Washington Mutual and DIMEQ

One security that has fascinated me and many investors for a number of months is the Dime litigation tracking warrants (DIMEQ). Without getting into the nitty gritty details and history of litigation participation certificates (If you are interested, read this document: POST-TRIAL MEMORANDUM OF LAW OF DIMEQ), the issue regarding DIMEQ in the Washington Mutual bankruptcy is whether the security should be considered equity of pre-bankrupt Washington Mutual, which for all intents and purposes is worth very very little, or something else entirely.

On one side of the table you had desk analysts arguing that DIMEQ will be considered equity and hence WAMU Holdco bonds would get a pop because they will receive a larger slice of pie (recovery). On the other side, you have one of the most focused legion of vested independent investors I have seen, discussing a very complicated issue, at the DIMEQ InvestorHub Message Board.

Earlier this week, Washington Mutual filed its 7th bankruptcy plan and disclosure statement. For those interested, here are the documents: WAMU's 7th Amended Plan and Disclosure Statement.

One investor that has been following the situation religiously is DDIC member Madclown, who writes a wonderful little blog entitled The Diligent Investor, which focuses on bankruptcy situations that most retail investors can participate. He contacted me last night with a post on the WAMU Plan and Disclosure Statement, which I've copied and pasted below. Enjoy!

Assessing the Impact of WAMU’s Reorganization Plan on the Dime Litigation Tracking Warrants (DIMEQ)

On December 12, 2011 Washington Mutual released the Seventh version of its Plan and Disclosure Statement. Woven within the Plan is a settlement agreement that provides for a recovery to equity holders in the form of Newco stock while dismissing charges levied by the Equity Committee against certain creditors for Insider Trading; charges that the Court found to be “colorable claims”. The recovery to equity represents a significant departure from the 6th Amended version of the Plan which did not provide for any recovery to equity.

These changes effectively put a floor of value underneath the litigation tracking warrants ("LTW") in a worst-case scenario if the Court rules against the LTW Holders in the Adversary Proceeding because the Plan provides that, in the event that the Court finds that the LTWs represent equity interests as opposed to either Class 12 General Unsecured claims or equitable lien claims, the LTWs will share a 30% stake in the Reorganized Company pari passu with common equity. In order to find that floor of value one must first determine what the reorganized Company is worth and then determine the proper conversion rate of LTWs into common equity to find the relative ownership percentage of this 30% stake for DIMEQ and WAMUQ. For simplicity’s sake we will assume that the Newco is worth $210 million which is the value assigned by the Court for the purposes of deciding “who gets what” under the Plan. As to the issue of the conversion rate, the Plan provides that the relative value of DIMEQ will be determined to be the lesser of:

• The amount estimated by the Bankruptcy Court as the maximum amount in which the Disputed Claims relating to the Dime Warrants may ultimately become Allowed Claims times the per share price of Common Equity Interests on a date established by the Bankruptcy Court bears to the market capitalization of all other Common Equity Interests (as determined by the Bankruptcy Court using such same per share price)
• The liquidated amount determined, pursuant to an order of the Bankruptcy Court, as the amount in which the Disputed Claims relating to the Dime Warrants are Allowed Claims times the per share price of Common Equity Interests on a date established by the Bankruptcy Court bears to the market capitalization of all other Common Equity Interests (as determined by the Bankruptcy Court using such same per share price)
• The amount established by the United States Court of Federal Claims in the Anchor Litigation, pursuant to a Final Order, as applied in connection with the Dime Warrant Litigation, times the per share price of Common Equity Interests on a date established by the Bankruptcy Court bears to the market capitalization of all other Common Equity Interests (as determined by the Bankruptcy Court using such same per share price)
• Such other amount as may be agreed upon by the plaintiffs in the Dime Warrant Litigation and the Liquidating Trustee; provided, however, the recovery in connection with the Dime Warrant Litigation will not exceed the lesser of (1), (2), (3) and (4) above,

I contend that this conversion rate is patently improper because it basically converts one share of DIMEQ into one share of WAMUQ and then adds the relative market caps and divides the total back into the improperly constructed DIMEQ market cap. The Debtor’s conversion method inexplicably ignores the conversion rate provided for by the LTW Agreement and further memorialized in an 8-k filed on March 13, 2003. Under the proper conversion method the “Adjusted Litigation Recovery” is divided by the “Merger Adjusted Stock Price” and then further divided by the number of outstanding LTWs. See calculation below.

So what exactly am I saying is the proper conversion rate? To simplify, we basically have to add the relative value of the LTW claims to the market capitalization of WAMUQ (1.7 Billion shares times the market share price of WAMUQ at a date to be determined) and then divide that total back into the value of the LTW claims. Now there are 4 possible amounts to assign as the value of the LTW claims which includes the lesser of the Estimated Claims ($337 million), the final allowed claims determined by the Bankruptcy Court (TBD), the final allowed claims determined by the U.S. Court of Federal Claims (TBD) and any stipulated amount agreed upon by and between the Liquidating Trustee and the LTW Plaintiffs (TBD or N/A).

We know what the highest possible claim amount is for DIMEQ and that would be the estimated Disputed Claims Reserve amount of $337 million. If one assumes that the LTW Plaintiffs don’t agree to less in a stipulated settlement, then the lowest amount that could be assigned to the LTWs would appear to be in the $228 million context. One can arrive at that value by taking the $356 million “pre-grossup” award from the Federal Claims Court (assuming the additional $63 million award is not awarded) plus the $104 million grossup less estimated litigation and issuance expenses of $22 million and that total then multiplied by a 38.757% tax rate (JPM’s estimate) and then reduced by 15% for the 85/15 split with WMI.

This whole exercise is, of course, a moot point if the Court finds that the LTWs constitute Unsubordinated General Unsecured Claims. The Court may also find that the LTW Claims are secured claims in the event that the Plaintiffs prevail on their Equitable Lien via Constructive Trust theory. In any event, whether the LTWs represent Unsubordinated Claims or Equity Interests and whether the Debtors prevail in their use of an improper conversion rate, it is now clear that the LTWs have value. What is also implicit in all of this is that barring any stipulated settlement between the Debtors and the LTW Plaintiffs, the Court will still have to conduct a final claims estimation hearing for the LTWs.

One final point I will make here is that the Plan currently provides that if the LTWs are deemed to be Equity Interests then they are an impaired Class and are not entitled to vote. Under this Plan construct it would apparently foreclose an LTW Holder from appealing the Judge’s decision to the District Court. Since there are many issues involved in the LTW Adversary Proceeding that are appealable and in the event that the Court finds the LTWs to represent Equity Interests, the LTW Holders should be given an election to either accept the treatment provided for under the Plan and to grant the applicable releases or in the alternative should be given an election to reject the treatment under the Plan, grant no releases, and take up any adverse ruling on appeal.

Conclusion - And most importantly, bottom-lining it:

The max upside in this case for DIMEQ that would result from being classified as a Class 12 GUC claimant or an equitable lienholder is about $3.00 per LTW (versus today ~ 65 cents) before post-petition interest if the full $337 million reserve goes to the LTW Holders. If the federal judgment rate is applied to that award for 3.5 years it moves the recovery up to about $3.20. On the downside, if DIMEQ is deemed to be Equity and if the Debtor prevails in applying the improper conversion rate then the worst scenario based on Plan value would put the DIMEQ security between $0.07 and $0.10.