Should Home Capital’s turnaround get your vote of confidence?

Things were looking great for Home Capital Group Inc. shareholders after Warren Buffett threw the fighting alternative-mortgage creditor a financial lifeline in June, and emerged as the organization’s largest shareholder.

But since then, Home Capital’s share price has lost its momentum. It’s meandered sideways for the last few months, raising questions about whether courageous investors should stick with it as a turnaround opportunity.

This week will solve at least one question hanging over the inventory: On Tuesday, shareholders will vote on whether Mr. Buffett’s company, Berkshire Hathaway Inc., should be permitted to increase its stake at Home Capital by purchasing another 24 million shares.

Believe it or not, the results of the vote is hardly apparent.

On the one side, fans of Mr. Buffett love the notion of the world’s biggest investor taking a significantly bigger stake in a troubled business, providing know-how, financial heft and a good name.

On the opposite side, some observers are grumbling over the fact that the shares are being issued to Mr. Buffett at a discounted price of $10.30, or nearly 25 percent below the current cost. The deal will dilute current shareholders, reducing their stake in the company at a time when Home Capital no longer wants a financial lifeline.

Institutional Shareholder Services Inc., which offers advice to big investors, is recommending shareholders reject the deal and at least one important shareholder, Taylor Asset Management Inc., supports this opinion.

There is more weighing Home Capital’s share price than this vote, however.

The company underwrites mortgages to home buyers who do not qualify for loans in the big banks, and this line of business appears far less secure given the changes which are impacting Canada’s housing market at the moment.

Regulators are tightening lending criteria, which might affect the amount of borrowers. And the Bank of Canada has raised interest rates twice since July, which is sending borrowing costs higher.

In Toronto, Home Capital’s main market, home prices are well off their highs and earnings are decreasing — giving investors all of the reasons they need to keep clear of Home Capital shares.

So why should you think about buying?

For starters, it appears clear that the uncertainty surrounding Canada’s housing market is already represented in Home Capital’s share price. The stock remains depressed, trading at roughly two-thirds of its book value, leaving loads of upside should the terrible news become not so bad.

But the upcoming shareholder vote on Mr. Buffett’s plan to purchase more stocks, which would increase Berkshire’s ownership stake in Home Capital to 38.4 percent from about 20 percent now, provides more immediate clarity on the inventory, no matter which way the vote goes.

Mr. Buffett’s first interest in Home Capital came in a time when it was not clear if the company could survive.

Depositors fled high-interest savings account earlier this year amid allegations from the Ontario Securities Commission that Home Capital had failed to properly disclose an investigation into mortgage broker fraud, raising further concerns about the health of the lender’s loan book.

The stock tanked to a low of almost $5 in May, down from over $30 before the crisis began.

Mr. Buffett’s initial investment, announced in June, assured investors that Home Capital was going to live and worries about its loan book were mainly the result of ingenious short-sellers, who gain when stocks fall.

Mr. Buffett, a long-term investor, must see something valuable here and if he succeeds in increasing his stake in Home Capital after the shareholder vote on Tuesday should not change this view.

If the vote goes his way, and he is permitted to buy more stocks, small shareholders who do not mind seeing their equity in Home Capital diluted will cheer: Mr. Buffett has only doubled-down, bolstering confidence in the firm.

And if investors reject Mr. Buffett, he will remain Home Capital’s biggest shareholder and there’s nothing preventing him from buying more shares on the open market.

He got a sweet deal when he bought his first batch of stocks. Given Home Capital’s lacklustre share price, investors are now being offered a pleasant deal of their own.

Courtesy: The Globe And Mail

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