The Gifts The Market Gives You

Sometimes, you take the gifts the market gives you.

This is how I felt when I saw shares of Commonwealth REIT (CWH) jump by over 50% on February 26.

When I first purchased shares of Commonwealth for my Dividend Growth Portfolio, it was a stock that had been left for dead. Wall Street hated management, earnings had been disappointing for months, and the stock had lost nearly half its value over the previous two years.

But the REIT was cheap, trading at barely half its book value, and the share price looked to have finally stabilized. It seemed a decent contrarian bet for the next 2-5 years. The value of the underlying properties limited my downside risk, and I could continue to collect the dividend indefinitely. There was always the possibility that the dividend would be cut—and in fact it was late in 2012. But even at the reduced yield, Commonwealth paid a better dividend than most of the alternatives.

All told, Commonwealth seemed like a very reasonable investment. No matter how incompetent management could be, it would be hard to lose with a portfolio of high-quality properties selling for well below their book value.

Or so I thought…

You can never put it past management to do precisely the wrong thing at the wrong time. Rather than buy low and sell high, public companies have a bad tendency to do the opposite. They buy back their shares when prices are high and issue new shares when prices are low—a destruction of shareholder wealth that should be unforgivable.

On Monday, Commonwealth announced plans to massively dilute shareholders with a new offering of 30 million shares. Not only was this a dilution of nearly 40%, but the shares were being offered at a 43% discount to book value.

While I was pondering selling, two large shareholders, Corvex Management and Related Fund Management, came to my rescue by suing the company for breach of fiduciary duty and offered to buy the company for $27 per share. Corvex and Related claimed that an independent assessment of Commonwealth’s properties put the value of the REIT at $40 per share.

Maybe Commonwealth is worth that, and maybe it isn’t. But in a situation like this, it generally doesn’t make sense to find out. At time of writing, Commonwealth is trading for a little less than $24 per share. If the Corvex and Related offer at $27 was approved, investors would be looking at 12-13% gains in a very short period of time.

But what if it isn’t approved?

Deals can fall through for any number of reasons. And in this case, a failure would mean that we are back to where we started on Monday—looking at 40% share dilution.

Commonwealth has become a coin-flip investment with very unappealing odds. Heads, you win a little. Tails, you might lose 40% or more.

This isn’t investing; it’s gambling. And with terrible, risk-seeking odds.

I took the gift the market gave me. I sold Commonwealth in all client portfolios, and if you currently own it I would advise you to do the same.