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

Friday, November 15, 2019

Hilton Grand Vacations: In Play, Speculating on a Deal

Another idea I'm returning to after it has received some takeover speculation is Hilton Grand Vacations (HGV), as a quick recap, HGV is Hilton Worldwide's (HLT) timeshare business that was spun (alongside Park Hotels & Resorts) from Hilton at the end of 2016.  I won't go through the timeshare business (I've done that a few times previously) but of the other two larger timeshare rivals (VAC and WYND), HGV is a pure play on one brand without an exchange or rental business, making it a simpler candidate for consolidation.

HGV ran into some accounting noise and operational/timing issues with their inventory strategy that caused a selloff in their shares opening the door for an activist or an unsolicited bid.  In August, the NY Post reported that private equity behemoth Apollo Global (APO) was interested in making a bid for HGV.  Apollo previously took unbranded (and somewhat controversial) timeshare operator Diamond Resorts International (DRII) private in 2016, and tried to re-list shortly after in 2018 but pulled the IPO.  Apollo clearly got feedback that the public markets weren't interested in an as-is Diamond Resorts (they've recently dropped the "International" from their name) at an acceptable valuation to Apollo, so they need a plan B.  It appears plan B could be to take HGV private and merge it with Diamond, re-brand the HoldCo and bring it back public without the same Diamond brand stench.  Some point to the risk that Hilton needs to consent to a merger, this is true, but it seems contemplated that HGV would be acquired or operate non-Hilton branded timeshare properties with the caveat that it would be operated separately from Hilton branded properties and without access to the loyalty program, from the 10-K:
We are able to operate vacation ownership properties under other brands (with no royalty due to Hilton) if we do so without using any Hilton IP or Hilton Data and they are otherwise separate operations from the Licensed Business.
And they would likely lose the Hilton Grand Vacations name per the licensing agreement since Diamond has more units than HGV, again from the 10-K:
Under the license agreement, our right to use the Hilton Marks as a trade, corporate, d/b/a or similar name will automatically terminate if (i) the aggregate number of units of accommodation in our Licensed Business falls below two-thirds of the total number of units of accommodation in our entire vacation ownership business; (ii) we merge with or acquire control of the assets of Marriott International, Inc., Marriott Vacations Worldwide Corporation, Hyatt Hotels Corporation, Wyndham Destinations and Interval Leisure Group, Inc.  or their respective affiliates and we or they use their brands in any business after such acquisition; or (iii) we become an affiliate of another Hilton competitor.
It wouldn't be the first time potentially competing (is Diamond technically a Hilton competitor?) hotel brand flags were housed under the same corporate timeshare entity, ILG had the Hyatt brand and first merged with Vistana which housed Starwood's timeshare business before being brought back into the Marriott/Starwood fold when it was purchased by Marriott Vacations Worldwide (VAC).  But the Hyatt timeshare properties remain at VAC, although they represent a much smaller percentage than Diamond's properties would be under a proposed HGV/Diamond merger.  Why might Hilton consent?  HGV pays a 5% royalty on all timeshare sales, this amounted to $100MM in 2018 (and essentially falls straight to HLT's bottom line), a well capitalized and scaled HGV is to their advantage, I'm sure the team at Apollo can come with a few slides showing how this revenue stream could grow in the coming years with Diamond cash flow being used to fund HGV inventory and growth.

The other buyer being mentioned is Blackstone (BX), they took Hilton private in 2008 but no longer have a significant investment in HGV having divested their stake in 2017.  They're familiar with the business, but they'd be strictly a financial buyer and seem less likely to be the winner.  Worth noting that Blackstone's president, Jonathan Gray, is also the chairman of Hilton, unclear if that matters but seems noteworthy.  Additionally, I wouldn't count out Wyndham Destinations (WYND) being involved in the bidding process either (although their stock trades well below that of HGV), there are lot of potential synergies and HGV is part of the WYND's RCI exchange network, plus it could move WYND slightly up market and bring down Wyndham's persistently high loan loss reserve averages.

HGV's management at least acknowledges the benefits of industry consolidation, essentially confirming the rumors, from the most recent earnings call:
Stephen Grambling: Great, and I appreciate you can't comment on the reports out there on M&A, takeover stuff specifically, but how do you generically think about the positive and negatives of consolidation in the space, and perhaps tying in anything that’s specific to HGV?
Mark Wang: Yes, Stephen, it's Mark. I think we recognize the value proposition of consolidation in our industry and other industries. I think, from our perspective, some of the key reasons for consolidation is you want to improve your asset base, you want to strengthen your brand, and in this industry's case, you want to have the access to a pipeline of incremental new customers. So, I'd say, look, we've got a great set of assets and we have this great brand and relationship with Hilton, and we've talked about the tour pipeline that they provide us, and we've had a long and strong history of execution and growth. So, look, I think consolidation has been positive in the industry and we understand the rationale behind it.
Clearly he's speaking from HGV's attractiveness as an asset and not how an acquirer might help HGV, but I think his comments could apply to either Apollo/Diamond or Wyndham quite nicely, primarily access to Hilton's growing hotel and customer base needed to source additional timeshare owners.

In the latest round of bidding, Bloomberg reported Apollo's bid is $40 and the stock currently trades for $35+ showing some skeptism that the deal will be consumated.  From a valuation perspective, HGV sits essentially in-line with VAC on 2020 estimates:
In 2018, VAC purchased ILG for a total enterprise value of approximately $4.7B on $365MM of EBITDA plus $75MM of synergies, for a fully synergized multiple of ~10.5x EBITDA.  ILG had an exchange business that while low/no growth is a free cash flow machine and likely pushed the overall multiple up some.  But let's say the number needed to finalize an HGV deal is $42, with no synergies that would be 10x multiple and using a $50MM synergy number gets it back down to just under 9x, quite attractive for control over a timeshare business with a quickly growing hotel chain like Hilton.

Other Thoughts:
  • Elliott Management was rumored to be involved in HGV, but it doesn't show up in their recent 13F, probably doesn't mean anything - maybe they never owned it, but worth closing that loop.
  • HGV offers a fixed/week interval product while Diamond Resorts uses a points based product, maybe a little additional culture clash to be concerned about, or Apollo could see an opportunity to modernize HGV's product into a points based system (one benefit of the points based system for the timeshare operator is its easier to sell upgrades to existing owners)
In summary, we have several buyers, both strategic and financial, circling HGV, I'm surprised that shares are trading well below the $40 reported first bid even if HLT needs to provide its approval.

Disclosure: I own HGV calls (also remain long WYND)

Franchise Group: fka Liberty Tax, Franchise Rollup

Franchise Group (FRG) is the result of the odd conglomeration of: 1) Liberty Tax (old TAXA); 2) Buddy's, a franchised chain of rent-to-own electronics and furniture stores; 3) Sears Outlet business; and soon to be 4) Vitamin Shoppe (VSI); that is being orchestrated by Vintage Capital's Brian Kahn who was recently named the CEO of the newly launched platform company.  Andrew Walker posted two excellent write-ups (here and here) on the situation a couple months ago, I won't do it the same justice, but I'll run through my thoughts anyway as I took a position in it.

Liberty Tax is the third largest tax preparer, well behind both H&R Block and Jackson Hewitt, the tax preparer market is a highly fragmented business with a lot of mom and pops.  It is the type of franchise business where you effectively own your job and you outsource the marketing and back-office infrastructure to the franchiser.  Liberty's business model is mostly targeted at lower income taxpayers who are unlikely to purchase TurboTax or do-it-yourself type software, they want someone else to do it quickly for them and assist in getting their refund as fast as possible, it's a decent business that should be relatively stable.  However, in 2018 Liberty Tax's founder and CEO was forced out after a sex scandal was uncovered and his shares where sold to Vintage Capital that July.  The company understandably struggled through this upheaval and EBITDA dropped 17% from 2017 levels to $35MM (9/30 fiscal year end).  Then in November 2018, TAXA received an acquisition proposal for $13 per share from a private equity buyer that ended up going no where.

Concurrently with all that, Vintage Capital was wrapped up in a bizarre failed merger with Rent-a-Center (RCII) which competes in the same rent-to-own market as Vintage's Buddy's chain with Vintage forgetting to execute a routine extension to the merger agreement that allowed Rent-a-Center to break the deal and force Vintage to pay a substantial break up fee.  Presumably Vintage was going to merge Buddy's with Rent-a-Center and continue to pursue a franchise model.  With that deal off, Vintage moved to Liberty Tax where they already had a substantial holding and offered to recapitalize the company and give existing shareholders an option to tender their shares at $12, a substantial premium to where the shares had fallen after the $13 buyer had backed away.  As part of the transaction, Liberty Tax bought Vintage's Buddy's chain of stores and created "Franchise Group" to pursue a rollup strategy of franchised or "franchisable" businesses.

Since the creation of Franchise Group, Vintage isn't wasting time buying additional struggling businesses, since the merger with Buddy's, they've entered into two transactions but while both Liberty Tax and Buddy's are primarily franchised, the next two fall into the franchisable category.  The first announced was with Vitamin Shoppe (VSI), a struggling vitamin and nutrition retailer that is being disrupted by internet shopping.  The second transaction announced, which just recently closed, is with Sears Hometown and Outlet for the Sears Outlet business and the 8 Buddy's stores that SHOS operated.  My guess is overtime these Sears Outlet stores more or less end up looking like or being re-branded to Buddy's stores as they sell similar household durable type items to the lower income segment.

There's a lot going on here, its a complex situation that I'd guess very few people are looking closely at, volume has been minimal and it just today uplisted back to the NASDAQ under the FRG symbol.  I'm sure there are quite a few mistakes with the below, so do your own homework as well, but I tried to come up with a proforma look at what the combined company might look like once the dust settles.
Most of these numbers are pulled from the recently completed tender offer and the VSI proxy statement.  Alongside the closing of the Sears Outlet transaction, they went ahead and franchised 5 stores to "A-Team" for $15MM (they have 120 more stores).  The tender offer closed this week with just under 4 million shares participating at $12.  Throwing it all together on an admittedly back of the envelope fashion, I come up with the proforma company trading at roughly 5x EBITDA.  Franchise businesses trade all over the map, but generally well above 5x -- a rent-to-own comp like RCII for example trades over 7x EBITDA and they are still mostly company operated stores.  It's hard to put an exact value on FRG, but I'm guessing there are a lot of value levers to pull here and if it works out (and the economy doesn't rollover) could be a multi-bagger.

Disclosure: I own shares of FRG

Ben Franklin Financial: Tiny Bank Merger and Liquidation

Ben Franklin Financial (BFFI) is a tiny (sub $10MM market cap) two branch community bank located in the northwest Chicago suburb of Arlington Heights that completed its second step mutual-to-stock conversion in 2015.  Ben Franklin Financial is a pretty straight forward community bank, it takes in deposits from a small local radius and primarily turns around and makes a mix of residential mortgages and commercial loans.  At just under $100 million in assets, Ben Franklin Financial is sub-scale, poorly managed and as a result loss making bank (to pile on, BFFI was also operating under an OCC consent order until this past February) that caught the attention of community bank activist Joseph Stilwell who encouraged the company to pursue shareholder friendly actions like repurchasing shares or pursuing a sale.  In July, the company announced a unique sale transaction with Illinois based Corporate America Family Credit Union ("CAFCU") for between $10.33 and $10.70 for shareholders, the stock bounces between $9.60 and $9.80 today.  Why sell to a credit union?  Since a credit union is technically non-profit, they might be willing to pay more for a struggling operation like BFFI since they just need to cover their operating costs.  The credit union buying a bank thing is a recent trend but this is a first of its kind transaction where the credit union is purchasing a bank that converted from a mutual holding company.  The catch being there is some uncertainty as to how depositors who did not participate in the mutual conversion process will be treated in the liquidation and other uncertainties like terminating employee benefit plans.  Not only is the amount uncertain, but the timing is as well, the transaction with CAFCU is expected to close in early 2020 with the distribution to shareholders occurring "within several months", thus this is more of a two step process, an asset sale and then a liquidation rather than a clean merger.

Assuming a 5/15/2020 payment date (call it 4 months after an early 2020 transaction settlement) and I get an IRR of between 12% and 20% off of the last trade at $9.75 or gross returns between 6% and 10%.
Maybe I'm underestimating the possibility of the deal breaking but I think you're getting paid for the illiquidity of a nano cap and the uncertainty of both the ultimate payout and timing, both risks that a small personal account like mine is well suited to take.

Disclosure: I own shares of BFFI