Is NovaStar's dividend at risk?
Commentary: More Overstock, naked shorting
By Herb Greenberg, MarketWatch
marketwatch.com
SAN DIEGO (MarketWatch) -- NovaStar -- the saga continues: Nobody is more tired hearing about NovaStar Financial, the subprime mortgage lender, than I am. But this is a story that just keeps getting better with age. (And by my recollection, it's been an ongoing tale here for more than two years.)
What now? The key reason to invest in NovaStar (NFI: news, chart, profile) , according to all of the bulls, has been its dividend. As of Thursday, its stock yielded 15.77 percent, which is among the highest of its highest peers.
With a high yield, however, comes high risk. Investors learned just how high on the company's fourth-quarter earnings call earlier this week.
On the call, rather than hearing NovaStar forecast a 2005 dividend of something like $5 per share, with a special dividend of another $3 or so -- as some analysts had been expecting -- shareholders had to settle for guidance of $5.60 per share. (That's merely quadruple the quarterly dividend.)
Turns out, the company said, the IRS is considering new regulations that could "potentially change" the timing of the way it recognizes taxable income. The issues involve an arcane and highly complex way companies like NovaStar do business. The final ruling could clearly impact the company's dividend.
As a real estate investment trust, NovaStar is required to pay out at least 90 percent of its taxable income to shareholders. A long-standing criticism by shortsellers has been that the company's GAAP income is well below its per-share taxable income and the dividend itself. As a result, they say, it doesn't look as though NovaStar earns its dividend.
The company fills the gap, the critics claim -- and the company denies -- by raising cash through the public offering in securities.
In the fourth quarter, for example, GAAP income was 40 percent lower than the dividend. As it turns out, in November NovaStar raised $48 million in a stock offering. The total cost of the dividend: Around $38 million.
That's why, rather than watch GAAP income, each quarter NovaStar investors pay closer attention to the "estimated" taxable income.
That changed in the fourth quarter, however. Unlike prior quarters, the company didn't give an estimate for taxable income and says it won't until it has had a chance to evaluate the impact of the potential rule changes. That won't happen at the earliest, it said, until it files its 10-K, which is due by March 1. "Based on the final determination of 2004 taxable income," NovaStar said, "the company may be required to pay special dividends in 2005."
But that also means it "may not" be required to pay a dividend, says a report by Gradient Analytics, which in a series of reports over the past year has been highly critical of NovaStar. Gradient co-founder Donn Vickrey says depending details of the IRS ruling -- and the way NovaStar deals with the situation -- 2004 may see the last special dividend for NovaStar. Vickrey, a former accounting professor, says as a result of his interpretation it's likely that NovaStar's dividends "will have to be cut drastically."
It's unclear when the IRS plans to rule, but this much is known: The issue was the focus of an IRS bulletin dated Oct. 4, 2004. That's 24 days before NovaStar issued third-quarter earnings and held a third-quarter conference call and a little more than a month before its November stock offering.
Why didn't it discuss the IRS ruling at the time? Did it know about it? If it didn't, why didn't it? Doesn't it have tax attorneys who keep up with such things?
And if it doesn't know what taxable earnings for 2004 will be, how can it provide dividend guidance for 2005?
I didn't ask NovaStar because the company still hasn't responded to a question I asked earlier this week.
Either way, if the stock's 24 percent slide this past week is any indication, investors are starting to grow concerned.
And that's not surprising: In addition to everything else, NovaStar said that in the future taxable income is likely to be closer to GAAP income. That's only good news for shareholders if GAAP income is going higher, which hasn't been the case lately. When does all this come home to roost? It's not a question of if, Vickrey says, but when. |
