The IPO Buzz: Cover Your Fannie

 
And here’s a tidbit that may, or may not, be a coincidence:
Citi and Merrill Lynch are the joint lead managers.
 
The IPO in question is American Capital Agency (Nasdaq: AGNC proposed), a company based in Bethesda, Maryland, which is located just a few miles from the rarefied air on Capitol Hill. American Capital Agency is a newly formed real estate investment trust, or REIT, that plans to price 12.5 million shares at $20 each to raise $250 million. Investment bankers expect to price the deal on Monday evening, May 12, to trade the following morning.
 
Now here’s where it gets interesting. And it leads to a question: When is a REIT not a traditional REIT?
 
Normally, a REIT invests in real estate, with holdings including such properties as shopping malls, office buildings, apartments, warehouses and hotels. To qualify as a REIT, a company must distribute at least 90 percent of its net income to shareholders as dividends. By doing this, the REIT avoids paying taxes.
 
In a slight departure from the usual script for a REIT, American Capital Agency plans to use proceeds from the IPO to acquire single-family residential mortgage pass-through securities and collateralized mortgage obligations, also known as CMOs.
 
Now here’s what separates this REIT from a routine REIT. The principal and interest payments of the securities that American Capital Agency will acquire will be guaranteed by a U.S. government agency, such as “the Government National Mortgage Association, or a U.S. Government-sponsored entity, e.g., the Federal National Mortgage Association, and the Federal Home Loan Mortgage Corporation,” according to the prospectus. Yes, the safety net for American Capital Agency’s investments will be provided by Ginnie Mae, Fannie Mae or Freddie Mac.
 
This isn’t an entirely new idea.
 
Hatteras Financial (NYSE: HTS), a REIT based in Winston Salem, North Carolina, was the last real estate investment trust to go public. On April 25, the company priced 10 million shares at $24 each to raise $240 million. It started trading the following morning at $24 and closed its opening day at $24.68. On Friday, May 9, the IPO closed at $25, UP $1 per share, or 4.2 percent from its initial offering price.
 
Now here’s what Hatteras is about: It was “formed to invest in adjustable-rate and hybrid adjustable-rate single-family residential mortgage pass-through securities guaranteed by a U.S. government agency (such as the Government National Mortgage Association, or Ginnie Mae), or issued by a U.S. Government-sponsored entity (such as the Federal National Mortgage Association, or Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac),” according to its prospectus.
 
Sound familiar?
 
The IPO handicappers, whose input makes up the Wall Street consensus of opening premiums in the IPO SCOOP rating system, gave the Hatteras deal a 1-Star rating -– just like the American Capital Agency offering.
 
Paper Money
This week, the American Capital Agency deal won’t be the only offering. There’s another IPO on the table.
 
Verso Paper (NYSE: VRS proposed), of Memphis, Tennessee, is a supplier of coated papers to catalog and magazine publishers. It plans to price 18.75 million shares at $16 to $18 each to raise $318.8 million.
 
Like American Capital Agency’s offering, this deal is also expected to be priced Monday evening to trade on Tuesday morning, May 13.
 
Formed in 2006, Verso Paper plans to use part of the proceeds raised from the offering to pay down some of its $1.4 billion of outstanding debt. Among the payees are Verso Fiber Farm LLC ($10 million), Verso Paper Finance Holdings LLC ($250 million plus $2.5 million in prepayment penalty) and Apollo for a “$23.1 million fee in connection with the termination of the fee arrangement under the management agreement.”
 
For the year ending Dec. 31, 2007, Verso Paper reported a net loss of $111.5 million on net sales of $1.63 billion.
 
For the three months ending March 31, 2008, Verso Paper reported a net loss of $3.1 million on net sales of $453.9 million, compared with a net loss of $35.4 million on net sales of $359.8 million for the same period a year ago.
 
And, yes, Verso Paper has a dividend history.
 
Its prospectus states: “On January 31, 2007, proceeds in the amount of $250.0 million from the incurrence of the senior unsecured term loan facility by our subsidiary, Verso Paper Finance Holdings LLC, were distributed to our equity holders. We intend to pay quarterly cash dividends on our common stock at an initial annual rate equal to approximately 1% of the initial offering price per share.”
 
After the offering of 18.75 million shares, Verso Paper will have about 56.8 million shares outstanding and Apollo will own about 38.1 million shares — or about 67 percent of the outstanding shares.
 
So IPO investors have just two deals to choose from this week. But it doesn’t mean they’re in for a dull ride. This is Wall Street, and anything can happen.