Crystal River’s New Loss-Driven Investment Strategy

Crystal River (CRZ) has had an absolutely terrible time of it. The REIT went public at $23 a share in July of 2006, and then blew through about $350 million, or almost $14 per share, in just eighteen months.

The second quarter of 2008 continued to show the unfortunate results of CRZ’s ill-timed buying spree. Book value fell even further, to just $2.46/share, after another GAAP loss of almost $90 million, driven again by continued impairment charges (including remodeled future cash flows) and mark-to-market losses. The company has been steadily selling whatever decent assets it has left in order to pay down debt, and this has added insult to injury by further reducing the quality of the earnings available for shareholders.

Consequently, the Company also announced another reduction in its quarterly dividend, this time by more than half, to just $0.10/share. The Company’s stock price has been marching relentlessly in one direction (south), and investors tempted to buy into this value trap even three or four months ago have been treated to nothing less than death by one million falling knives. or maybe just a nice pair of cement boots for crystal river’s sea of red ink

The Company announced last quarter that it was pursuing “future strategic business opportunities”, which is usually a euphemism for selling out run for the hills! or merging. Given that they called off the initiative this quarter, one can reasonably assume they found no takers.

Interestingly, however, the company did manage to generate positive operating earnings of $.67/share. The Company’s CMBS portfolio was also looking pretty good, with delinquencies of less than 1% (in line with the market, but this will surely increase), no shaky interest-only loans, and no near-term maturities to worry about. Even more interesting, however, was this little nugget in their earning release: CRZ says that all these losses may actually cause the company’s operating earnings to exceed its taxable income for the next several years.

Is this bit of accounting errata of any real consequence? For this cash-starved REIT, it is potentially very significant. IRS rules require all REITs to distribute 90% of taxable income to shareholders. If there is no taxable income, there are no distributions. However, CRZ is actually generating cash earnings from operations. Because the Company is generating tax losses, this cash operating income will now be sheltered from taxes as well as the requirement to distribute it to shareholders.

There is a saying about pissing on somebody’s leg and then telling them that it’s actually just raining, but this oxymoronic situation could wind up being very beneficial for CRZ investors. It would give management some crucial breathing room by allowing them an opportunity to reinvest that cash in the continued reduction of short term debt, or the acquisition of new, accretive higher-yielding investments. please, not again

With access to capital in this sector reduced to zero for the foreseeable future, even something is better than nothing. Significantly, the Company’s CEO, Bill Powell, announced that he would be making purchases of the stock on the open market after his blackout period ends, and he followed up with a reasonably big purchase. Reasonable, yet also pretty adventurous given CRZ’s precariously thin unrestricted cash position of $2 million (the company does have access to its revolver) and the composition nuclear waste of its investment portfolio.

I personally won’t be dumping any of my hard-earned clams into this disastrous bubble mania, bed-wetting poster child anytime soon, but it’s becoming a more interesting story. Current shareholders may soon owe a debt of gratitute to 2006 shareholders for helping to produce what could turn out to be CRZ’s most valuable asset: tax losses

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