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Why Shares of Fannie Mae and Freddie Mac Soared Higher

Common shares of Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) rose 9.2% and 6.2%, respectively, on the first day of trading to kick off the week. What prompted the GSE's latest move higher and how have big money investors been playing these companies during the past couple months?

Ackman weighs in
Bill Ackman, manager of Pershing Square, is best known to Fannie and Freddie investors as the man who bought nearly 10% of the publicly traded common shares of both GSEs. While other big-money investors have focused on the preferred stock of Fannie and Freddie, Ackman's bet on the common shows at least some of the big money expects returns for more than just the preferred shareholders.


As is the case with most corporations, the common stock carries more risk and more upside than preferred. If the preferred stock of the GSEs were to trade at liquidation value, most series would triple from current levels.

But Ackman expects even more upside from the common stock, and noted in an investment conference that he expects the GSE shares to increase in value 10 times during the next several years. He also noted his expectation that the Supreme Court would side with the shareholders, and that shares could be worth 10 to 15 times current levels after the decision is issued.

When Ackman speaks, investors listen; and when Ackman talks of multi-bagger gains, stocks easily get a boost. Ackman has made multibagger profits before by investing in common shares through restructurings. Perhaps his most famous investment was in mall operator General Growth Properties (NYSE: GGP  ) . Having invested in the company and assisting it in exiting bankruptcy, Ackman was richly rewarded. In 2011, Ackman told Bloomberg News the level of success in the investment, which "turned $60 million into $1.6 billion."

Ackman only recently sold the last of his General Growth shares, and investors are eager to follow him into his next restructuring investment.

More common stock interest
Ackman's investment in the common stock of Fannie Mae and Freddie Mac has been seen as unique in a market where big money has been going after the preferred stock of the GSEs. But another major GSE investor has joined Ackman in owning common shares of the companies.

Bruce Berkowitz, manager of The Fairholme Fund, has focused his GSE attention on Fannie and Freddie's preferred stock until recently. The Fund's latest 13F filing shows it now has stakes in the common stock of both GSEs.

Not only does this show there is more big money support for the common stock, but it also brings another powerful fund manager to advocate for the interest of the common shareholders. Berkowitz had proposed a plan to recapitalize the GSEs and repay preferred shareholders at liquidation value, while leaving common shareholders less well off. Although that plan was quickly dismissed by the White House, having Berkowitz on the common shareholders' side in any future action is definitely a positive for common shares.

The bottom line
The futures of Fannie and Freddie still rest largely in the hands of politicians and the courts. But with politicians continuing to remain at odds about almost everything, many investors are counting on the courts to render a decision.

Berkowitz, along with several others, have filed lawsuits against the government challenging the amendment that directs all profits earned by the GSEs to the Treasury. And if Ackman is right about the potential returns from a court victory for shareholders, Fannie Mae and Freddie Mac common stock have some of the biggest upside -- and risk -- in the investing world.

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Read/Post Comments (4) | Recommend This Article (14)

Comments from our Foolish Readers

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  • Report this Comment On February 25, 2014, at 12:50 PM, edus wrote:

    Ackman is right about the valuation. Both GSEs have a P/E round 1. This fairly gives an upside up to P/E=10 as fair value, ie. 10x of current market price.

  • Report this Comment On February 25, 2014, at 12:53 PM, edus wrote:

    Most probably US will lose some of the lawsuits and a hybrid solution will be created with less role of GSEs.

  • Report this Comment On February 25, 2014, at 2:01 PM, Caludio wrote:

    Fannie made $84B in 2013 but it is not normal. An acceptable profit for the next several years will be $20B. If the Court allows the government to exercise the warrants, the fully diluted outstanding shares will be 5.5 B. It means EPS will be about $ 3.63. The normal PE for this kind of companies is 10. So 3.63 x 10=$36

    This is the worst case. But what will happen if government cannot exercise the warrants? The outstanding shares will be about 1.2B only and EPS $16.6 . It may never happen but, just in case...,do not short sell Fannie nor Freddie.

  • Report this Comment On February 25, 2014, at 2:07 PM, Caludio wrote:

    Also I am sure that Ackman is right about HERBALIFE. It is a piramyde scheme.

    I have been talking with several Herbalife dealers and they are quite disappointed.

    At same point Icahn will sell (and sell short) and Herbalife will crash big time!

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Alexander MacLennan

Alexander MacLennan is a Fool contributor covering Industrials, Airlines, and Financial companies. He is always ready for a good growth or turnaround story and tries to find them before the market does.

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