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Why Billionaire Leon Cooperman’s Large Stake in Chimera Investment Corporation Isn’t a Good Reason to Buy Its Stock

Despite a litany of problems at Chimera Investment Corp. (NYSE: CIM  ) , the high-yielding mortgage REIT has nevertheless caught the eye of hedge-fund billionaire Leon Cooperman. In the last few years, the renowned investor has accumulated over 66 million shares in Chimera, equal to 6.44% of its outstanding share count.

Before calling your broker and following suit, however, I'd advise you to keep two things in mind. First, Chimera is a highly speculative stock that remains mired in an accounting debacle dating back to its inception as a publicly traded company. And second, Cooperman's resources give him an edge that simply isn't available to the average investor.

A primer on Chimera's "accounting error"
Because I've addressed Chimera's problems on multiple occasions in the past -- here's a good place to start -- I won't go into great detail here. In short, Chimera came clean in the middle of 2012 with the revelation that it had overstated its net income from 2008 through 2011 by a factor of three. Instead of earning a reported $1.06 billion, it had actually earned only $367 million.

Over the course of the next two years, Chimera missed nearly every filing deadline for its quarterly and annual financial statements, has been threatened with de-listing by the New York Stock Exchange, and suspiciously fired its former auditor Deloitte & Touche after the accounting giant informed Chimera that all of its financial statements since inception needed to be restated.

Chimera has nevertheless brushed off the accounting issue by saying it was an innocent mistake. According to a press release at the time, it had inadvertently used the wrong accounting rule to determine the treatment of other-than-temporary impairment on certain investments in non-agency residential mortgage-backed securities -- nevermind, of course, the size of the "accounting error" and the suspiciously convenient fact it was in Chimera's favor.

But innocent or not, what makes the accounting error inexcusable is who made it. More specifically, Chimera's chief financial officer at the time was a 30-something former "business consultant [from] Fort Lauderdale" with no evident qualifications for the position. How did she get it? She was the sister of the co-founder and now-CEO of Annaly Capital Management (NYSE: NLY  ) , which established Chimera in 2007 and has managed it since then.

I trust you get the point. Say what you will about valuations and claims that Chimera has cleaned up its act, the fact remains that the management of this company -- and, for that matter, Annaly Capital Management -- leaves a lot to be desired. "You can't do good business with bad people," the late Walter Wriston used to say.

Why you shouldn't blindly follow Cooperman's lead
Given these facts, it may come as a surprise that someone with the reputation and track record of Cooperman would take such a large position in Chimera. Aside from being one of the wealthiest people in America, he's the founder and CEO of Omega Advisors, a New York-based hedge fund with more than $10 billion in assets under management. In a former life, moreover, Cooperman served as the chairman and CEO of Goldman Sachs Asset Management.

Although I can't speak on Cooperman's behalf, it seems safe to assume that his interest in Chimera stems from the fact that it's trading for a discount to book value -- I say this because he's a well-known value investor. When he first started accumulating the stock in 2012, in fact, it traded for as little as 70% of its stated book value. This means that a person with Cooperman's resources and expertise could theoretically generate a 30% return on investment simply by taking control of the company and liquidating its assets.

The point is that Cooperman's resources and expertise are an indispensable part of the equation. They give him access that an ordinary investor doesn't have. And they also mean that he can bend the ear of Chimera's wayward management. For instance, here's a selection from one of Chimera's recent regulatory filings:

Mr. Cooperman has engaged in communications with members of the Board of Directors of the Issuer regarding various matters related to the Issuer, including discussions regarding the Issuer's operations, business, strategies and strategic direction. These discussions have reviewed, and may continue to review, options for enhancing shareholder value through various strategic alternatives, improving the Issuer's operational and financial execution, and general corporate matters.

When was the last time you "engaged in communications" with a company's board members about "various strategic alternatives" and improving "operational and financial execution"? My guess is never. And this is the point. You see, Cooperman could very well have other objectives that conflict with the average Chimera stakeholder. It isn't his job to protect or advise them. If anything, he's an adversary that's justifiably bent on maximizing his take to the exclusion of others.

To this end, consider this anecdote from my colleague Morgan Housel about the "worst investment" he ever made:

The housing market was crumbling, and a smart value investor I idolized began purchasing shares in a small, battered specialty lender. I didn't know anything about the company, but I followed him anyway, buying shares myself. It became my largest holding -- which was unfortunate when the company went bankrupt less than a year later.

Only later did I learn the full story. As part of his investment, the guru I followed also controlled a large portion of the company's debt and preferred stock, purchased at special terms that effectively gave him control over its assets when it went out of business. The company's stock also made up one-fifth the weighting in his portfolio as it did in mine. I lost everything. He made a decent investment.

The Foolish takeaway
Just to be clear, I'm not saying that Chimera is on the verge of bankruptcy -- though it wouldn't surprise me if that eventually happened. What I am saying, however, is that no one other than Cooperman and perhaps those in his inner circle knows why he's established such a large position in the ailing mortgage REIT. Nor do we know, to Housel's point, what Cooperman's strategy is for maximizing his return on investment. Perhaps it's in line with other holders of common stock. But perhaps it isn't.

The takeaway is that Cooperman's position in Chimera -- or, for that matter, any institutional investor's stake in any company -- should at best be considered irrelevant when drawing your own conclusion about a stock. And at worst it should be viewed skeptically. It pays to remember that the only person looking out for your interests is you. Forgetting this lesson is a great way to pad someone else's pocket.

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Read/Post Comments (4) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 09, 2014, at 12:38 PM, marshgerda wrote:

    I find this article very strange. The fact that I have my interests aligned with a Leon Cooperman who has the ability to advocate on shareholder's behalf seems to me a reason to follow his lead. The fact that he owns 6,4% gives me comfort that the accounting issues in the past are priced in.

    So I guess I agree that this is a speculative stock as mentioned in 2nd paragraph, but I find the fact that he has significant resources not available to average investor the very reason to ride his coattails.

  • Report this Comment On July 09, 2014, at 1:47 PM, mrmrmrj wrote:

    Cooperman only buy s a stock if he thinks it will rise. He just added over 4 million shares in the 1Q. The key risks were noted above. This is a small but not tiny position for Cooperman at roughly 2.5%. Debt has dropped from $4B to 1.6$ over the last 4 years. Operating cash flow is steady at $300 over the same period. This looks on the surface as a reasonable speculation, not as trap where Omega owns the debt with the intent to squeeze out the equity holders.

    I do not own CIM and I do not plan on buying. While the author's point that we shouldn't dumbly follow other investors is valid, the dangers of that do not seem to be in immediate evidence here.

  • Report this Comment On July 09, 2014, at 2:09 PM, ChrisWalczakSD wrote:

    Hedge funds aren't forced to disclose short positions. Cooperman could be long the common stock as a hedge against a larger short position on CIM's preferred shares or debt.

  • Report this Comment On July 09, 2014, at 3:02 PM, AFMS wrote:

    Do as Cooperman does. Didn't even read this article

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John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

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9/2/2015 4:07 PM
CIM $13.83 Down -0.14 -1.00%
Chimera Investment CAPS Rating: ***
NLY $10.14 Up +0.07 +0.70%
Annaly Capital Man… CAPS Rating: ****