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The Company operate as a real estate investment trust and provide senior and subordinated commercial loans, invest in real estate, engage in asset management and servicing activities.
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saltyseaweed (91.73) Submitted: 8/27/07 11:26 AM : Start Price: $15.42 CSE Score: -4.96
I just recently bought CSE. I think it's the scariest pick I've ever made. I have not noticed other pitches, and even M* analysis, going deep into the exact nature of this company. I'll try to give a more informative analysis of the company, and explain my rationale for my purchase.CSE is a REIT company engaged in the business of borrowing money and lending it to medium-to-small size companies. Its REIT structure fundamentally distinguishes it from other similar companies, and dictates the fundamental benefits and risks inherent in the company.REITs are required by law to disburse at least 90% of their earnings to shareholders. This explains CSE's amazing yield, which is close to 13% at $17.80 per share. Additionally, REIT structure exempts CSE from federal income taxes for most of its activities. Hence, CSE's federal tax rate was about 20% last year, compared to 34% it would otherwise pay. Those are the upsides.However, the requirement that it pay out 90% of its earnings severely hampers CSE's ability to accumulate capital. In other words, CSE can only grow by borrowing money or issuing more stocks. This explains the eye-popping 86% debt-to-equity percentage (industry average is less than 20%). With such heavy leverage, a single disaster could put the company belly-up within months, if not days.There is additional risk associated with its REIT status. Because the company has to give out 90% or its earnings, not 90% of its free cash flow, the company can face cash flow squeeze, and in fact, for the last three years, the company had negative free cash flow. In 2006 annual report, the company openly admitted that it requires continuous additional borrowings to sustain its operation. To free up cash, the company is forced to issue additional stocks, diluting shareholder earnings. From 2004 to 2007, the number of outstanding shares increased approximately 60%, eating up much of shareholder gains.So there you have it. This is a company that is, due to its heavy leverage, basically ropewalking, and will be ropewalking for the foreseeable future as it has to continuously borrow to grow. It's a company with a permanent 86% leverage ratio. The company is definitely not my usual Buffett-style pick (JNJ, BRK-A, Y, LOW, USB etc.). So why did I pick the stock? I think the price is just too good. I don't think the company is particularly exposed to the subprime crises. Yes, the financial crunch may affect the company's ability to borrow, thereby restricting its growth. But it will not cause it to collapse as long as it can borrow enough to cover its negative cash flow, and there is no evidence the company is having any trouble doing that yet. Meanwhile, one can simply sit on the market-beating 13% dividend, even if the stocks stay still. I do believe they will pay out their dividends at least for the remainder of this year (that's 6% return on 4 months), and when they do, the share prices should see a moderate gain as well (maybe 3 to 4%)--so that's potentially 10% return on 4 months. Not too shabby.I personally don't think there is too much room for upside swing on this one (not counting dividends). Its heavy leverage and very structure limits that possibility. I know plenty of investors who will simply refuse to buy company that has permanent 86% debt-to-equity percentage (Graham said his limit was 60%) and whose business plan requires continuous share dilution. There is some sign that the company's specialty market has been saturated (complex structured loans for middle to small cap companies) and it is branching outside its specialty (this is based on the fact that its charge-off rate has been on an increase, albeit slightly. Could be insignificant). Barring a catestrophy in the health-care segment (it's biggest clientele--33%), however, I think the company will do okay, despite its top-heavy structure. Anybody who buys this company, however, is recommended to keep a hawk's eye on the cash flow of the company.
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JASCruz (48.91) Submitted: 9/07/07 4:23 PM
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Thank you for the detailed pitch! I have been watching this one for a while, especially since it is an II pick. The negative cash flow has been the major reason I haven't jumped in already, although the yield was enticing at 8%, then 9%, now 13%!I understand that this company will likely have a high amount of debt and share dilution for a while--do they have a feasible plan to get out of that? It seems like the share price will continue to go down, as well as the dividend, as the shares are diluted and debt is increased. More debt means more interest payments, which means lower earnings, which means lower dividends. I don't see how their current business plan is sustainable--and possibly not worth my money, despite the allure of 13% cash returns. Any comments?Thanks,Joel
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saltyseaweed (91.73) Submitted: 9/10/07 12:10 PM
The reason why the cash flow is negative is because the company is trying to grow. For this company model, growth = more debt = negative cash flow. Since in long term, cash flow must match earnings, if the company decided to curve its aggresive growth, the cash flow should return to the positive side. Sooner or later, this has to happen.As a side note, the company announced dividends as predicted, but the stock tanked instead of rising on the news of low employment figures. That will teach me to make predictions on the market's short-term movements. . .
jermskirk (< 20) Submitted: 10/08/07 5:31 PM
My recollection is that a large amount of the debt is from the decision to become a REIT. It borrowed a bunch of money so as to purchase a large amount of PRIME MBS to satisfy the real estate assets piece of qualifying as a REIT. I don't recall the numbers, but I would tend to think of the net expense from the interest expense CFs (from the debt) less the interest income CFs (from the MBS); it should be a significantly large off-set; my bet is on CSE as a specialty/niche lender that makes a premium on complex financing transactions. Leverage of 4:1 isn't that bad in this space & CSE makes a lot of senior & collaterallized loans.
thebopper (< 20) Submitted: 1/03/08 5:27 PM
If this was "scary" for you in August, what are you thinking now? You didn't invest, you gambled!
megastockmaster (95.83) Submitted: 1/21/08 10:02 AM
I just invested in CSE.It is a gamble if he sold now just because of PPS. It is an investment if the fundamentals of the company did not change and he held.My investment in CSE means that I will be holding for a while and participating in the lovely DRIP program. 15% dividends for me -- as long as they hold up -- plus a 2% discount* on shares purchased through the DRIP program.Heck, even if they cut their dividend by 25%, I will still be improving my average yield per portfolio.I don't think market cap has much lower to go unless they a) cut their dividend or b) announce awful news about a portfolio company.Good luck to all.
tjn68 (< 20) Submitted: 3/20/08 8:29 AM
Company will not go belly-up. Yeild is too good to pass up. Two years from now we all wish we accumulated more shares.
KIPSBERG (< 20) Submitted: 3/20/08 12:46 PM
THE POINT OF MUSICAL CHAIRS, IS THAT AFTER EACH PLAY OF THE MUSIC, A CHAIR DISAPPEARS.
K6BVK (76.37) Submitted: 8/26/08 1:50 PM
Don't look forward to the juicy dividend of over 20%. Their filing with the SEC several months ago mentioned, among other things, that their dividend would probably be discontinued.
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