Thursday, March 26, 2020

What I've Been Buying, Coronavirus Edition

I hope everyone is staying safe and healthy, but if you're interested, here are some thoughts on a few current positions where I've added in recent weeks, some I've bought above where we're trading today, some below.  I probably started averaging down in some of these too soon, eaten some humble pie and have slowed my activity down significantly.  I assume we'll have more opportunities as it'll take awhile for the new economic reality to work its way through our system, credit agreements will need to be amended, etc.  There will be pot holes and bankruptcies, one change from recent years is we're likely to start to see bankruptcy reorgs that are the "good business, bad balance sheet" type that have been rare lately.  Things will likely get worse, so treat this more as a watchlist than a buylist.

Howard Hughes Corporation (HHC)
I'm a long time HHC bull, my pride is hurting here at the moment, 4 of 5 of HHC's primary markets have significant near term challenges: 1) NYC is front and center of the pandemic in the U.S., likely further pushing back (I've lost count how many times now) the stabilization date of the Seaport development; 2) Houston is dealing with yet another crash in oil prices just weeks after HHC made what they describe as the "largest acquisition in the company's history" by buying Occidental Petroleum's office buildings; 3) Nevada casinos are closed indefinitely, that will have its ripple effects through the Las Vegas service based economy and slowing the development of Summerlin; 4) Similarly but maybe less impacted, Honolulu will see significantly less tourism in 2020 than it did 2019, but more importantly a fall in financial markets doesn't lead to more wealthy people purchasing vacation beach condos.  Only Columbia, MD is mostly spared due to its connection to government services jobs.

The stock has bounced back slightly, but for a while there was trading below $40 which is where it was following the spin-off from GGP almost a decade ago, I was able to add a bit there, but still find the shares incredible cheap around $50.  In early 2019, I pegged the value of the land at ~$2.35B after subtracting out land level debt using a straight line NPV approach with a 10% discount rate, sure the near term sales might be low, but the nature of raw land is long term and Nevada and Texas remain attractive states for corporate relocations due to low/no taxes and friendly regulations.  HHC has $1B in corporate level debt, so just the land portfolio is worth ~$1.35B or about $35/share, obviously this is a somewhat silly back of the envelope valuation exercise that doesn't include overhead, etc.  But sort of thinking about what has happened since the spin-off a decade ago, HHC lays out the development activity in aggregate since then in their 10-K:
We have completed the development of over 5.2 million square feet of office and retail operating properties, 2,516 multi-family units and 909 hospitality keys since 2011. Excluding land which we own, we have invested approximately $2.0 billion in these developments, which is projected to generate a 9.5% yield on cost, or $192.7 million per year of NOI upon stabilization. At today’s market cap rates, this implies value creation to our shareholders in excess of $1.0 billion. Our investment of approximately $444.9 million of cash equity in our development projects since inception, which is computed as total costs excluding land less the related construction debt, is projected to generate a 25.5% return on cash equity assuming a 5.0% cost of debt, which approximates our weighted-average cost. These investments and returns exclude condominium development as well as projects under construction such as the Seaport District. We exclude condominium developments since they do not result in recurring NOI, and we exclude projects under development due to the wider range of NOI they are expected to generate upon stabilization. In Ward Village, we have either opened or have under construction 2,697 condominium units, which have approximately 89.8% units sold as of December 31, 2019 at a targeted profit margin, excluding land costs, of 23.6% or $747.3 million.
If we go back to 2015 and early 2016 when oil collapsed from around $100, there was a lot of anxiety about Houston office space and HHC dropped from ~$150 to ~$80 in a few months, but in the aftermath of the drop, HHC's Woodlands sub-market performed fairly well, their last speculatively built office property (Three Hughes Landing) still hasn't reached stabilization 4 years later, but the bottom didn't fall out either.  Not to directly compare the two time periods, this oil route seems worse for U.S. producers as it coincides with a demand shock due to coronavirus, but Houston is a major metropolitan market (it's not say, Midland TX or OKC) and the economy will evolve over time.  The Occidental office property buy certainly looks like unfortunate timing, but the bulk of the purchase is centered in the Woodlands giving them additional control over the sub-market, the Houston Energy Corridor former OXY campus was only ~10% of the purchase price and not a significant drag if they can't sell it in a year or three.  OXY's equity is certainly in question, the company signed a 13 year sale leaseback with HHC when the transaction happened, but even a reorged OXY will need office space, and HHC recently leased some empty space in the second office tower in the Woodlands to OXY's midstream company, WES.  HHC is taking a portion of the remaining space for themselves as they move their corporate headquarters to Houston, so in reality, there isn't a lot of current vacancy in HHC's Houston offie portfolio.

I'm less worried about Ward Village in Honolulu or Summerlin in Las Vegas, Summerlin is likely to have a terrible year, coronavirus feels temporary to me when you take a longer view, whereas domestic oil production might not be viable for many years.  The Seaport has always been a bit of a clown show, it was former management's pet project, there might be more willingness now to part with it for a reasonable offer that eliminates much of the risk/earnings volatility from HHC results.

Par Pacific Holdings (PARR)
Similarly, owning a refining business is tough here, if we just had the supply shock due to the OPEC+ breakup then refiners might be sitting pretty with cheap crude and strong gasoline demand, but with everyone staying in their homes and not commuting to work or traveling, gasoline and jet fuel demand have dropped almost as much as hotel occupancy.

Quick recap, Par Pacific is part of Sam Zell's empire, he doesn't technically control the company or sit on the board, but he owns a significant stake and the PARR management team is made up of former members of his family office - Equity Investments.  Over the last several years they've bulked up their operation to include three refineries, related logistics and a growing retail presence, focusing on niche/isolated markets.  Following a small tuck-in acquisition, they're the only refining presence in Hawaii and thus exposed to their tourism market via jet fuel sales.  They've got a turnaround scheduled for later this year in Hawaii which could be a blessing in disguise as it takes supply offline in that market just when there is a lack of demand.  But in a normalized year, Par Pacific should have a current run rate of approximately $225-250MM (after the next 12 months, PARR won't have a scheduled turnaround for several years), below is the breakdown of EBITDA between their business lines and sort of a reasonable, more rational market multiple for each.  It could take us a while to get there, but management on their last call (guessing there will be a lot of cringing across many management teams when they play back their comments on Q4 earnings calls) said that PARR is "today" a $3/share free cash flow business.  Obviously it won't be this year, but that's how the owners/managers of the business think of the earnings power.
It currently trades for $7-8/share, so that looks like a silly price and maybe it is because things are really different this time.  PARR also has ~$1.5B in NOLs that should shield it from ever paying cash taxes in the foreseeable future (not that it'll be an issue this year) and a stake in a natural gas E&P, Laramie Energy, but I mentally wrote off that investment a long time ago.  Given the natural gas price environment, Laramie has no active rigs, is reportedly cash flow positive and won't require additional investment from PARR to keep it a going concern, so we can sort of sidecar it.

PARR is a small cap and thus only has a relatively short term option chain with the latest expiration being in September.  Moving up market cap, Marathon Petroleum (MPC) is a similarly constructed downstream business with refining, midstream and retail operations that has January 2022 LEAPs available.  Marathon has been under pressure from activist investor Elliott Management to abandon their conglomerate structure and separate into three businesses: 1) retail (which operates the Speedway brand of gas stations/convenience stores); 2) midstream (which is publicly traded as MPLX, MPC owns 63% of MPLX and owns the general partner); 3) and the remaining refining operations.  The company recently rejected the idea of converting MPLX into a C-Corp and spinning MPC's MPLX units out to investors, but they are still committed to separating the Speedway retail business off by year end.  Convenience store 7-Eleven's owners, Seven & i Holdings, recently scrapped a deal to buy Speedway for $22B citing coronavirus and valuation concerns.  If you assume a $15B valuation for Speedway and back out the MPLX shares and consolidated debt, the remaining refining business is something like a $9B EV (with no value given to the MPLX GP) for a ~$5B EBITDA business in normal times.  There's also reason to believe (well maybe) that MPLX is undervalued as well as they're exploring selling their gathering and processing business segment for $15B which represents 1/3 of EBITDA.  The EV of MPLX is ~$34B, and the remaining logistics and storage business should fetch a considerably higher multiple.  I threw some speculative money at out of the money calls, maybe by early 2022 the world is a little more sane, until then I don't really plan on following the day-to-day swings in MPC's share price.

Five Star Senior Living (FVE)
Five Star is debt free (besides a small mortgage on the owned facilities), has a significant net cash position for its size and receives what should be a reliable management fee off of revenue.  Even if we do see small changes in occupancy (for morbid corona related reasons), FVE isn't as exposed to the high fixed cost structure of owning the senior living properties or leasing them.  FVE shares are trading below where they sold off when it was dumped following the distribution to DHC shareholders.  While there is certainly some operational or reputation risk associated with operating senior living facilities during such a high-risk time for the elderly, if Five Star can avoid a Kirkland WA style outbreak, their business should be positioned well and is extremely cheap.  We're still dealing with swag proforma estimates from management as the new structure is only a few months old, but at the EBITDA midpoint of $25MM, that should generate somewhere in the neighborhood of $14MM in FCF for about a 6.4x multiple at the current price of $3, plus you get the owned real estate and $30+ million of cash on a $90MM market cap company.

Wyndham Hotels & Resorts (WH)
Wyndham Hotels generates sales primarily on franchise fees based on hotel revenues (93% of their business) compared to their upscale hotel brand peers like Marriott (MAR) or Hilton (HLT) which have significant hotel management businesses where they get paid a percentage of hotel level profits and employ the workforce.  During good times, the management company model is better but during bad/terrible, I'd rather have the franchise model, hotel revenues will certainly be a fraction of what they were last year, but they won't be negative like profits.  Wyndham's typical hotel is an economy or midscale hotel with limited business or convention business and less reliance on food & beverage -- convention/conference business might take a while to recover as people stay cautious on large events, and if business travel does pick back up, maybe business travelers move down in hotel segment for a period of time.  Additionally, the typical Wyndham branded hotel owner is a mom or pop who owns just the one hotel, they likely got their financing from a local bank or the SBA who might be more willing to work with them on amendments/forbearance versus a large syndicate of lenders like the larger lodging REITs.  They do have a financial covenant of 5x EBITDA that is at risk, maybe other credit folks could chime in here, but I imagine by the time the TTM month EBITDA trips that covenant we might be back on the other side and WH could work with their creditors.  I did buy a little bit of shares, but also calls as to limit my downside if things do go south with their balance sheet.

My watchlist - quick blurbs, maybe turn into full posts if I buy:
  • Exantas Capital (XAN): This is the former Resource Capital (RSO) that I owned for a couple years after C-III took over the management, cut the dividend, and reorganized the assets to a cleaner mortgage REIT.  XAN funds its assets in two ways, one is through repurchase agreements and the other is through CRE CLOs.  CRE CLOs are term financing and not mark-to-market, however the repurchase facilities are mark-to-market and Exantas failed to meet margin calls on their CMBS portfolio this week, sending the preferred and common cratering.  I'm maybe too optimistic on the commercial real estate market (HHC bull) but I think a lot of these loans get amended and Exantas might find its way out of this mess, however it won't be without some pain.  The CRE CLOs might end up tripping their OC tests and shutting off cash flows to the junior notes and equity which is owned by Exantas, so I'm on the side lines for now.  Additionally, like most CRE CLOs, these are "transitional loans" meant to fund a development project, say renovate an apartment building and move it up market, something like that.  So if the market shuts down, the borrower might not be in a financial position to complete said project or refinance into longer term financing, sticking XAN with the exposure longer than expected.
  • iStar (STAR): I want to revisit another former holding in iStar, their SAFE ground lease business has grown far larger than I imagined (although likely very overvalued), taking SAFE at market value you could make a case that the legacy business that I originally liked is very cheap.  But they do have a CRE finance arm similar to XAN, but more concentrated on construction lending in major markets (NYC and Miami IIRC) that could be a problem.  Worth looking into given the SAFE stake and the management contract associated with SAFE.
  • NexPoint Residential Trust (NXRT):  Another former REIT holding of mine, this is one that sort of got away, I'll get the exact numbers wrong but it spun off from a closed end fund at ~$11 and I sold somewhere around $22, not too far from where it is trading today at $25, a few months ago it was $52.  I love the strategy, they acquire garden style Class B apartments in the sun belt, put a little money into them to move up market a touch, maybe "B+", this investment is very high return on invested capital and then they'll sell, recycle the funds and do it all over again.  Sure their tenant base might have some credit issues in the next year, but demographic trends are still in the sun belt's favor, working class people will need reasonably affordable housing in the future, supply is relatively constrained, and this management team (it is external) has proven they can execute on their strategy.
Disclosure: I own shares of HHC, PARR, FVE, WH (and calls) and MPC 2022 LEAPs

SciPlay: Fake Slots in a Casinoless World

I've averaged down on a few current positions (possibly too early and unwise), many of which carry debt, are exposed to customers leaving their houses and are thus down significantly.  But I also wanted to look for a company that might be thriving during this crisis, debt free and can take advantage of people having too much free time.  One such company is SciPlay (SCPL), which a reader asked me to look at in the comments section on my post on Accel Entertainment (I still own despite all bars and restaurants being take out only in Illinois).  I feel like a click bait author associating this idea (which is admittedly a little scummy and not without hair) with the "stay at home trade" but SciPlay should accelerate their already healthy growth rate in this environment with casinos closed for at least the next several weeks, potentially much longer.

SciPlay is a social casino gaming company that was IPO'd off of Scientific Games (SGMS), a major slot machine manufacturer and casino supplier, in May 2019 to reduce SGMS's heavy debt load.  Scientific Games still controls SciPlay with an 82% ownership stake in the operating entity (this is one of those ugly Up-C structures).  Social casino games are free-to-play simulations of slot machines where there isn't explicit gambling occurring but players can purchase virtual tokens to move the game along faster similar to other freemium style mobile games.  I downloaded one of their games and didn't understand it, but SciPlay has 8 million monthly users, however only 6% of those actually pay up for virtual tokens but those users are quite valuable, paying on average ~$88/month (!!) for these in-app purchases.  SciPlay pays a 30% revenue share to Apple, Google, Facebook and the like to be on their platforms, a dispute with any would be an issue, but otherwise this is a decent enough decent business that spits off a fair amount of cash.

The proceeds from the IPO (priced at $16) were used to pay a one-time upfront $255MM licensing fee to Scientific Games for their intellectual property library which allows SciPlay to develop new games in the future based on popular slot machine themes like James Bond or the Godfather that Scientific Games has a license for the rights.  Scientific Games and other slot machine manufactures have years of experience creating and cultivating addictive gameplay -- the "Scientific" part of the name seems almost nefarious to me -- that gameplay design can be fairly easily translated to a mobile device.  SciPlay currently has 7 games, the most popular and the one that makes up 40-50% of their revenue is Jackpot Party Casino, its a few years old now but does receive regular updates, there is some fatigue risk to their revenue but so far they've shown the ability to extend the game's life.  The one risk that remains a bit untested is how online/mobile gambling being rolled out impacts the social casino games, SciPlay claims in states like New Jersey where mobile gaming is legal they see no significant change in their customers behavior.  The explanation given -- social casino is more of a mindless time wasting exercise or a way to learn about slot machines versus a true gaming experience, not sure I totally buy it, but I do see people on my commuter train (when I wasn't holed up in my basement) playing social casino games on the train in the morning.  Doubt that would be the same activity if its actual slot machine mobile gaming with an 8% rake, but then again, maybe the time wasting crowd aren't the 6% of users that are paying.

The share count and market capitalization of the company often appear wrong on free sites due to the Up-C structure where the public company only owns 18% of the operating partnership with Scientific Games owning the other 82% economic stake directly in the operating partnership. SciPlay finished 2019 up with $110MM in cash and no debt, the company did $122MM of adjusted EBITDA in 2019 or $94 million in net income before the non-controlling interest allocation.  This represented EBITDA growth of 30% over 2018, let's dial back the growth rate a touch (although I wouldn't be surprised if they matched or exceed that) and say they do $150MM in EBITDA in 2020.  Keeping the same revenue base and converting an extra 1% of users from 6% to 7% paying users through this casinoless time would do it.
Even in a no growth environment, SCPL is trading at 7.8x TTM adjusted EBITDA (sorry if the price is stale by the time you read this), prior to the coronavirus market volatility, peers (ZNGA and GLUU) were trading at 14x 2021 EBITDA estimates, there's a big gap there between where 2021 EBITDA could be for SCPL and where the stock is trading today.

I bought a small amount, feeling a little guilty about the business model, but I'm not an ESG investor.

Other thoughts:
  • Scientific Games controls SciPlay, and Scientific Games is essentially controlled by Ron Perelman, I don't have any real thoughts about him but he's a semi-controversial investor to some.
  • Scientific Games might be forced to sell additional shares in SciPlay to keep it afloat through the crisis as SGMS is highly levered and I'm assuming if the casinos are closed, they're not buying new VGTs.
  • David Einhorn had a quick blurb in his Q2 2019 letter about owning SGMS partially because of its stake in SPCL, backing out the SPCL position and you can create the core SGMS very cheaply.  I like the idea in concept, but would rather just own the no debt growth company in this environment versus something that will rely on the kindness of creditors.  There is an argument that SGMS's stake in SPCL is unencumbered and could provide a floor to SGMS stock, I don't know if its possible for SGMS to go bankrupt and spin their SPCL shares to pre-bankruptcy shareholders, but if they could SGMS's stake in SPCL is worth about $9.25 of each SGMS share.
  • SciPlay wants to branch out into non-casino games like puzzles, also they're 90+% U.S. based revenue, fair amount of runway internationally if they can navigate regulatory environments.
  • Repeating the risks here: 1) impact of legalized mobile gaming; 2) SGMS overhang; 3) no-to-low barriers of entry for mobile games; 4) reliant on Apple, Google and Facebook to remain in their good graces and on their platforms; 5) revenue concentration with Jackpot Party Casino.
Disclosure: I own shares of SCPL

Monday, March 16, 2020

Madison Square Garden: MSGE Form 10, Corona Fears

Financial markets are in turmoil, it feels like a strange time to be writing anything new as lives are being drastically impacted, hope this doesn't come across as tone deaf, keep your families safe.  I don't normally talk about macro or have any thoughtful insights into how coronavirus and the oil route will play out over the near term, but over the long term I suspect it will subside, we'll get through it, adjust in some ways and life will eventually turn back to a new normal.  But how long will that take and which companies won't be able to weather the storm?  My portfolio is hurting, I've sold some things I didn't want to sell to raise cash, I certainly don't envy anyone who is managing other people's money in the current environment.  However, some opportunities are arising from the wreckage and forced liquidation we've seen over the past few weeks, one such company is Madison Square Garden (MSG) -- zero points for originality here -- most readers will have likely read a dozen similar pitches, but given the pace and depth of market sell-off, I don't think there is any reason to over-complicate things and I bought some recently.

For the uninitiated, MSG owns two premier sports franchises in New York City (NBA's Knicks and the NHL's Rangers) plus several arenas and entertainment venues where they host concerts, comedians and other live entertainment.  At the end of the month (guessing that'll slip with the market conditions), the company is planning on splitting off the sports teams ("MSGS") from the entertainment business ("MSGE").  The sports teams are relatively easy to value as Forbes does most of the heavy lifting in an annual publication of sports team values, we could argue if Forbes systematically under-prices where private transactions have occurred or if the stock should deserve a minority discount, but either way sports teams are a valuable scarce asset that should trade within a reasonable discount/premium of the Forbes valuation.  The tougher side to value will be MSG Entertainment, and given coronavirus fears with all events either cancelled or postponed for the time being, it could experience significant volatility once it starts trading (again, seems likely the spin will be postponed, but it'll happen eventually).  Not to downplay the virus risk with MSG, both sides of the company will experience significant revenue hits this year as the NBA and NHL seasons are suspended and no large scale entertainment events will be occurring for the foreseeable future.  However, the sports teams are trophy assets that should continue to hold their value and at current prices you're paying very little for the entertainment business that despite a few red flags does hold some interesting assets.  The company is controlled by James Dolan, the son of Cablevision founder Chuck Dolan, the family's business empire has gone through a series of M&A and spin-offs transactions, mostly value creating, it currently consists of voting control over MSG, MSG Networks (MSGN), and AMC Networks (AMCX).

MSG Sports (MSGS)
I'm going to make it pretty simple with the MSG Sports business, this will be the parent (originally this was the spin but the transaction has since been revised to a simpler structure), below is the current Forbes valuation for each team and I'm going to use a swag 20% discount to account for a minority ownership discount, corporate overhead and the new arena license agreement both teams will have with MSG Entertainment.
Most people are familiar with the sports team thesis, premier teams are relatively unique assets that are coveted by the ultra-wealthy and come with a lot of social status and tax benefits.  Plus, of course, sports have valuable media rights that content distributors will pay a premium for as its a must watch live viewing experience.  James Dolan is widely considered one of the worst owners in sports from a fan's perspective, over the past several years he's gotten into public spats with several Knick icons like Charles Oakley and Spike Lee more recently which haven't improved his image.  Fans chant "sell the team" at home games, not a great look.  But despite that, Dolan seems to have no intention of selling the teams or giving up majority control, so this does deserve some discount for minority rights and then just all the overhead, jets, potential taxes in a sale, etc.  Going forward, the current capital allocation plan is to return capital to shareholders, so this should be a fairly simple story to value and own.  And of course, if the Knicks ever return to being a winning team, there could be additional upside from playoff ticket revenue and associated sponsorship opportunities.

MSG Entertainment (MSGE)
The spin-off will be the entertainment company, this side of the business is more challenging to value as its probably best done as a mix of an NAV and an earnings based metric on some of their operating businesses, however the financial disclosures make this a challenge.  Not to be lazy, but at today's current price of ~$200 (could change wildly by the time you read this) for the combined company you're not paying much for the entertainment business so this will be light on hard numbers.  MSGE will consist of the following assets: 1) the Madison Square Garden arena itself and associated air rights (I'm skeptical of assigning value to the air rights, but if you think they're worth something, go ahead); 2) MSG Sphere under construction in Las Vegas; 3) the Forum in LA; 4) Chicago Theater; 5) Christmas Spectacular show featuring the Rocketts; 6) leases and operations of the Radio City Music Hall and Beacon Theater; 7) the events booking business at all their venues; 8) a controlling stake in Tao Hospitality; 7) and some smaller assets like a stake in Townsquare Media (TSQ) and festival promoter Boston Calling.

I tend to like these grab bag of assets that are hard to value spin-offs as they don't fit neatly into a valuation box which makes them hard to own for some investors.  This one has its own unique challenges obviously with the coronavirus halting near term operations, but could present a longer term opportunity, we still have Instagram, people want to be seen and be social, we'll still want to attend big live events when this passes.

The Garden
The company namesake property is located in Midtown Manhattan atop of Penn Station, the current structure dates back to 1968 and was heavily renovated in 2011-2013.  As part of the spin-off, both the Knicks and the Rangers entered into long term lease agreements with MSGE to remain at the Garden for the next 35 years.  The arena license is almost structured like a triple net lease, the sports teams will be responsible for the maintenance and property taxes associated with the arena, the Knicks will start out paying $22.5MM and the Rangers $16.7MM per year with a 3% annual escalator.  What cap rate would you place on that lease agreement?  I would think given the location, high investment grade tenants, where interest rates are today, that this would be valued a very low cap rate. In addition, MSGE will get a portion of the sports team's suite revenue, on-site advertising, concessions, etc.  This also doesn't include the non-sports booking business where the Garden regularly hosts premier music and comedy acts.  Putting a 4.5% cap rate on the arena license makes it worth ~$900MM, with the additional revenue and air rights, I think its reasonable to assume the Garden is worth somewhere between $1-1.5B.

MSG Sphere
The MSG Sphere is an outlandish live entertainment venue being built next to the Venetian hotel on the Las Vegas strip, the current projected cost is $1.66B (up considerably from where it was first discussed in 2018) with a goal to be open by the end of 2021.  It's a bit wild to think of building an arena for $1.66B without an anchor tenant, for example the T-Mobile Arena which is located between Park MGM and the New York New York casino, is the home of the Vegas Golden Knights (NHL franchise) and the Las Vegas home o't f UFC events and was built for only $375MM.  The $1.66B price tag ($268MM of that has already been spent) also doesn't include the content and expenses related to producing content for the Sphere.  This is essentially a bet the company type investment and management has been a bit cagey about estimated returns.  And the problem with cost overruns is they don't lead to additional revenue, so each time the costs go up, the returns likely go down.  MSG has been successful in the past (management likes to point this out when defending the Sphere) in renovating the Forum and turning it into a premier concert venue, but that was only a $100MM investment, this might end up being 20x that.

The basic premise to the Sphere is it will be a totally immersive experience unlike anything else (for that price tag it better be), concert promoter AEG has a deal with T-Mobile arena and it is likely that MSG will strike a deal with Live Nation (LYV) to promote concerts at the Sphere ensuring a steady stream of big shows.  When not hosting a touring act, the Sphere is intended to have proprietary content (riskier business than the license your venue for a fee business, but potentially more lucrative) and be available to large conventions or corporate events.  The company intends for it to be more utilized than the Garden which would be quite a feat.  We'll see.  MSGE also has a site picked out for a London Sphere, they don't plan on starting construction until the Las Vegas one is complete (but reminds me of the line from the movie Contact, "why build one when you can build two for twice the price?").

MSGE will be spun with about $1.25B in net cash after receiving a payment from MSGS (usually the spin pays the dividend to the parent) but most if not all of that will be used to fund the construction of the Sphere, so maybe it's worth applying a haircut to the cash, again I don't think it matters too much given today's valuation for the combined MSG but I wouldn't argue against it.

Other Assets:
  • The Forum: MSG bought the Forum in Inglewood, CA in 2012, renovated the former home of the Lakers (they left in 1999) and reopened it in 2014 as a concert venue.  From all accounts its a great place to see a show, but it might not be part of the company for long, ESPN has reported that LA Clippers owner Steve Ballmer is in talks to purchase the Forum to resolve a long standing dispute.  The Clippers want to build a new arena (currently they share the Staples Center with the Lakers under a punishing lease agreement) near the Forum, buying out MSGE would clear the way for that to happen and give the company additional liquidity to pursue the Sphere project without additional debt financing.  MSG spent approximately $100MM renovating the property, Steve Ballmer isn't price sensitive, let's call it worth $200+MM in our swag valuation.
  • Tao Group Hospitality: MSGE owns a controlling stake (~63%) in the nightlife and restaurant operator Tao Group.  Tao operates 30 high-end venues, mostly in Las Vegas, LA and New York under the Tao, Marquee, Lavo and a few other names.  Part of the thinking in making the $181MM investment in 2017 was to partner with Tao's management team on designing and operating hospitality aspects of the Sphere project.  Nightclubs and restaurants are notoriously fickle and difficult to see a moat here, but maybe there could be some synergies with the Sphere, although this seems like a vanity investment.
  • Christmas Spectacular: While their popularity is a bit of a mystery to me, the Rocketts Christmas Spectacular show has been a holiday mainstay for many years and generates about $100MM annually in revenue.  Let's call it 1x revenue to be safe.
  • Entertainment booking business: This is a big piece of the pie and I admit I have no idea how to value it based on their disclosures, but they license their venues out to third-party promoters for a fee.  All the biggest acts want to perform at the Garden, or their other venues, when I had more free time I would go to several shows a year at the Chicago Theater, that's where all the top comedians (Chris Rock, Jerry Seinfeld, etc) stop where they're in town.
  • Sports booking business: MSGE will end up receiving the sports booking business which is current embedded in the Sports operating segment of the combined MSG, this is the business that books events like boxing, college basketball tournaments, MMA and other non-Knicks and Rangers sporting events at the Garden or Forum.
  • Other other: they also own 3.2 million shares of Townsquare Media (TSQ), a radio broadcast company, that's worth about $14MM at today's depressed prices and 50% of the company that puts on the Boston Calling music festival.
Again, apologies for being lazy on the MSGE valuation, don't think it matters at this price, and I just find it difficult to piece together based on the financial disclosures in the Form 10, but I've fared well in these grab bag type assets.  As they mature as a standalone, they tend to uncover value and become easier to understand.
Adding them up, I get what I would call and overly conservative valuation $287 for the pre-split MSG shares.  We will recover, people will go out to live event again, but remember to wash your hands.

Disclosure: I own shares of MSG

Thursday, January 30, 2020

Emmis Communications: Selling Below Net Cash, Mediaco Holdings

Emmis Communications (EMMS) is a micro-cap (~$50MM) radio broadcaster that recently sold their two popular New York radio stations (substantially all of their remaining operating business) via a creative transaction (which is interesting in its own right, more on that later) leaving Emmis as a cash pile and some miscellaneous assets that is currently trading at 60% of net cash.

Emmis has a long history in radio, it was founded roughly 40 years ago and is still run (and controlled via super-voting shares) by CEO Jeff Smulayn, they've done many radio station M&A deals as both a buyer and more recently a seller in the past but in recent years made the strategic decision to effectively exit the business.  Radio is a mature industry but slow-to-no growth as it is increasingly being competed against with superior on-demand products like music streaming and podcasts.  The few times I have the radio on in the car, I usually cringe at how terrible the listening experience is or how ridiculous it is that in 2020 we're still giving out weather and traffic every ten minutes.  Podcasts and streaming services are also getting quite good at targeting ads, I was recently listening to a highly popular podcast and received ads for a car dealership down the street from me -- radio's local advantage is overstated.

But back to Emmis, it now has the following assets:
  • ~$88MM in proforma cash after taxes and other costs of selling the New York radio stations
  • 5 radio stations, four of them are in Indianapolis (local ESPN sports talk affiliate, soft-adult FM that's #2 in the market, a country station that's #3 and a news/talk channel) and the other is an urban gospel channel in New York that's way down the ratings table.  Too much noise in the financial statements to determine what these are worth, but I doubt Emmis sells the Indianapolis stations anyway - there's likely a lot of social status that comes with being a media executive in your hometown, so I don't see Jeff Smulayn divesting these.
  • A licensing agreement with Disney for WEPN-FM in New York, which is the ESPN radio affiliate in the market, Disney is contractually obligated to pay the $42MM in debt associated with that station by 2024 and the debt is non-resource to Emmis.  This arrangement hides the true net-net position of Emmis.
  • Their headquarters building, 40 Monument Circle in Indianapolis, its just under 100k sq feet and was built in 1998 for $25MM.  They do have a $13MM mortgage loan with their headquarters and an additional 70 rural acres in Whitestown, IN (yes, an actual place) collateralizing the loan.  This is their only real debt remaining.
  • $5MM convertible note with Mediaco (MDIA) and they'll also be receiving $9MM in working capital from Mediaco, plus a $1.5MM/year fee for continuing to run the stations
Taking a fairly conservative view of the assets and I come up with Emmis trading at an adjusted enterprise value of -$64MM, or said another way, trading at $3.75 despite having $6.34 in net cash per share ($88MM + $9MM WC from Mediaco - $13MM mortgage debt).
Why is it trading at such a discount to net cash with no value to their other assets?  Well for one, the operating expenses and overhead of the remaining business are such that there is now a quarterly cash burn.  But more importantly, it is a legacy media company with a controlling share class structure, Jeff Smulayn owns all of the Class B shares (and effectively none of the publicly traded Class A) giving him a majority of the vote while only owning ~10% of the economic value of Emmis.  He has outlined a vague plan to buy a "growth business" outside of radio, kind of fashioning Emmis has a middle market PE buyer with its new found cash balance.
That's certainly a bit scary and almost SPAC like in nature, but what I think is potentially more likely and more appropriate for Jeff Smulayn to do is a large tender or take the company private and pursue that family office strategy outside of the public markets.  What's the logic in keeping the controlling structure in place when it is now effectively a SPAC?  The argument behind the legacy media control structure should no longer apply; seems inappropriate and an abuse of minority shareholders.  He tried to take EMMS private in 2016 but couldn't come to agreement on price with the board, I think he might try it again, if not, shares are pretty cheap at just 60% of net cash.

Mediaco Holdings (MDIA)
Potentially more interesting to some -- as part of the sale of the two New York radio stations (Hot 97 and 107.5 WBLS), a new company was formed controlled by Standard General LP, a hedge fund that has historically done well in media sector.  The new company, blandly dubbed Mediaco Holdings (MDIA), is a tiny microcap at this point, the Class A public float that was distributed to EMMS shareholders is around $11MM (Class B is 100% owned by Standard General), but the stated strategy is to pursue an M&A fueled growth strategy looking at "off-the-run" deals in the media space.  The first one was with Emmis and they recently completed another deal funded with debt and convertible preferred stock to buy a billboard company.  The trading dynamic kind of reminds me of Five Star (FVE); Mediaco's current public float was distributed as a taxable dividend to Emmis shareholders on 1/17 as a tiny fraction of their holding in EMMS.  It has traded erratically since the spin/distribution, but Standard General effectively paid ~$7.75 per share for their super-voting shares in the New York radio station deal, although they do have converts and other economic interests that aren't aligned with minority shareholders it still could be interesting well below that price.  Standard General seems to agree and actually bought some of the Class A shares in the open market in the past week:
MDIA is so levered (EV is about $153MM versus a market cap of $47MM) that it is not going to be cheap on an EV/EBITDA basis against radio or billboard peers, but might be on a FCFE basis and is essentially investing in a quasi-public private equity media fund.  I haven't found a website for Mediaco yet, but they did publish an investor deck to Edgar for those interested.

Disclosure: I own shares of EMMS and an insignificant amount of MDIA

Wednesday, January 8, 2020

Five Star Senior Living: Reorg with Spin Dynamics

*This one ran away from me a little bit today but still likely cheap, wrote most of this last night after @valuewacatalyst (probably my favorite follow) tweeted on the idea and reminded me that the distribution had just happened, but below is the thesis -- interesting situation that's worth keeping an eye on or looking for something similar in the future*

Five Star Senior Living (FVE) is an RMR Group (RMR) controlled operator of primarily independent and assisted living communities for Diversified Healthcare Trust (DHC), which is RMR Group's externally managed senior housing and medical office REIT that was formerly known as Senior Housing Properties Trust (old ticker: SNH).  RMR manages a series of REITs and doesn't have the best reputation with investors, there's an obvious conflict of interest present in most external REITs, we last ran into RMR when they purchased the net-lease retail assets of SMTA for RMR's hotel REIT, Hospitality Properties Trust (HPT), their incentive is growth regardless of price or fit.  Their agreement with FVE is similarly structured, RMR gets a 0.6% cut of revenues without paying attention to profit.  Everyone knows the demographic tailwinds that should support the senior housing sector, the population of those 75 or older is growing at 2-3x the rate of the overall population in the United States.  Developers got excited, overbuilt in recent years into this well telegraphed demographic trend and senior housing operators have struggled due to the oversupply of rooms.  However the trend might be improving, construction is a little more rationale now and each year we move forward the demographic wave of seniors gets closer to being realized.

Five Star has been on the brink of collapse a few times (it was originally a spin of DHC 15+ years ago), they've been hampered with a poor business model of both high operating leverage (labor is expensive and often semi-fixed regardless of occupancy levels, insurance premiums, private vs public pay, etc) and high financial leverage via leasing their properties on a triple net basis from big brother Diversified Healthcare Trust.  They couldn't survive the oversupplied market and their troubles have bled into DHC's share price as well.  Through a restructuring with their largest creditor DHC, which is akin to a pre-packaged bankruptcy reorganization, Five Star will now be primarily an asset-lite operator of senior housing and the capital requirements will be DHC's responsibility.  The new structure is very similar to what is used in the hotel REIT industry where the REIT owns the property but in order to qualify as a REIT, the REIT needs to hire a third party management company, that's going to be Five Star going forward, switching from being DHC's tenant to their hired hand.  The primary difference, in the hotel industry the best revenue stream is the brand/franchise royalty, the Five Star brand isn't Marriott, so its just the less attractive but still a decent enough business of managing the property component in this situation.  In return, DHC received about 85% of FVE equity and distributed about 51% of the proforma shares outstanding to DHC's shareholders via a taxable special dividend, keeping the rest on DHC's balance sheet.

Five Star's new management agreement is for 5% of gross revenues plus the opportunity to earn another 1.5% of revenues in incentive payments if certain property level EBITDA targets are met.  FVE management is guiding to $20-30MM in EBITDA this year, even putting a 4-5x multiple on that and the stock could be a double from here.  The company has essentially no significant conventional debt following the restructuring, they will have a few remaining owned properties that carry mortgages but its pretty minor, a few non-DHC leases and a self insurance liability that is backed by their marketable securities portfolio.  Following the share issuance and sale of fixed assets to DHC, Five Star has approximately $100MM in proforma cash (this will likely not be all cash but a receivable from DHC for working capital liabilities, but eventually will be cash **EDIT: apparently this is wrong, being told that cash will be ~$35-40MM**), not far off from the proforma market cap of $112MM (31.1 million shares using a $3.60 share price).  Even at a 4x multiple of $25MM in the mid-point EBITDA range, the business is worth $100MM plus the $100MM in cash, FVE could be a $6+ stock without a demanding valuation.

Why does this exist?  DHC's shareholders are primarily retail investors who are hungry for yield or REIT index funds, few fundamental institutions would continually want to suffer the abuse of owning an RMR externally managed REIT.  The distribution of FVE shares was especially small, on 1/2/20 for each share of DHC, DHC shareholders received 0.07 shares of FVE, meaning it's likely an automatic sell due to its insignificant size and its 0% dividend yield (or if it's a REIT index fund holder, it would no longer be in the index).  Five Star has plenty of red flags, but the combination of a reorg to a better business model and the spin like dynamics of placing the new shares in disinterested holders makes it an interesting near-to-medium term opportunity.

Disclosure: I own shares of FVE

Tuesday, December 31, 2019

Year End 2019 Portfolio Review

It is once again time to close the books on another year (and this time a decade), with a similar caveat to my mid-year update, the 2018 year-end was particularly painful and proved to an easy starting point for 2019 performance numbers.  With that said, my personal/blog account was up 98.63% in 2019 versus the S&P 500's 31.49% total return.  I'm fully aware this performance isn't comparable to any professionals out there managing large or small funds, it reflects some dumb luck and imprudent risk taking in hindsight, but it's still fun to nearly double in a year.  I expect next year to be difficult to put up great numbers considering the starting point (sort of the reverse of last year), but I'll continue to look for interesting corporate actions and other situations that might be obscuring value in some way or another.
Thoughts on Current Positions:
  • Franchise Group (FRG) has really gone a bit bonkers since the tender offer expired in November, not only are they combining four struggling businesses as I discussed, but since my post they've acquired two more including a large $450MM deal announced Monday for furniture retailer American Freight funded with debt.  I can't really explain why the equity has roughly doubled in 45 days, but it does appear that something potentially interesting is happening under the surface, the new CEO is clearly moving aggressively to assemble an asset base to launch his low-end sub-prime lending type business franchise thesis.  It remains very high risk but I imagine there are a number of value creation levers to pull through all these combinations.
  • I tripled my position in Howard Hughes (HHC) this year, which although high conviction had fallen in position size the last few years.  Initially, I bought more in March prior to the strategic alternatives announcement and then again during the fallout of the company announcing the strategy review failed to find a buyer.  The "new" strategy laid out following the failed auction is really the same strategy the company has had all along, just maybe sped up a little, with less overhead (a fair and constant knock against my SOTP analysis) and now with the company returning cash to shareholders through a buyback funded via asset sales that should have been disposed of some time ago.  It's still a great asset with plenty of internally generated growth opportunities, if its chronically undervalued by the public markets, so what, should still provide an attractive long term return to patient shareholders.
    • Yesterday (after I wrote the above), HHC announced a large deal with Occidental to acquire their Houston area real estate assets, including two towers in The Woodlands Town Center.  While not optically in line with the asset disposal strategy, its right in line with their long term thesis in controlling the supply in their master planned communities.  It's one of the few cases where a commercial real estate transaction can provide true synergies outside of just overhead cost cutting as HHC will now own even more of The Woodlands sub-market and can control when and where new supply comes online.  Occidental is a bit of a forced seller as they repair their balance sheet following the acquisition of Anadarko this year.  As part of the deal, they also bought Occidental's 63-acre corporate campus in Houston, they'll be selling the campus immediately, I imagine the net price paid for the additional Woodland's assets will look quite cheap once the dust settles.
  • I still continue to like Green Brick Partners (GRBK) as the home building cycle continues to recover from the recession, it's likely not super cheap as book value is roughly right (all the land bought up cheap following the recession as been built on/sold), but we could easily wake up one morning to news that it is being sold to a larger builder.  The NOL is gone and David Einhorn needs a win after all these years, however it is a confusing/unique builder in its structure and hard to know how a buyer would view some of the related party friends and family type arrangements with the underlying legacy builders.
  • I also continue to like my other large legacy positions in MMA Capital Holdings (MMAC) and Par Pacific Holdings (PARR) but don't have much new to add, always open to questions in the comment section.  Same goes for simpler businesses like Wyndham Hotels & Resorts (WH) and Perspecta (PRSP), both are relatively asset-lite and cheap compared to peers, both did some smaller M&A this year that I think was beneficial and I continue to like them longer term although they're lower down my conviction scale.  My two cable positions I kept steady this year in GCI Liberty (GLIBA) and Liberty Latin America (LILA), I'm a cable noob and mostly cloning others here to mixed results but continue to hold.

Closed Positions:
  • Spirit MTA REIT (SMTA) was one of my biggest gains ever, I was consistently over optimistic on the ultimate value but that gave me the conviction (rightly or wrongly) to size up my position and be rewarded for being directionally right on the sale process outcome.  I did sell out of it prior to SMTA becoming a liquidating trust, management's estimate of the remaining proceeds was below my expectations and the upside relies on the fate of the bankruptcy proceedings of a small day-care operator.  To me it's not worth the pain of no liquidity and dealing with a K-1, but I hope it works out for those left in it and thanks for the lively discussion in the comment sections of my posts, really was beneficial to me and hopefully others.
  • Closed out both sides of my IAA and KAR Auction Services (KAR) trade from the first half that I discussed in my mid-year review, haven't paid too close of attention since then but the KAR side is probably cheap. 
  • Command Center (CCNI), now called HireQuest, worked out essentially as expected following the close of their reverse merger and tender offer.  I sold at roughly today's prices, management doesn't give off shareholder friendly vibes and the company's business model is particularly economically sensitive, figured it was an easy win to book and move on.  While I didn't make a huge profit on CCNI, it did give me the confidence to size up FRG more when that transaction shared a lot of similarities to CCNI.
  • Gannett's (GCI) merger with New Media was announced and closed, I initially closed my position the day of the announcement before the market seemed to digest the news that the combined company would cut their outsized dividend in half.  The stock dropped hard and I attempted to bottom fish (New Media's external manager, Fortress, creates some of the best/most misleading investor presentations), that didn't work out and lost some of my gains, the deal closed and now I'm once again done with newspaper companies.
  • Small merger arb names that closed and mostly worked out as expected (maybe with a few stressful days) were Empire Resorts (NYNY), Northstar Realty Europe (NRE) and Speedway Motorsports (TRK).
  • I cleared out of a few busted spinoffs -- CorePoint Lodging (CPLG), Donnelley Financial Solutions (DFIN) and KLX Energy Services (KLXE) -- that I had sizable losses in and given the good year, needed to offset some gains.  Somewhere in my mind I still believe in the thesis for each, but using tax loss harvesting as an excuse to sell can be a helpful way to reset your brain on a company for a while.  Don't be surprised if DFIN or KLXE make a return visit to my portfolio, but I'm likely done with CPLG as I've replaced it with Extended Stay America (STAY) that operates in a similar market segment plus has the benefit of owning the management company (which will one day be split off). 
    • I've heard others argue that spinoffs are no longer attractive or we're seeing lower quality ones, that might be true, but I don't remember Joel Greenblatt ever saying that all spinoffs should be bought in a systematic way like an ETF factor, just that they can sometimes be mis-priced, good places to fish.  There seem to be fewer of them on the calendar for 2020 (MSG looks interesting but heavily followed and I have a hard time valuing the entertainment company; HDS might be one to look closer at as it separates into two, seemingly under the radar and the MRO business is a quality one), so we'll get a natural break as the cycle continues but I imagine we'll still see some interesting opportunities before too long and its a good place to continue to look for value.
  • Despite my Craft Brew Alliance (BREW) thesis being wrong and AB InBev passing on their $24.50 option to buy BREW in August, AB InBev did come back to the table and offered $16.50 for the company.  I should have been out of the stock using any reasonable risk management parameters, but instead I purchased shares shortly after the deal deadline passed and then further doubled down and bought call options (done for a tax loss, I sometimes like to double down for 31 days using options and then sell the original shares for a loss, mentally this helps me put an exit date to the trade whenever the options expire).  I admittedly got extremely lucky on the timing and the deal announcement happened when I had twice the exposure I really wanted or intended.  I'll be selling my position once the calendar turns over to push the tax bill out another year.
  • In October 2018, I did a similar trade with Wyndham Destinations (WYND) to realize some losses on the common and bought call options that will expire in a few weeks, those worked out nicely as the economic outlook bounced back providing a lift to the economically sensitive timeshare sector.  I'll be selling those as well once the calendar flips, fortunately the gains are long term for tax purposes, which is an additional benefit to buying/holding leaps.
  • Miscellaneous: 1) I participated in the Danaher (DHR) exchange offer for Envista Holdings (NVST) and then sold immediately upon receiving my NVST shares; 2) the Miramar Labs (MRLB) CVR has begun to pay out and should be fully realized in 2020; 3) I own the Celgene CVR (BMY RT) that was issued as part of the Bristol Myers Squibb (BMY) acquisition, I put the trade on with a fair amount of leverage on the closing day, didn't really work out pre-deal like I hoped but I like these kind of risk/reward payoffs in small sizes. 
Performance Attribution
Grayed out are closed positions
Portfolio as of 12/31/19 
No cash was added or withdrawn this year, and to clarify, average cost is my current cost basis and not my historical - this is a taxable account and I try to trade around positions to harvest losses where possible.  If everything goes to plan with some of these smaller merger arbitrage and liquidations, I should have a decent amount of cash (margin free) for the first time in many years, so I'm actively looking for ideas, please send any my way!  Thank you for reading and have a happy and safe New Years.

Disclosure: Table above is my blog/hobby portfolio, I don't management outside money, its a taxable account, and only a portion of my overall assets.  The use of margin debt, options, concentration doesn't fully represent my risk tolerance.

Tuesday, December 3, 2019

Accel Entertainment: SPAC, Distributed Gaming in IL

I did it, I finally fell for a special purpose acquisition company ("SPAC") pitch -- Accel Entertainment (ACEL) came public via a merger with TPG Pace Holdings (TPGH) and is one of the largest distributed gaming companies in the United States, although currently they only operate in Illinois, where my family and I reside.  Distributed gaming is where a bar or a truck stop (technically anyone with a liquor license) contracts with a company like Accel to place video gaming terminals ("VGTs" but kind way of saying slot machines) in their establishment with a revenue share agreement between the two parties.  Accel owns and operates the machines, but in an asset-lite fashion as the local business owner has all the real estate, operating risk and expense of running a bar/restaurant/truck stop.  You can think of distributed gaming as an operating casino but without the capital intensity of owning the real estate or the capitalized lease of operating a large casino.  Here's the basic business model:
Illinois is a fiscally challenged state that has gone all-in on gambling as a tax revenue source, recently approving 5 additional casinos plus 1 mega-casino within the Chicago city limits (where there currently are no casinos or VGTs in bars/restaurants), a 60% increase from the 10 commercial casinos that have been in operation historically.  As part of this gambling expansion, lawmakers also increased the maximum bet size from $2 to $4 and increased the number of VGTs a liquor license holder can have from 5 to 6 machines.  While the legislation was passed in July, neither the increase in the number of machines nor the increase in hold percentage has been meaningfully rolled out yet.  Each municipality in Illinois is additionally strained for tax revenue and competition among bars is intense, thus it's increasingly becoming necessary for a local dive bar to have gaming terminals on their premise.  If your town doesn't allow VGTs, chances are the town over does and customers may follow (alongside the food/beverage sales tax that local governments survive on).  The state needs revenue, local bar and restaurant owners need new sources of revenue especially with rising labor prices, all setting up a nice tailwind for continued distributed gaming growth in Illinois that was only legalized in 2012.

Distributed gaming is disrupting regional casinos, it is more convenient for gamblers to drive to a local bar they might already frequent than to drive an hour to one of the first generation riverboat style casinos that doesn't provide much more in terms of experience than a typical bar.  Gaming tax revenue via VGT surpassed that of the casinos in Illinois for the first time last year, giving them a possible lobbying advantage for continued expansion in the future.  The big wildcard is Chicago, which currently does not allow VGTs within the city limits, given Chicago's fiscal situation (it's not good) that will likely change in the future as well which would provide a massive boost to the distributed gaming industry.  VGTs, like the lotto, are an easy short term fix for politicians looking to avoid raising property taxes.

The new gaming law isn't all positive for operators, the Illinois tax rate on VGTs is increasing from 30% to 34% in 2020, the VGT operator (Accel) and the business owner by law must split the revenue 50/50, essentially the government (mix of state and local) gets 1/3rd, VGT operator gets 1/3rd and the business owner gets 1/3rd.  Since VGT operators can't compete on price in Illinois, it means they must compete on service, machine quality, and other areas where scale will give Accel an advantage over smaller competitors that can't spread those costs over a larger base, have buying power with suppliers or don't have the accumulate data that Accel has built up to help improve operations.  Fixing the pricing also creates sort of a unnatural oligopoly structure to the industry in Illinois (this is not the case in other markets like NV or MT), there won't be pressure to reduce their split or lose a contract and the gambling customer base isn't price sensitive (the hold rate on Accel's machines is about 8%, meaning it'll pay back about $0.92 of every dollar played) creating a pretty durable margin.

Scale matters, this is a fragmented industry with a lot of potential to roll-up the smaller players in the state and enter into new jurisdictions as more states legalize distributed gaming as a way to increase their tax revenues.  Accel has been a serial acquirer of smaller Illinois competitors, they've completed 9 deals since distributed gaming was legalized in 2012, and now that they have a public stock as currency, I would anticipate them doing more in the future.  Smaller operators in Illinois or elsewhere in the country might find it attractive to sell to Accel yet retain some equity upside in a liquid public stock.  Rolling up an industry like this seems less risky as the end product and pricing is generally the same, its a fairly standardized product and since pricing is fixed, you're not expected to share any synergies with the customer.  Accel also has a conditional license to operate in Pennsylvania, where lawmakers recently approved VGTs located in truck stops, a potential first step before a broader roll out to other liquor license holders, it will be a small market initially, but like Illinois, Pennsylvania has really pushed gaming as a tax revenue source.

Accel is projecting about $115MM in EBITDA for 2020, after their most recently closed acquisition, they have over 10,000 VGTs and representing about 1/3rd of the Illinois market.  Maintenance capital expenditures are pretty limited, mostly just servicing existing machines occasionally, creating a pretty attractive free cash flow conversion rate.  Using management estimates (its a SPAC, these could be wildly ambitious and include a lot of assumptions from the new gaming expansion and recent acquisitions), I'm coming up with ACEL trading around 9.2x EBITDA or a just sub 10% free cash flow yield (pre-growth capex).
There aren't any great public peers (seems to be the case with all SPACs, that way they can always comp themselves against inappropriate peers) but on an absolute basis that doesn't seem particularly expensive for what should be a pretty durable, growing and recurring revenue stream.  Boyd Gaming (BYD) did buy a Illinois distributed gaming peer for 8x EBITDA in 2018 and Golden Entertainment (GDEN) which is a mix of Las Vegas local casinos and distributed gaming trades quite a bit cheaper but also has significant debt and is more capital intensive.  I would imagine Accel performing better through a recession than casino peers as gamblers choose the hyper-local option over making a day out of traveling to a regional casino.  That along with their asset-lite model, lower leverage, and growth profile means Accel should trade for a decent premium over gaming peers.

I bought a small toehold position, could be a mistake as the SPAC aspect makes me nervous, but I like the business.

Other Thoughts:
  • There's some poor counterparty credit risk aspect to their business model, they partner with small local mom and pop type operators, you're not likely to see VGTs at a Buffalo Wild Wings for example, but you will in the beat up corner bar.  Bars and restaurants go out of business regularly and their 7 year contracts aren't enforceable if the business in question closes down.
  • No one is going to include Accel in an ESG portfolio, it's about the opposite of ESG, VGTs are an eye sore (often they're in a separate room with a seedy looking saloon door entrance), encourages addictive gambling and just not a great productive use of time/money for society, truly a tax on the addicted and often poor.  But it's a proven business model and the hold percentage is much better to players than say the state lotto industry.
  • Accel currently doesn't have a players rewards program that many gaming companies utilize to market to and retain customers.  Given distributed gaming is a natural competitor to the regional casinos, could it make sense for someone like PENN to acquire Accel, roll out their rewards program and link the two customer bases together to drive people to the regional casinos?  It's unclear if current regulations would allow Accel to have a rewards program, but an eventual combination with a regional casino player could make sense.
  • Accel also does similar arrangements with other bar equipment like pool tables, darts, jukeboxes, sort of an open a bar out of the box type arrangement, but the non-gaming side is just sub-5% of total revenues.
  • Like every other SPAC, Accel does have warrants that will dilute equity at $11.50 and above, the capital structure is a bit confusing but that's par for the course for a SPAC, I imagine they'll attempt to buyback some of the warrants.
  • They pitched themselves as a "gaming-as-a-service" company in the SPAC investor decks, thankfully that's been removed in the latest post-merger presentation on their website, seemed a little scuzzy even for a distributed gaming SPAC.
  • Every SPAC needs a story on why it went the SPAC route versus the traditional IPO route -- Clairvest is a Canadian PE firm with a solid track record in gaming (they own a chunk of the highly successful Rivers Casino just outside O'Hare Airport) that owns a piece of Accel, they had some board and governance rights if the company went IPO but not if the company merged with a SPAC.  Clairvest ultimately sued and recently the two sides came to an agreement with Clairvest remaining equity owners in Accel and getting a board seat.  Unclear to me what the dispute was between Clairvest and Accel that started the SPAC route, but in the end its been resolved somewhat amicably, make with that story what you will.
Disclosure: I own shares of ACEL