Seth Klarman's Baupost Group first bought shares in Maryland-based commercial lender CapitalSource (NYSE:CSE) in the second quarter of 2008, purchasing 2.3 million shares. In addition, Baupost has gone on to invest in two subordinated debentures issued by the company including a 7.25% senior subordinated debenture due in 2037 but redeemable anytime after July 20, 2012. Baupost currently owns 20.3 million shares of CapitalSource common stock and $46 million of the 7.25% debenture.

When Klarman first got involved with CapitalSource, it operated as a real estate investment trust. Last year it revoked its REIT status and today operates primarily as a real estate lender through its California bank. Baupost has accumulated a 6.3% ownership position over the past two years. Read on to find out why some of the biggest names in investing are banking on this company.

IN PICTURES: 4 Biggest Investor Errors

What It Got
In 2007, CapitalSource went looking for a bank to buy to complement its existing mid-market commercial lending. It originally had a deal to acquire TierOne Bank, until the Lincoln-based company's stock collapsed due to bad loans. TierOne was taken over by federal regulators in June of this year and then sold to Great Western Bank. CapitalSource ultimately bought Los Angeles-based Fremont Investment and Loan, a 22-branch community bank with $5.6 billion in deposits. Federal regulators forced Fremont to exit the subprime business.

As part of the April 2008 deal, CapitalSource lent $200 million to the bank to shore up its capital. Its clients at the time of acquisition included shoe designer Jimmy Choo and fractional real estate giant Exclusive Resorts, run by former AOL CEO Steve Case. With a bank in tow, it could expand its commercial lending footprint using deposits held there. Unfortunately, the economy went south about the same time and is only beginning to show slight signs of recovery. CapitalSource bought the bank to further its leadership position among small and mid-sized businesses. Klarman's original investment was approximately $54 million. Today, it's over $150 million. He obviously sees the potential of combining a bank with a strong commercial lender. The move hasn't paid off just yet but it should. (Learn more about detecting distressed banks in Banking Stress Tests: Would Yours Pass?)

The Transformation
In November, CapitalSource's CEO, John Delaney, announced he would become executive chairman with two other officers becoming co-CEOs. Delaney wanted to focus on the company's transformation into a bank holding company. Several steps were taken late in 2009 and into this year that will make the move a profitable one. At the same time it announced a change in management, the company also announced a three-step deal to sell its 143 healthcare facilities to Omega Health Care Investors (NYSE:OHI) for approximately $857 million. Of this, $279 million was cash, $522 million represented debt assumption and $56 million was Omega stock. The final part of the deal closed June 29. Then CapitalSource sold its interest in a $1.1 billion collateral debt obligation to North Star Realty Finance (NYSE:NRF) for $7 million. The cash isn't the important point here - it's the removal of the debt from CapitalSource's balance sheet that matters.

At the end of the first quarter, CapitalSource had $159 million in loan loss reserves to protect against losses from the CDO. Finally, in April, it bought Main Street Lender LLC for $100 million. The purchase came with a $111 million portfolio of small-balance SBA loans as well as conventional loans. Already very familiar with the middle-market, this brings an experienced team of small business lenders to the fold. Now, all CapitalSource has to do is execute its lending plan.

Bottom Line
It turns out that Seth Klarman isn't the only value investor interested in CapitalSource's resurrection. Mohnish Pabrai owns 2.8 million shares of the commercial lender. His other financial holdings include Berkshire Hathaway (NYSE:BRK.B) and Leucadia National (NYSE:LUK), both of which are excellent companies. So, if two of the smartest investors in business are making big bets on this company's turnaround, the question is: why aren't you?

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  5. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  6. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  7. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  8. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  9. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
  10. Stock Analysis

    The Safest Stocks You Can Invest in Right Now

    These stocks are likely to hold up better than others in a bear market, but there's a twist.
  1. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  2. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  3. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  4. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  5. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  6. Impact investing

  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!