Wednesday, November 18, 2020

NexPoint Strategic Opportunities: Exchange Offer

Back in August, I wrote up a quick post on NexPoint Strategic Opportunities ("NHF"), it is a closed end fund that is transitioning into a REIT over the next 18-24 months (they'll technically be a REIT in 2021, but won't fully transition the assets until later, quite a bit of wood to chop here before its a clean story).  To summarize the thesis, NHF is trading at 57% of NAV and they'll be selling much of those assets presumably somewhere near NAV to invest opportunistically in real estate -- there should be no shortage of attractive opportunities coming out of the pandemic -- add in some leverage and it could have quite the multiplier effect (see what the same team has done with NXRT).  And to get the negatives out of the way, NHF hasn't articulated a clear strategy at this point other than saying it will be a diversified REIT and there's the potential for double dipping on fees, much of what NHF owns today are investments that were at one time or are now managed by NexPoint/Highland, it has sort of acted as a dumping ground for them.

The stock's reaction to the conversion news has been muted and it hasn't rallied much recently in comparison to the market or other real estate assets.  The company came out with an exchange offer structured as a Dutch tender that expires 12/10, shareholders can exchange common shares for a combination of 80% in a newly created preferred stock and 20% in cash, the range is set at $10-12 and the stock currently trades at $9.50.  The $10-12 number is highly dependent on the value the market prescribes to the newly issued preferred shares, the company is trying for a 5.5% dividend rate on the prefs, that feels a bit aggressive, but more on that later.

I love the idea of the exchange, the maximum amount is $150MM on a $433MM market cap company, the exchange will essentially force a portion of the shares to be valued at NAV accruing that closed discount value to the remaining shareholders.  It also further tightens the spring when they do fully transition to a REIT, this is already going to be a levered vehicle.  But again, the 5.5% dividend yield feels a bit aggressive on the preferred shares, so thinking through the possibilities of where the preferred could trade after the exchange, I came up with a little table:

The x-axis is where the Dutch tender prices at and the y-axis is where you think the preferred shares should trade on a yield basis incorporating the 20% cash component.

I've also played around with different scenarios based on how many shares are actually tendered and what it would do to the NAV ($16.70/share as of the latest proxy) of the remaining shares, just based on the share price and my uneducated view, seems like the market is skeptical of the exchange.  The minimum amount is $75MM.

Then my last table is using the NAV in the table above, what the price/NAV ratio would be (using a $9.50 share price, or a 57% starting point):

I've spent a lot of time in the last few months on the commercial mREITs (maybe more posts to come), most of them have preferred shares that have yields well above the targeted 5.5% NHF management is shooting for and that might be skewing my view of where the prefs will trade following the conversion.  NHF is likely to be focused on either self storage or single family homes, maybe both, equity REIT preferreds in those sectors do trade below 6%.  I took a look at the holdings of PFFR, a REIT preferred index fund, and here are the names that trade sub-6.0%, some of these didn't surprise me as they're seasoned and/or loved REITs, but others were a bit surprising.  

For example, Office Properties Income Trust's (OPI) 5.875% pref trades just above par, this is an externally managed REIT of RMR Group (RMR) that has a history of abusing minority shareholders and is in the office sector.  Is 5.5% too aggressive?  Possibly, but not by that much in a zero interest rate world.

I've added to my NHF position.  I'm currently thinking about the exchange like this: I'm planning on tendering a portion of my shares somewhere in the middle of the range (could change as we get closer to the expiration date), but still leaving behind a relatively full position.  If there is enough interest where I don't get filled on the tender and it goes closer to the lower-end of the range, common shareholders should benefit as the NAV increases even more and they've obtained cheap financing.  If I get filled, I still feel comfortable that the trading price of the prefs following the conversion should result in a good short term IRR.  Either way feels like a win to me.  NHF could also bump up the yield on the preferred shares if there isn't enough investor interest (they got a rating agency to put a BBB- rating on the prefs, presumably to head off investor skepticism on the proposed dividend yield), even paying 0.5-1.0% more in yield to entice shareholders to exchange would be very accretive to the remaining common.

Disclosure: I own shares of NHF

Friday, November 6, 2020

LGL Group: Warrant Dividend, SPAC Sponsor

LGL Group is an illiquid small (~$55MM market cap) aerospace and defense parts maker I covered once before in 2017 when they did a rights offering while at the same time an acquisition offer was outstanding for their operating business.  That thesis didn't quite work out as planned, the acquisition offer never materialized into a deal, but maybe for the best, the operating business has performed quite well over the last three years, growing revenue 50% (total, not annualized) and EBITDA has jumped by 300%.

The company is effectively controlled by the Gabelli family, they own/manage the top three spots on the shareholder register:

Mario's son, Marc, is the chairman of the board and steering the ship here, although his father hasn't been shy about expressing his views in the past.  The Gabelli's have done a number of corporate actions in the last decade to increase their investment in LGL, the stock is illiquid, so in order to meaningfully increase their exposure to the business, they do things like rights offerings and backstop them.  Back in 2013, the company issued a warrant dividend with a 5 year term and a $7.50 exercise price, despite the stock trading below the exercise price on expiration, Mario exercised the warrant and added to his position.  So clearly they want more of it and are up to a similar transaction announcing a new warrant dividend to shareholders.  Here are the details from the press release, the stock trades at ~$10 as I type this:

The LGL Group, Inc. Declares a Warrant Dividend


ORLANDO, FL, October 29, 2020 – The LGL Group, Inc. (NYSE American: LGL) (the "Company") today announced that on October 27, 2020 the Board of Directors declared a dividend of warrants to purchase shares of its common stock to holders of record of its common stock as of November 9, 2020, the record date set by the Board of Directors for the dividend. Each holder of the Company’s common stock as of the record date will receive one warrant for each share of common stock owned. Five warrants will entitle their holder to purchase one share of the Company's common stock at an exercise price of $12.50. The warrants will be "European style warrants" and will be exercisable on the earlier of (i) their expiration date, which will be the fifth anniversary of their issuance, and (ii) such date that the 30-day volume weighted average price per share, or VWAP, of the Company's common stock is greater than or equal to $17.50. The warrants are expected to be issued on or around November 16, 2020, and the Company intends for the warrants to be listed and traded on the NYSE American on or around such date, subject to NYSE American approval.

Part of LGL's stated strategy is to be an acquisition vehicle, but since that 2017 rights offering the company hasn't made a significant deal and has mostly let cash pile up on the balance sheet, currently at $22MM (including marketable securities which is in a Gabelli fund and can swing net income around a bit).  Thus another rights offering probably doesn't make sense, but a warrant dividend could as a way to get more exposure to the company, either through adding in the secondary market if the warrant trades poorly or just in another five years, exercise the warrant again.

LGL has two main operating businesses, MtronPTI and Precise Time and Frequency, both sell highly engineered products into the aerospace and defense sectors.  The operations did about $4MM in EBITDA in 2019, with a market cap of $55MM and $22MM in net cash, you're paying about 8.25x EBITDA for the business today.  They do other things to signal the operating businesses might be undervalued, like break out the accumulated depreciation of their PPE which is multiples of the carrying value of the assets on the balance sheet.  But the most interesting asset inside LGL is an ownership stake in a SPAC sponsor, its 2020 after all, the SPAC is LGL Systems Acquisition Holdings (DFNS) which is targeting a defense business, thus the ticker.  

Being the SPAC sponsor is a great deal, depending on the final details of the deal, but often the sponsor ends up with ownership in the proforma company worth 20% of the SPAC trust fund.  If DFNS does an attractive deal and doesn't negotiate a discount of the sponsor shares, the result could be a material asset for LGL.  DFNS raised $172.5 million and trades at a 1.7% discount to the net asset value of the trust.   DFNS has about another year to find a merger, the deadline is 11/12/21, otherwise they'll send the money back to the SPAC shareholders and the sponsor is out of luck.  Here are the details on the SPAC investment:

In November 2019, we invested $3.35 million into LGL Systems Acquisition Holdings Company, LLC, a subsidiary that serves as the Sponsor of LGL Systems Acquisition Corp (NYSE: DFNS), a special purpose acquisition company, commonly referred to as a “SPAC” or a blank check company, formed for the purpose of effecting a business combination in the aerospace, defense and communications industries. Prior to a business combination, the Sponsor holds 100% of the shares of Class B convertible common stock outstanding of DFNS (the “B shares”) along with 5,200,000 private warrants at a strike price of $11.50. The B shares equal 20% of the outstanding common stock of the SPAC. Upon the successful completion of an acquisition the proforma ownership of the new company will vary depending on the business combination terms.

The Company is expected to own approximately a 43.57% interest in the Sponsor through its direct investment. Assuming the terms of the business combination are identical in capital structure as that of DFNS, the Company anticipates its economic interest will include approximately 8.7% of the SPAC’s pro-forma equity immediately following a successful business combination. There can be no assurances that this scenario and the resulting ownership will occur, as changes may be made depending upon business combination terms.

If DFNS is able to come to a deal, the value of the shares attributable to LGL could be worth ~$15MM, certainly material for a company of this size.  A couple of the DFNS executives joined the LGL board in August, possibly signaling that being a SPAC sponsor isn't a one-time affair (the mania is showing signs of cooling, so maybe that's a bit of a stretch).  Either way, it is some built in optionality inside of LGL, and could have a bit of double leverage, the SPAC shares and warrants inside of LGL and then the LGL shares and warrants.

Even though I play around with options quite a bit, not an expert at valuing the warrant itself, but if you plug in terms of the warrant into a calculator and use a 50% implied volatility, spits out about a $0.75 per warrant (need 5 of them for one share of stock).  Could trade a bit like a spinoff and certain shareholders might be inclined to sell it immediately.

Disclosure: I own shares of LGL

Catabasis Pharmaceuticals: Selling at 50% of Cash, Reverse Merger Candidate

Here's another entry in my sporadic biotech reverse merger candidate investment theme, Catabasis Pharmaceuticals (CATB) is a clinical stage biopharmaceutical company that recently announced their lead product candidate, edasalonexent -- a potential treatment for a form of muscular dystrophy, did not meet its primary or secondary end points of their Phase 3 trial.  I'll keep this pretty brief, from the sounds of the press release it sounds like this is game over for Catabasis:

BOSTON, MA, OCTOBER 26, 2020 – Catabasis Pharmaceuticals, Inc. (NASDAQ:CATB), a clinical-stage biopharmaceutical company, today announced that the Phase 3 PolarisDMD trial of edasalonexent in Duchenne muscular dystrophy (DMD) did not meet the primary endpoint, which was a change from baseline in the North Star Ambulatory Assessment (NSAA) over one year of edasalonexent compared to placebo. The secondary endpoint timed function tests (time to stand, 10-meter walk/run and 4-stair climb) also did not show statistically significant improvements. Edasalonexent was observed to be generally safe and well-tolerated in this trial. Catabasis is stopping activities related to the development of edasalonexent including the ongoing GalaxyDMD open-label extension trial. The Company plans to work with external advisors to explore and evaluate strategic options going forward.


“We are deeply saddened and disappointed by the results of our Phase 3 PolarisDMD trial,” said Jill C. Milne, Ph.D., Chief Executive Officer of Catabasis. “I want to sincerely thank all of the boys, their families and caregivers, investigators and the trial sites that participated in and enabled this program. The entire Catabasis team has worked tirelessly to find a treatment for this progressive disease. We hope that our data and work to date can be used to benefit ongoing and future research in DMD.”


The Phase 3 trial was a one-year placebo-controlled trial designed to evaluate the safety and efficacy of edasalonexent in boys ages 4-7 (up to 8th birthday) with DMD. The global trial enrolled 131 boys across eight countries, with any mutation type, who were not on steroids. Edasalonexent was well-tolerated, consistent with the safety profile seen to date. The majority of adverse events were mild in nature and the most common treatment-related adverse events were diarrhea, vomiting, abdominal pain and rash. There were no treatment-related serious adverse events and no dose reductions. The global COVID-19 pandemic had no meaningful impact on the trial or its results. Data from the PolarisDMD trial will be further analyzed and are expected to be presented at an upcoming scientific conference and published.


“These results are disheartening for the Duchenne community, and specifically for the boys who participated in this trial and their families. However, the results contribute to the natural history data of Duchenne and add to the knowledge base that will one day produce a foundational, long-term therapy for this disease,” said Pat Furlong, Founding President and Chief Executive Officer of Parent Project Muscular Dystrophy (PPMD). “The continued advancement of research and the development of possible treatment options will remain of critical importance to our community. We appreciate Catabasis’ efforts and commitment to every family that is or has ever been affected by Duchenne.” 


The Company expects to report Q3 2020 financials in November of 2020. As of September 30, 2020, Catabasis had cash and cash equivalents of approximately $52.9 million.

The company is pre-revenue, R&D is likely at a full stop now, general and administrative expenses have run a little under $3MM:

Now that the company is a cash shell, the burn rate should be lower, but let's just call it $1MM a month going forward.  Cash and marketable securities were ~$54MM as of 6/30, Catabasis does have an ATM program they have been hitting for incremental cash, so to square the cash burn against the $52.9MM they reported in their press release, let's assume they've issued another 1 million shares, bringing their total to approximately 20 million shares outstanding.  At a price of $1.36, that gives us a market cap of $27MM versus a cash balance of ~$50MM, almost a 50 cent dollar.  And since CATB never generated revenue, we have a large NOL here as well of approximately $200MM. 

The most likely outcome is in the next few months a privately held biotech will merge into and come public through a reverse merger with CATB.  Effectively using CATB as a capital raising transaction with a deSPAC like transaction except here a target has more certainty in the actual amount of cash raised.

Disclosure: I own shares of CATB

Tuesday, October 6, 2020

BBX Capital: New BBXIA, Form 10 Notes

BBX Capital is a familiar name, I wrote it up about three years ago when they were floating a 10% piece of timeshare operator Bluegreen Vacations (BXG) with the idea that the rest of the enterprise was trading at a negative value due to the HoldCo discount and shady management team.  That strategy was largely unsuccessful, (not one of my better pitches in hindsight), next BBX tried to take Bluegreen private again but then the timeshare operator got into a dispute with their largest marketing partner, Bass Pro Shops, and BBX pulled the offer.  And now just recently, BBX is at it again, this time engineering a spin where they've separated their 90% BXG stake as Bluegreen Vacations Holdings (BVH) - mind you, BXG still trades separately - and then spun out the rest of their assets as "new" BBX Capital (here's the form 10).  New BBX Capital (BBXIA) trades for a significant discount to its net assets, even when considering a significant discount for the grifter management team (Levan's son is now set to run new BBX).

New BBX Capital has a few attributes that make it a potentially cheap spinoff, although due to management, I do not want to be caught holding this for the long term:
  1. Taxable spin - some investors might treat it as a dividend, already getting taxed on it, sell
  2. Trades OTC - some investors might not be able to hold over the counter securities, or might worry that a few weeks after the spin it might be too illiquid to hold, sell now when there is some liquidity
  3. Grab bag of assets without GAAP earnings - new BBX is largely cash and a promissory note from BVH, but the other asset include real estate in Florida and a door manufacture, Renin, that both could benefit from covid-induced tailwinds
For every share of old BBX Capital, investors got 1 share of new BBX (there is a dual share structure here, again, grifter management with a history of run ins with the SEC) for a total of approximately 19.3 million shares outstanding.  Shares have been volatile since the spin, but I'm going to use ~$4.00 as the current price for the write-up, which gives us a market capitalization of approximately $77MM, here are the proforma assets of new BBX Capital:
  • $96.5MM of cash
  • $75MM promissory note from BVH, as part of the spinoff and to provide some cash flow to BBX, BVH will be paying 6% on the note put in place between the two entities, BVH is essentially a levered bet now on BXG (I assume the longer term play is for the two Bluegreen entities to merge, but I'll leave that aside for now).
  • $162MM book value of real estate assets, much of which are new construction developments in Florida, the historical BankAtlantic real estate assets have largely runoff, but there's still some upside in the book value.  Post financial crisis, BBX has been reasonably good real estate investors, some of that was helped by marking the assets at extreme lows following the financial crisis, but there could be some acumen here.
  • Additionally there some other assets including a bankrupt IT'SUGAR chain of candy stores (appears they're using Chapter 11 to get out of some unprofitable leases, BBX is providing the DIP financing), Renin the maker of doors which should benefit from a housing boom and did a little more than $2 million of EBIT in 2019, and a restaurant in Florida, for the purposes of this simple math, we'll throw these assets in for free.
  • On the minus side of the equation, there is $42MM of debt and then however you want to capitalized the oversized corporate G&A, which was a proforma ~$21MM in 2019, maybe 5x that?  So call it -$150MM in debt and overhead in the sum of the parts.
So on a very basic back of envelope math, I come up with a value of roughly $9.50 per share, more than double the current price, feels crazy but book value is around $15.50 per share (I'm backing out the carrying value of IT'SUGAR), ~60% of book value seems reasonably discounted for the all the hair involved here considering it's not a melting ice cube.  I assume the end game with new BBX is to eventually do a take under by management, making it a taxable spin and OTC listed, seems intentionally designed to sell cheap.  I don't intend to stick around that long, but I bought a few puked out shares, unfortunately didn't get them late last week when they traded much cheaper -- pays to be on top of these small spins.

Disclosure: I own shares of BBXIA

Friday, September 18, 2020

Marchex: Joint Tender Offer

Marchex (MCHX) is a small (~$80MM market cap) software company that has gone through a few iterations over the years, now they're focused on call and text analytics, basically trying to capture data on customer interaction to increase sales and improved customer satisfaction.

On 8/31, Marchex and Edenbrook Capital (which owns 19.5% of MCHX) formally launched a 50/50 joint tender offer that expires on 10/7 to acquire up to 10 million class B shares (approximately 25% of the publicly traded B shares), the tender is slightly unique in that it has a tiered payment structure.  If less than 6 million shares are tendered, Marchex and Edenbrook will pay $1.80/share, if between 6 million and 10 million shares are tendered, the price will be $1.96/share.  Above 10 million shares tendered and you'll be pro-rated, but with the shares trading at the lower bound $1.80, it seems like the market is saying that less than 6 million shares will be tendered.

The company has a lot of cash in relation to their market cap, $46.8MM as of 6/30, they did get a $5.3MM PPP loan, so depending how you want to account for that, the enterprise value is roughly $40MM.  They've made several acquisitions in the last few years to bolster their call analytics business that total up to more than that, either some poor capital allocation or the market is missing the transformation.  To highlight that core call analytics business, in parallel with the tender offer the company is selling their legacy business to management in a complicated transaction, it certainly looks a little strange and isn't arms length, but they've tried to unsuccessfully sell it for a couple years now and is essentially a quickly melting ice cube.  It's an attempt to remove the bad business that might be hiding a good business.

Edenbrook clearly thinks there is value here, from their initial letter to the board highlighting the undervaluation:
We believe Marchex’s trading price of $2.63 per share (as of December 21, 2018) demonstrates a substantial discount to comparable industry valuations. Similar analytics-based public companies are trading at 4-6 times revenue, while private companies are being financed at 6-10+ times revenue. If Marchex were valued at 3 times analytics revenue (which is still a substantial discount to the market and less than Marchex just paid for Callcap), and approximately $44 million in cash were factored in, this would yield a value today of approximately $4.65 per share, which is 75% above today’s trading price of $2.63 per share (as of December 21, 2018). Adding in discounted values for the legacy business and the NOL carryforward would yield another approximately $1.60 per share, totaling approximately $6.25 per share, more than double today’s price. Further, given the continued profitable growth of the business, we expect these values to continue to expand in the coming years.
The business doesn't quite click for me, but clearly Edenbrook wants more of the asset (if fully subscribed they'll increase their stake from 11.50% to 36.67%) even though this is a dual share class structure with management owning the super-voting Class A shares.  Edenbrook isn't the only one, another investor has opined publicly, Harbet Discovery Fund (owns 6.4% of MCHX):

After years of investment in the analytics products and platform, which we estimate exceeded $150 million, the Reporting Persons look forward to breakout sales growth in 2020. As the Issuer’s management team mentioned on the last earnings call, early momentum with the Sales Edge Rescue product and the expected expansion into a key OEM client could each independently drive material growth. With accelerating growth, the Reporting Persons can see a path to the Issuer’s stock trading over $5.75 per share (+186% upside from current levels), assuming 10% analytics sales growth in FY20, a 4x sales multiple on that business, and stable cash balance. Over the next twelve months, higher valuations could be reached if the market begins to ascribe the value of the marketplaces business and data library.


Absent a significant increase in growth in 2020 in the analytics business, the Reporting Persons anticipate the Issuer may consider a broad range of strategic options to maximize the value of its business units, balance sheet, intellectual property, and data library. Conversely, with rapid growth in the analytics business and the gross margin expansion that should accompany it, the Reporting Persons wonder if the analytics business will ultimately receive the maximal value as a standalone company, and also anticipate the company taking measures to simplify its structure and streamline its model over time. The Reporting Persons also expect the Issuer’s long-term track record of returning capital to shareholders through buybacks and special dividends to persist for the foreseeable future.

So the stock might be worth looking at post tender, some of these large tenders can attach the stock price to the offering price and then afterwards the stock takes off.  I'm not comfortable enough with the business to take that view but either way it makes me a little more comfortable if the tender is oversubscribed and I end up with some orphaned shares.  Edenbrook and management aren't tendering, Harbet Discovery is likely not tendering, so there may be limited shares participating if other institutional shareholders also sit it out.  In the more likely scenario and less than 6 million shares tender, I get my money back and just lose some opportunity cost, for it to work out perfectly and get the $1.96, it is a bit of a thread the needle proposition, but I don't see much risk in attempting it.

Disclosure: I own shares of MCHX

Lubys: Asset Heavy Restaurant Business Opts for Liquidation

Luby's (LUB) is a small restaurant business based out of Houston, TX.  Currently, they operate two restaurant chains (previously a third, Jimmy Buffett themed "Cheeseburger in Paradise", all of which are now closed), the namesake "Luby's Cafeteria", a Texas comfort food buffet chain and "Fuddruckers", a fast casual burger concept that is partially franchised but has seen better days.  Luby's also has a contract food service business that caters their cafeteria style menu to hospitals, senior housing facilities, sports arenas, etc.  Luby's has struggled as their concepts are a bit stale (maybe that's being kind), mature, and operate in hyper competitive market segments like Fuddruckers with burgers.  Luby's has been treading water for several years -- management has reshuffled some senior leaders and fought off a proxy contest (from Jeff Gramm, author of Dear Chairman), but none of the turnaround plans really came to fruition.  Then of course, covid hit and suddenly going out to a buffet/cafeteria style restaurant like the namesake Luby's sounds pretty unappealing or simply impossible due to local shutdowns.

Last year, Luby's commenced an effort to explore strategic alternatives, but on September 8th the company kicked up the effort by formally announcing they were pursuing a liquidation (requiring shareholder approval) by selling their operations and assets in several transactions, then returning the proceeds to shareholders along the way.  Disclosed in the announcement, possibly to convince shareholders to vote for the liquidation, management announced an estimated distribution amount:
While no assurances can be given, the Company currently estimates, assuming the sale of its assets pursuant to its monetization strategy, that it could make aggregate liquidating distributions to stockholders of between approximately $92 million and $123 million (approximately $3.00 and $4.00 per share of common stock, respectively, based on 30,752,470 shares of common stock outstanding as of September 2, 2020)
The stock trades for $2.35 today.

Luby's is a throwback to the old world, they own much of the real estate for their restaurant locations versus leasing them, that's where most of the value is in the liquidation.  They've even previously considered selling the restaurant operations and converting to a REIT at one point.  In the proxy statement they've disclosed the current post-covid value of the real estate (they've hired two separate real estate appraisers):
As of August 26, 2020, we owned 69 properties, consisting of the underlying land and buildings thereon, most of which operate, or have operated in the past, Luby’s Cafeterias and/or Fuddruckers operations. The estimated value of those properties as of August 26, 2020, was $191.5 million.
Hidden Value Blog did a nice write-up on the situation a few months ago and did more diligence than me on the underlying real estate portfolio in order to validate the company's appraisal, worth a read.  Most of the real estate is in Texas, which should hold up fairly well, major cities like Houston, San Antonio and Dallas all annually rank near the top of job growth and new home construction.

The company has ~$63.7MM of gross debt, $10MM of which is a PPP loan that will likely be forgiven by the government.  Without giving value to the restaurant operating entities or on the downside expenses regarding the liquidation, the value of the real estate is potentially worth just over the top end range of $4/share.  There's reason to believe that management might be understating the distribution range, in the background section of the proxy statement, Luby's financial advisor presented the following range on 7/20:
Duff & Phelps noted a reference range of aggregate potential liquidation proceeds available to holders of Luby’s common stock from $127.0 million to $172.1 million or $4.15 to $5.62 per share of Luby’s common stock, based on an estimated 30,625,470 shares of common stock outstanding and the Company’s estimates of value for its owned real estate.
Later in the proxy, its mentioned that the Duff & Phelps estimate didn't reflect the current real estate portfolio, but that seems odd since any real estate sales in the interim would be netted off against net debt.  Or it could just be a financial advisor telling a management team what it wants to hear.

Timing and the duration of a liquidation are always a big risk, these take twice as long to wrap up as you'd think, especially the last puff which can be frustrating if you're late to the situation.  However in this instance, much of the distributions will likely take place in the next 6-12 months as the company has been in active discussions on each of the assets for months.  It is mentioned a few times in the proxy that the distribution estimation is based on actual indications of interest for each asset, reading the tea leaves, it seems likely we'll see significant asset sales in the near term.  I wouldn't be surprised to wake up and see news that Franchise Group (FRG, still long) was buying Fuddruckers after their failed attempt to buy another struggling chain in Red Robin (RRGB) last year.

I've participated in a few liquidations over the years, the only time it worked out poorly for me is NYRT, in that instance an activist came in with overly lofty projections in order to win over shareholders so they could earn management and incentive fees.  Here the liquidation is more of a white flag, management has been in place for two decades and should have a sense of the value of their assets, they also own 30% of the shares and thus aligned to get maximum value within a reasonable time frame.

Disclosure: I own shares of LUB

Monday, August 31, 2020

NexPoint Strategic Opportunities: CEF to REIT conversion, Possible NXRT Replay

Back in 2015, closed end fund NexPoint Strategic Opportunities (NHF) (then known as NexPoint Credit Strategies) spun out NexPoint Residential Trust (NXRT), a value-add class B multi-family REIT it had incubated inside the CEF, NXRT went on to 4-5x over the next several years (unfortunately I only caught about 2x of that).  Last week, news came out that NHF shareholders voted to convert the fund to a REIT, possibly setting up another similar opportunity for a multi-bagger as the valuation metric evolves from a discount to NAV story to a multiple on FFO story.

The thesis here is a bit incomplete at this stage but promising if you followed NXRT, NHF trades at $9.45 or 55% of net asset value (pre-covid that discount was more in the 15% range), as part of the conversion to a REIT they'll be selling non-REIT related assets presumably near NAV of $17.19 per share, capturing that discount by then buying distressed real estate in the post-covid fallout.  By applying a similar NXRT value-add strategy, NHF will look to sell newly stabilized assets and then recycling that capital back into opportunistic real estate, rinse and repeat, creating sort of a multiplier effect.  The new-REIT will have a pretty wide investment mandate, essentially any asset class is fair game according to the proxy although I assume they'll stay away from multi-family and hospitality/lodging as NexPoint already has publicly traded REITs that focus on those sectors.  The public REIT market likes simple stories, this doesn't appear like it will be one, at least not initially, but NHF does intend to maintain a monthly dividend, so it could entice retail investors interested in yield.

NHF's current portfolio is sort of grab bag of assets, looking at it and its seems a bit incoherent, many readers will recognize some of the individual equity names, several bankruptcy reorgs and other special situations, NHF even has 8 shares of NOL shell Pendrell for those looking to pick some up in the coming months.  They also own CLO debt and equity, which has generally held up well through the crisis and are probably worth more than where they're marked.  But 25% of the portfolio is in a wholly owned REIT they've once again incubated, NexPoint Real Estate Opportunities, which owns self-storage facilities, a Dallas office building (City Place Office Tower), a new construction Marriott hotel in Dallas and a single family rental operator.  Again, not a real coherent strategy, this idea is a bit of a leap of faith based on their past track record and we'll likely know more in the next 6-9 months through this conversion.  I picked up a smallish position with the intention to add more as the story unfolds.

Other quick thoughts:
  • NHF post REIT conversion will be externally managed, the fee agreement has an expense cap at 1.5% of assets for the first year and there are no incentive fees.  This is a similar setup to NXRT, I believe some of the "investor friendly" aspects of the fee agreement are related to being a historical 40 act mutual fund and not just out of the kindness of management's heart.
  • Speaking of management, James Dondero will be the CEO, he has a litigious reputation (feel free to Google), but again, hard to argue with what the team did with NXRT and he owns 11.5% of the fund/stock.
  • They have a repurchase plan in place that allows them to repurchase 10% of the stock over a one year period (plan was put into place on 4/24/20), unclear if they've acted on it at all or if they would with the new change in plans.
  • One big benefit of being a REIT over a CEF will be index inclusion, joining the REIT indices should improve the valuation and analyst coverage.
Disclosure: I own shares of NHF