the company signals the PE firm may use it for its next billion dollar deal.

The investment was characterized as a speculative bet by Errico and centers on net operating loss carryforwards that KKR may be able to utilize were WMI Holdings to begin making large acquisitions. In March, a two-year waiting period for WMI Holdings to realize its NOLs expires, giving the company the ability to make acquisitions at advantageous prices, according to Errico's comments.

He estimated on Wednesday that WMI Holdings carries nearly $6 billion in loss carryforwards, an attractive asset in prospective acquisitions.

In January, KKR made what it called a "strategic investment" in WMI Holdings consisting of a $11 million purchase of the face value of its convertible preferred stock, which converts at a price of $1.10 per share. The PE giant also committed to purchase up to $150 million aggregate principal amount of WMI Holdings subordinated 7.5% PIK notes, which may be issued in one or more tranches over a three year period, with a seven year term from the date of that issuance.

As part of the investment, KKR received five-year warrants to purchase approximately 61.4 million shares of the Company's common stock, 30.7 million of which has an exercise price of $1.32 per share and 30.7 million of which has an exercise price of $1.43 per share. 

KKR received the right for three years to participate up to 50% in equity offerings up to an aggregate of $1 billion by WMI Holdings, including a cap on ownership by KKR of 42.5% of the company's common equity.

"We believe the investment in our Company by KKR will enhance value for all shareholders of WMI Holdings.  KKR has a history of investing across a wide range of asset classes and we look forward to working with the KKR team as we execute on our acquisition strategy," Michael Willingham, chairman of WMI Holdings said at the time.

Errico of Locust Wood believes KKR made the investment so it can push forward acquisitions that utilize WMI Holdings NOLs. He now characterizes WMI Holdings as a "KKR special purpose acquisition vehicle."

"Expect acquisitions to be announced sooner rather than later," Errico said. He said it was a smaller cap, more speculative way to invest alongside KKR.

WMI Holdings shares were little changed on Thursday. KKR didn't respond to an email seeking comment.

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