3 Potential Fannie Mae and Freddie Mac Multibaggers

These three investments carry major upside if shareholders can win their lawsuits against the government.

Apr 22, 2014 at 10:05AM

Source: Flickr / Images of Money.

Investors in Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC) are already well aware of the risk reward scenario surrounding the future of the GSEs. But different investors have picked different ways to play Fannie and Freddie with each having their own risk reward profile. Here I'll look at two widely known Fannie and Freddie investments and one you may never had heard of.

Maximum reward
Just a few years ago, shares of Fannie and Freddie traded around 30 cents per share but have since risen over ten fold. As the GSEs have returned to profit, and then to massive profit, speculation began that the GSEs could be freed from government control and give their new earnings power to private shareholders.

At this point, common shareholders have no power with the annual shareholder meetings cancelled, and have no share of the profits following the Sweep Amendment. With warrants to acquire 79.9% of both GSEs, the government could exercise its warrants and take a majority stake for a minimal cost.

Until recently, common shares of the GSEs have mostly been left alone by hedge fund investors. Bill Ackman changed this last year when his fund, Pershing Square, acquired nearly 10% of the publicly traded shares of each GSE. More recently, Ackman found a way to effectively increase his exposure beyond 11% in each GSE by taking out a deal with a counterparty.

Trading at around $3.80 per share, Fannie and Freddie common shares have the potential to increase ten times in value based on the estimates from Bill Ackman. In a previous article analyzing the potential for these shares, I reached a similar estimate in the $30 to $40 per share range.

Preferred stock
Even though Fannie and Freddie have returned to profitability, the dividends on the junior preferred stock (the non-government owned preferred stock) remain suspended. With no maturity date and no dividend, the GSE preferreds are speculation on the government loosening its grip on Fannie and Freddie.

Fannie and Freddie preferreds have attracted a lot of hedge fund buyers including Bruce Berkowitz, manager of Fairholme Funds, and Richard Perry, manager of Perry Capital. Both hedge funds have since filed lawsuits against the U.S. government challenging the legality of the Sweep Amendment.

Although Fannie and Freddie each have several series of preferred stock, they share similar characteristics. With liquidation value of $25 or $50, most series trade in the range of 30 to 40 cents on the dollar. If the GSEs are freed from government control and allowed to distribute profits to private investors, the preferred shares could increase to liquidation value making for a tripling of your investment.

The big preferred
While most series of Fannie and Freddie preferreds have a liquidation value of $25 or $50, one series is a major exception. Fannie Mae 5.375% 2004-1 Preferred Stock (NASDAQOTH:FNMFO) carries a few interesting characteristics for its investors.

First of all, this series has a liquidation value of $100,000 per share and has a last price of $32,750. FNMFO is also very low volume so it could take some waiting to get a reasonable buy order through. But for investors with patience and willing to make a large investment in Fannie Mae, FNMFO two features that create the potential for greater upside.

First of all, the liquidation value is $100,000 but Fannie Mae has to pay $105,000 to redeem the series if it chooses to do so. FNMFO is also the only series of Fannie and Freddie preferred stock that is convertible to common stock. At the holder's option, FNMFO can be converted into 1060.3329 shares of Fannie Mae common stock. To get $100,000 in value from FNMFO in the form of common shares, common shares would have to be at $94.31.

Although rising from $3.80 to $94.31 seems like a tall order now, it could happen under a certain set of circumstances. To see any major increase in the value of common shares, the government will need to release Fannie Mae and allow private investors their share of the profits.

The $30 to $40 per share estimate for the common stock takes into account the dilutive effect of the government's near 80% warrant stake.

However, some lawsuits against the government claim that the warrants were illegally taken during the bailout. If the warrants were to be nullified, it would eliminate the dilutive effect from the government stake allowing common shares to rise significantly higher possibly above the conversion price. Although nullifying the warrants poses an even greater challenge than ending the Sweep Amendment, it could still be possible and FNMFO offers preferred stock investors additional upside if this scenario were to play out.

GSE investments
Fannie and Freddie are some of the most binary return investments in the market today. While the common stock carries the greatest risk by being last in line among stakeholders, it also appears to have the greatest potential reward. The preferred stock also offers multibagger potential if the GSEs can begin paying dividends again.

For those willing to make a large investment, Fannie Mae 2004-1 Preferred Stock brings both the stakeholder position of preferred stock and some even more upside if the GSEs can return to private investors and the government warrant stake is deemed void.

Take advantage of this little-known tax "loophole"
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Alexander MacLennan  owns common shares of Fannie Mae and Freddie Mac. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers