Description

On 12/31/2008, I wrote up the common of Lexington Realty Trust as a long at $4.60. LXP common is now $4.00. The flaw in my recommendation was my inability to foresee a change in the tax code governing REITs. As many of you may be aware, REITs must distribute 90% of their taxable income each year in order to maintain their REIT status. Under the change in the tax code, REITs are now permitted to meet the threshold distribution level by paying out up to 90% of taxable income in shares and the remaining 10% of taxable income in cash. There are several  important results of this. First, a shareholder will receive a fully taxable dividend in shares rather than cash, which is at inconvenient if the owner is a tax payer. Second, a shareholder will suffer dilution if they sell their deividend shares to pay the taxes owed or to spend the dividend income. Both of those results are pernicious. On the other hand, the senior securities in the capital structure will see their credit worthiness improve due to the company's retention of earnings. This is what is happening at Lexington Realty Trust. Last year, the Company was paying out a dividends of $1.32 a share in cash on about 108 million shares or $142 million a year. At the time of my December write-up, the dividend rate had been reduced to the $0.72 a year level, and the Company was using the retained cash to buy in and pay-down debt. Due to a softening real estate market, the Company felt it advisable to reduce the cash portion of its dividend to $0.072 in cash with the rest of the $0.72 being paid in stock. The result is that the Company is retaining about $134 million a year which had previously been paid out to the equity holders.

Due to management's aggressive actions, the improving balance sheet, and the granting of security,  the Company's banks have extended the maturity of $200 million of loans from 12/31/2009 to 2/2011 with a further extension to 2/2012 available. In addition, the loan was expanded to $250 million and may be further expanded to $500 million if acceptable collateral is available. The pricing is at an attractive rate of 2.85% over LIBOR. In addition to improving their bank lines, the Company has aggressively repurchased its debt in the publiuc market and has retired about $290 million of bonds at a 30% discount to par.

The Company has three issues of preferred stock outstanding. There are 3,160,000 shares of $25 par 8.05% preferred "B" outstanding which trade at $10.55 for a stripped yield of 19%. There are 2,598,300 shares of $50 par 6.50% convertible "C" outstanding which trade at $16.50 for a stripped yield of 19.6%. They are convertible at $22.00 for a premium to conversion of 79%. Their conversion ratio is adjusted for the dilution of newly issued dividend shares. Last, there are 6,200,000 shares of $25 par 7.55% preferred "D" outstanding which trade at $9.65 for a stripped yield of 19.5%. I believe that these securities offer good value. Lexington Realty Trust is a triple-net lessor of commercial properties. As such, their leases are long term in nature. Their tenant base is attractive.  Although commercial real estate will encounter difficulties over the near and intermediate future, the Company has the cash flow and willingness to overcome these problems.  

Catalyst