KFN stock is cheap, buy ahead of earnings - FBR Capital Mkts
04-Nov-09 08:02 ET KFN KKR Financial: 3Q09 preview; stock is cheap, buy ahead of earnings - FBR Capital Mkts ......FBR Capital Mkts is buyers of KFN shares into the 3Q09 earnings release scheduled after close on Thursday, for several reasons. Firm expects KFN to report a book value to increase from $5.69 at June 30 to over $6.00 as of Sept. 30. Also, FBR believes 3Q09 results will set an earnings "base" from which we expect growth to occur for the foreseeable future, as mgmt actively manages the portfolio to create net interest margin expansion. Firm believes that progress has been made to date regarding the co's two large 2007 CLOs that were non-compliant as of June 30 in terms of moving the structures conservatively closer to compliance. FBR continues to believe that there is significant underlying embedded value in KFN shares, not only in terms of long-term book value upside, but also in terms of the ability, based on the co's irreproducible liability structure, to take advantage of opportunities in corporate credit to create a powerful and consistently growing earnings stream over time.
Looking at FBR Capital Mkts statement from earlier today, I think it's sort of a generic forward statement that is very conservative in stating they think KFN has some nice future upside. I find two statements particularly interesting.
1.) 'Firm expects KFN to report a book value to increase from $5.69 at June 30 to over $6.00 as of Sept. 30.'
Personally, I expect book value to be over $6.25 on the very conservative low-end, possibly significantly closer to $7 as the leveraged loan market and KFN's bond holdings have seen significant increases in value. If there were any upgrades to these bonds it could bring more money into KFN, getting closer to CLO 2007-1 compliance and a reissue of the dividend.
2.) 'Firm believes that progress has been made to date regarding the co's two large 2007 CLOs that were non-compliant as of June 30 in terms of moving the structures conservatively closer to compliance.'
After KFN cancelled $298.4M mezzanine and junior notes on July 10, 2009 to bring CLO 2005-1, CLO 2005-2, and CLO 2006-1 into compliance with their senior OC test, only CLO 2007-1 was out of compliance with the senior OC test, by $244M. CLO 2007-A met the senior OC compliance, but was out of subordinante OC compliance by $82M, which improved to $71M by the end of July.
It looks like $636M of CLO 2007-1's holdings are rated at or below CCC. I don't think they could have made enough in paydowns to get CLO 2007-1 above the senior OC test, but if any of $636M of the lower-rated holdings were upgraded it could have helped it meet the senior OC test. That means that KFN would then begin collecting interest on $678M of their holdings in CLO 2007-1. I don't think this has happened yet, but KFN is so tight-lipped it's hard to know what's been happening until the quarterlies are released.
So, the two main items I'll be looking for in the CC are: 1.) will KFN issue a dividend for Q3?, and 2.) how close is CLO 2007-1 to meeting senior OC compliance? I still see Q4 as the earliest they'll issue the dividend, unless the board wants to appease the shareholders now. If they don't it will be interesting in the post-CC questions, as the dividend will certainly be on the minds of large shareholders. Once CLO 2007-1 has met the senior OC tests, we'll see some nice cash flows and the dividend issue will be a thing of the past.