Let me be clear at the outset: I wouldn't recommend buying shares of Chimera Investment Corp. to my worst enemy -- oh wait, yes I would.
Anybody who's read my recent columns (like this one) knows full well what I think about this company. It hasn't published a single financial statement for over a year now, it's restating the lion's share of its previous filings due to a purported accounting error, and its CEO and CFO are both close relatives of executives and board members of its manager Annaly Capital Management .
That being said, I could be wrong. And it's in this vein that I'll grin, bear it, and offer three reasons that could entice an investor to buy shares in this unconscionably risky company.
1. It's undervalued
At the beginning of March, Chimera dropped a bombshell on its investors by announcing that it wouldn't file its 2011 annual report because "additional time is required ... to review the application of GAAP guidance to certain of its non-Agency assets."
If this wasn't bad enough, five months later, by which time it had also missed the deadline to file its report for the first quarter of 2012, it acknowledged that it will restate all quarterly and annual financial statements dating back to the third quarter of 2008.
And in the meantime, it's provided only the most cursory of updates to book value. Consequently, investors in the company have been left in the dark with respect to 90% of the company's existence.
While this is unquestionably a problem -- an inexcusable one in my opinion -- it nevertheless leaves significant room for mispricing, as investors know little to nothing about what's going on inside Chimera's portfolio of private-label mortgage-backed securities.
Between the first and second quarters of this year, for example, Chimera estimated that its economic book value increased from $2.76 per share to $2.87 per share. Meanwhile, it currently trades for $2.76 per share, a nearly 4% discount to its economic book value at the end of June -- the discount increases to almost 11% when GAAP book value is used as the denominator.
As a result, when it does announce, presumably by the middle of January to avoid being delisted by the New York stock Exchange, its shares could theoretically shoot up.
2. Its accounting problems are misunderstood
Make no mistake about it, the significance and tangible impact of Chimera's accounting problems will dictate the short-term price movements of its stock -- if not the company's continued viability. But despite the typical view of accounting as a cut-and-dry exercise in pencil-pushing, it's much more of an art than a science. This is why investors and analysts like myself could very well be misunderstanding the net effect of Chimera's purported accounting error.
There are two things to keep in mind, here. In its press release announcing the restatements, Chimera estimated that its net income would drop by two-thirds over the time period between the third quarter of 2008 and the third quarter of 2011 because of the deterioration in the value of its private-label mortgage-backed securities. That's significant! At the same time, however, according to Chimera, all of the changes will be balance-sheet neutral because it had already deducted the losses from its shareholders' equity account.
Consequently, once the restatements are published, and again assuming there's no tangible impact on its ability to continue operating, the cloud that's depressing Chimera's shares could be lifted, yielding an immediate appreciation in its share price.
3. It could be a takeover target
One company's trash is another company's treasure. What I mean by this is that the same private-label mortgage-backed securities causing Chimera so many accounting problems could be just what Annaly is looking for.
At the beginning of last month, Annaly submitted a bid to acquireCrexus Investment Corp. , a much smaller REIT that specializes in commercial real estate assets. It did so because Annaly is diversifying away from increasingly low-yielding, agency-issued mortgage-backed securities. Not to mention, because Crexus is effectively debt free and already operating under the Annaly family of companies, its consolidation would be immediately accretive to the Annaly's bottom line. It's for these reasons that Annaly offered to pay a 13% premium to the Crexus' pre-announcement closing price.
Chimera comes into the equation because it shares many of the same characteristics as Crexus. It has a portfolio of higher-yielding non-agency securities that could be used to counterbalance Annaly's portfolio of agency securities. And it already operates under the Annaly umbrella, offering self-evident synergies. If Annaly were to pull the trigger, in turn, it would likely pay an analogous premium to where Chimera trades today.
These reasons aside, steer clear of this stock
Allow me to end this column on the same clear note that I began. These three reasons to buy Chimera are nothing more than pie-in-the-sky scenarios. That said, I wouldn't touch this stock with a ten-foot pole, and neither should you.
To see more reasons why this is so, or if you're even halfway thinking about buying stock in this company, I implore you to download our in-depth report on Chimera. To access a copy while it's still available, click here now.
The article 3 Bad Reasons to Buy Chimera Now originally appeared on Fool.com.
John Maxfield has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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